Knowit AB KNOW
October 13, 2020 - 5:45am EST by
Barong
2020 2021
Price: 242.50 EPS 0 0
Shares Out. (in M): 19 P/E 0 0
Market Cap (in $M): 4,680 P/FCF 0 0
Net Debt (in $M): -200 EBIT 0 0
TEV ($): 4,496 TEV/EBIT 0 0

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Description

Knowit AB

 

Knowit at a glance

Knowit AB (KNOW SS Equity) is a Swedish IT consultant listed on the Stockholm stock exchange, operating in Scandinavia and to a lesser extent in Germany. Its strategy is to "offer digital solutions that increase its customers' business value over the long term". Knowit generates 38% of revenues from the public sector, 16% from banking and insurance and 15% from retail and industrial clients. Its operations are divided into 3 main areas (% of sales in parentheses):

1. Solutions (66%)

System development and tech-related services, whether in production or administration. Knowit collaborates with the clients' operative departments throughout the process of taking an idea from the drawing board to implementation. That means deciding on the proper system architecture, project governance, building, testing and refining systems and creating a useful data analytics framework for the clients.

2. Experience (23%)

Digital communications solutions and data-driven customer experiences. The typical customer are marketing and sales departments who need help with customer facing applications, data analytics and in general using technology efficiently to strengthen customer relationships to decrease churn and increase brand loyalty.

3. Insight (11%)

Management consulting and organizational development. When making large investments in tecnological capabilities, the optimal allocation of human resources for an organization often changes as well. Companies appreciate a consulting partner that can help on this side, too (what roles will be needed, what roles become redundant etc).

Clients often need assistance in multiple areas and Knowit often assembles teams with employees from all the main areas. It is a competitive advantage to offer a complete package of services, as it allows Knowit to take on more comprehensive and longer lasting projects for larger clients, yielding more sticky customers and recurring revenue streams. Large projects for large clients normally require IT-consultants to have a wide offering.

 

Why is Knowit an attractive investment?

Knowit looks interesting because it is an established player in an attractive, growing market - the Scandinavian IT-consulting market. This market is supported by structural tailwind: the ongoing digitalization wave. I can see no good reason why this should stop anytime soon. The pace of technological development seems to only accelerate rather than slow down. A couple of years ago (this is still happening of course), businesses rushed to move to the cloud. Now, analytics, machine learning, AI and the internet of things are the new buzzwords and the future cash cows for the consultants. Everybody talks about becoming data-driven and how to leverage new technology, but the reality is that most businesses don't have the competence to make that transition without external assistance. The IT-consultants are the pick and shovel-salesmen of the digitalization gold rush the way I see it.

The bottleneck for growth for the consulting companies seems to be qualified personell rather than demand, utilization is consistently very strong. While competition for the best heads is fierce, most of the listed players have been able to grow their headcounts over time and hourly rates are currently increasing (the companies all report this). Universities in the region are expanding their IT programs a great deal, but it will not be enough to satisfy the demand from the consultants and the market. As such, this bottleneck will probably persist for many years.

Near and offshoring of certain tasks is possible, but in many cases, the client requires the consultants to work on the premises, so I don't view the competitive threat from say Indian IT consultants as high for Knowit overall. A lot of challenges are hard to solve properly from far away. Consultants on their part will usually say that having their people on premises facilitates upsales and increases the stickiness of the customer relationships. Another competitive threat are consultant brokers such as EWRK SS. There is no question that both simpler tasks and well defined specialist projects with a high degree of technical difficulty can be efficiently handled by individual consultants. However, as noted above the more complex projects that require multiple comptencies are usually better handled by larger companies like KNOW. Furthermore, the degree of competitive pressure from brokers varies from country to country, and is much more pronounced in Sweden than in Norway, for example.

I like Knowit because it has a strong track record of growth, profitability and shareholder value creation. The 5yr CAGR in revenues is 8.6% and the 5 yr median ROE is 20%. This is a solid business. It appears to be led by an able management team (caveat: I am not that good at assessing management teams, but at least I have found no red flags worth mentioning). Finally, it's available at a relatively reasonable (though not outright cheap) valuation (see below) and could very well become the target of another company's growth ambitions or alternatively a private equity buyout (more on this point below).

