Webstep is a recently IPO’ed Norway-based IT consulting firm. It has offices and operations in Norway (85% of revs) and Sweden. Clients are split into public (25%) and private. Webstep specializes in core digital transformation services (cloud migration and integration, digitization), data analysis and IoT and machine learning applications. The majority of earnings today comes from the first segment (core digital transformation), but in the future, faster growing niches like analytics, IoT and machine learning will be important growth areas for WSTEP. A lot of competent employees in these areas are now in place, and full utilization of these employees is yet to come. I believe this will help WSTEP grow at a higher pace than the market on average as these service areas will probably command a price premium (as will WSTEP’s senior consultant profile) and help open new and profitable growth opportunities in both existing and new verticals in the future. WSTEP’s key industry verticals today are finance, TMT, retail and transportation. Another incremental revenue driver will be a normalization of the Swedish operations, which have been through a period of restructuring.
WSTEP’s business is steadily growing due to long term growth in IT-spending in the broader economy Mid-single digits over the longer term looks realistic. It is low-cyclical and capital light with very high returns on tangible capital, highly cash generative and led by a competent management team with skin in the game. It is among the market leaders in terms of profitability (rev/head, EBITDA/head) while also paying the highest salaries in the industry, reducing employee attrition. Its cost structure is variable based on invoiced hours, providing a flexible and efficient cost base acting as a buffer against margin contraction when times get tough.
Is it cheap? Why does this opportunity exist? What will trigger repricing?
The small market cap and limited investor familiarity with the name combined with some uninspiring Q3 figures (largely due to increased onboarding costs from new employee additions and investments in new focus areas) are probably mostly to blame for the mispricing. Additionally, some investors are skeptical because a PE fund floated the company now, but I think that fear is overdone. This Reiten fund was mature, and has been invested since 2011. Reiten also has a record of leaving money on the table, take for example the Zalaris ASA IPO. ZAL was floated by Reiten at 21 NOK in 2014 but now trades at 58 NOK.
WSTEP is clearly undervalued both on a relative and on an absolute basis. This is an opportunity with substantial upside and a very limited downside in my opinion: My probability-weighted fair value estimate for WSTEP in 2020 is 40 NOK including dividends, implying >60% upside or an interim CAGR of 17% from the current price of 25 NOK. I expect dividend yields of 6-7% in ‘18/19/20, which makes waiting for a repricing here easier. Compared to peers on 2018 EPS, WSTEP trades at an undemanding 11.5x, a 26% discount to the peer group median. In a downside scenario, where growth stalls completely starting next year, dividends are cut in half and WSTEP ends up trading at 10x 2018 EPS in 2020, the downside is still limited to a few percent.
The catalysts for that re-rating are likely to be: increased analyst coverage and investor attention, earnings growth from both core digitalization ops and increased earnings potential from emerging business lines like IoT and ML, a recovery to normal earnings power in Sweden and high dividend payments. M&A is not impossible, though not that likely in the short term, I think – one may reasonably assume that Reiten has shopped the name around before deciding to take it to market.
Recent M&A in the industry supports the undervaluation thesis in Webstep though: Tieto just bought Avega at 15.6x 2018 consensus EPS. These are comparable companies in both services offered and size. The cash offer for Avega thus implies a minimum current fair value of 34 NOK for WSTEP and given WSTEP’s superior revenue generation and profitability per capita, one could easily argue a premium to the Avega deal would be justified. Weirdly, this acquisition has not been mentioned yet in analyst reports on WSTEP (granted, only two have been published so far). Another financial buyer could be interested as well: as I will show later, even modest leverage should provide a promising return even without successful new growth initiatives or any cost saving efforts.
Sector exposure and customer concentration
Key offerings. Potential for increased revenues as more offices start offering the higher value services (2,3,4).
Categories 2,3 and 4 only constitute 17% of revenues today - that should change over the next few years…
…as these are rapidly growing markets. (Source: Radar, Statista, company).
The key risk factors
Loss of qualified personell. Webstep operates in a sector where the best heads can charge the highest prices and are attractive assets for all players in the space. Employee churn is high relative to other industries (WSTEP’s churn is lower than the sector average at 15%, but still close to 9% p.a.).
IT consultant brokers stealing business. In the Nordics, consultant brokers allowing customers to pick freelance consultants for jobs is on the rise. However, this is most prevalent in commoditized, shorter-term project based assignments. WSTEP mostly does not compete in that segment and is protected to a degree by its premium-heavy profile.
Loss of large public and/or private clients. While this is always a risk, the company claims no major contracts are being renegotiated at the moment. WSTEP’s top 10 clients constitute about 30% of revenue and its industry exposure is well diversified. The largest exposures are to finance (30%), telecom (18%) and retail (13%).
Development of (and earnings growth from) new focus areas don’t work out or takes longer than I expect, and/or Sweden fails to recover and stays at these rock bottom levels of profitability.
Company history (source: WSTEP)
Revenue history – flatter trend in recent years due to restructuring of Swedish operations (now complete)
The company management team seems competent and trustworthy. Its track record in terms of capital allocation is not perfect, but they seems to have learned from the experience. CEO Kjetil Bakke Eriksen has been with the company for 10 years and has no intention of leaving, it seems. I view succession risk as low since there are probably several possible candidates for the job in house. The board raises no red flags in my book but is largely unknown to me with the exception of the chairman.