 

Impact of the COVID-19 pandemic: some, but not dramatic

In the second quarter report, KNOW beat analyst consensus and reported 1.5% revenue growth yoy in spite of the pandemic (note that while Sweden did not shut down, Norway most certainly did). This beat was primarily driven by the largest and most important Solutions segment. The weakest segment was Insight, this is in my view the segment most vulnerable to sustained weakness. EBIT rose by 10% yoy to 70.5m SEK, implying an EBIT margin of 8.2% vs 7.5% last year. Headcount at the end of the quarter was marginally down at 2325 (2356). I think this is pretty impressive overall and speaks to the low cyclicality of IT consulting in today's digital world. I do expect some short term margin pressures as government COVID-subsidies wind down, but this will probably only be a temporary effect and does not ruin the long term business case for KNOW.

 

Valuation: DCF implies 26% upside to fair value in a base case scenario

Knowit has a 5yr median EBIT margin of 9.4% and an explicitly stated long term target of 10%. I'm assuming they reach this level again relatively fast, but that they don't surpass it for longer periods of time. I'm assuming 5% revenue growth on average going forward. 

Free cash flow calculation 2017 2018 2019 2020 2021 2022 2023 2024 2025
Revenue 2733.5 3083.3 3335.1 3350.0 3517.5 3693.4 3878.0 4071.9 4275.5
Revenue growth 13 % 13 % 8 % 0.4 % 5 % 5 % 5 % 5 % 5 %
EBIT margin 10.1 % 10.0 % 9.4 % 9 % 10 % 10 % 10 % 10 % 10 %
EBIT 275.1 308.9 314.0 301.5 351.8 369.3 387.8 407.2 427.6
-taxes paid -64.3 -71.7 -71.5 -69.3 -80.9 -84.9 -89.2 -93.7 -98.3
+D&A 17.5 18.0 79.4 75.0 75.0 75.0 75.0 75.0 75.0
-capex -13.4 -6.1 -7.9 -20.1 -21.1 -22.2 -23.3 -24.4 -25.7
-WC change -37.1 23.2 -8.1 0.0 0.0 0.0 0.0 0.0 0.0
FCF 177.8 272.3 305.9 287.1 324.7 337.2 350.3 364.1 378.6
growth in FCF   53 % 12 % -6 % 13 % 4 % 4 % 4 % 4 %
FCF/EV yield 3.1 % 4.8 % 5.3 % 5.0 % 5.7 % 5.9 % 6.1 % 6.4 % 6.6 %
FCF/share                           9.2                        14.1                        15.8                        14.9                        16.8                        17.5                        18.2                        18.9                        19.6
FCF/EBITDA (FCF conversion) 61 % 83 % 78 % 76 % 76 % 76 % 76 % 76 % 75 %
                   
DCF exit multiple model                  
Discount rate 8.0 %                
PV of forecast period value (2020-2025)                      1,556                
Exit multiple FCF (= 6% FCF yield)                    16.6                
T12 FCF end of period                          379                
Terminal value                      6,284                
Years ->TV date (2025e)                           5.3                  
PV of terminal value                      4,170                
Enterprise value                      5,725                
NIBD( - = net cash) -200.0                
minority interest 16.0                
Equity value                      5,909                
Number of shares                         19.3                
Equity value per share                          306                
Upside to current price 26 %                

 

M&A scenario

Recent transactions in the sector suggest a high takeout multiple is possible. HiQ, a relatively similar peer, is being bid on by Triton at 22xFCF. The implied takeout price for KNOW is 346 SEK, 46% above today's share price. While obviously a demanding valuation, CGI bought Acando last year at the same multiple, so this seems to be the sort of price the market is willing to pay in the current climate.

 

Risks:

  • Increased competitive pressure from consultant brokers or overseas players intensifying presence in the Nordic region
  • Botched M&A - examples in this sector abound. 
  • Wage inflation impacting margins
  • Severe cyclical slowdown impacting IT-spend budgets

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Continued proftable growth

Buyout from an industry player or PE-fund

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