Finally got round to reviewing the position with HSN and determining what action to take.

Discl: Held IRL and in SM

1HFY24 Summary

• Robust 1HFY24 results with growth in revenue, underlying EBITDA margin, strong cash generation, debt repayment and returning of cash to shareholders, underpinned by stable and predictable revenue, very low customer churn
• Net cash positive for the first time since 2017, $8m, pre-powercloud acquisition where cash reserves of ~$45.1m exceed debt of $36.9m

powercloud Acquisition Feb 2024

Market has been spooked by the powercloud acquisition in Feb 2024

The strategic rationale for the acquisition makes sense (1) buying a robust, modern and entrenched suite of complementary billing software (2) opens access to the broader DACH region markets (3) at a stage in powercloud’s maturity that will benefit from the more robust Hansen discipline and processes to become more efficient and hence more profitable

Downside: 

• Requires ~$20m more investment over and above the upfront acquisition price of EUR30m
• Will adversely dilute short term FY24 underlying EBITDA by ~$7-8m, bringing FY24 underlying EBITDA margin to +26% from the normal pre-acquisition underlying EBITDA margin of ~+30%

HSN has a strong proven record of successfully integrating acquisitions into the broader HSN business - this acquisition should be no different. Must however, sit through the risk of margin dilution in the next 12-18M before powercloud can be fully earnings accretive.

Current Position and Action

• Price has been drifting towards a ~3-years old well-supported zone between ~$4.21 and ~$4.42
• this zone was a strong resistance zone for a good 18M prior to mid-Mar 2021 when the resistance was penetrated
• Since Mar 2021, this has been a strong support zone, successfully defended in Oct 2023, then April 2023
• If price falls into, or in the vicinity of the top up zone, increase position from current ~1.8% to 2.5%

Discl: Held IRL

THE GOOD

Revenue

• 5.2% increase in operating revenue, 2.1% in NPAT, 1.0% increase in EPS - organic growth, highest ever operating revenue result vs FY2023 guidance was 3-5% increase in revenue
• Services, Support & Maintenance revenue grew organically 7.3% YoY, well above historical average of the business
• No customer makes up more than 7% of revenue - diverse across geography, currency, product, and industry
• Continued generating significant cash-flows and the paying down of debt - effectively net debt zero outcome
• Several new logos and renewals won during FY23, no material loss of customers in FY23

Cash Flow and Debt

• $78.8m of operating cashflows in FY23, used to (1) retire $33.6m of debt (2) pay dividends of $18.4m (3) fund the capitalised portion of ongoing product development program of $21.1m.
• At the end of FY23, total borrowing's is $54.3m, net debt is effectively zero
• Strong balance sheet with headroom for future borrowing capacity when the right acquisition opportunity is secured
• Final Dividend of 5.0c, partially franked to 1.5c

FY24 Outlook

• Organic revenue growth rate in FY24 is 5-7%, higher than FY23 5.2% growth
• EBITDA expected to remain above 30%, and above pre-pandemic historical run rate of 25-30%
• FY24 capitalised R&D spend of 5-7% of revenue

Acquisition Pipeline

• Macro-economic factors increasingly favourable for acquisitions
• Having effectively zero debt, HSN has significant financial resources for acquisitions

NOT SO GOOD

• Underlying EBITDA FY23 was $99.5m, Labour costs and staff churn has stabilised
• EBITDA margin at 31.9% reflects careful cost control - 2HFY23 EBITDA margin was 33.5%, indicating HoH margin improvements
• Licencing revenue bounces around from half-to-half - driven by revenue recognition standards, does not appear to be a concern

WATCH & RISKS

FY24 seems set up to be a year of acquisition as (1) opportunities increase with the current macro challenges globally and in EMEA where HSN has a big footprint (2) decks have been cleared from a debt perspective to build the war chest to fund acquisitions - need to watch that the acquisitions make sense - excellent track record in this respect, so risks are very low

SUMMARY

• Good solid results, exceeding FY23 guidance, steady as she goes - as “defensive” as technology companies can go
• FY24 guidance is bullish
• Expecting M&A activity in FY24

Positives

• Stable, steady-as-she-goes result - boring really
• No loss of customers, significant project go-lives, stable margin - signs of continued operational excellence amidst staff, wage and inflationary pressures and a highly sticky customer base
• Guidance for FY2023 maintained - 2HFY23 should see a better result than 1HFY23 due to (1) license renewal revenue - a timing difference in 1HFY23 (2) benefits flowing through stabilisation of workforce churn (seen in higher costs, reducing EPS)
• Continue to be robustly cash generating, enabling rapid payment of debt (net debt $28.7m, 0.32x leverage ratio, but no debt actually paid this half), war chest in in place to take advantage of M&A opportunities as businesses globally face increasing pressures to shed cost as interest rate rises and other business inflationary pressures kick in - IT is always a good candidate for cost shedding, HSN is well placed to pounce
• HSN is well placed with operational excellence/improvement and cash generation continuing in one stream, which then directly feeds its ability to find and execute M&A opportunities
• Recent history has suggested that patience in M&A opportunities will likely be well rewarded as financial screws tighten further globally in CY23 and CY24 - next 12-18M could be very interesting

Minuses

• Growth is significantly more “steady-to-flat” and boring - out performance will occur in distinct steps, tagged to M&A activities
• Flat pcp revenue

Things to Watch Out for for 2HFY23

• No improvement in license revenue in 2HFY23 - this would be a cause for concern
• Costs continue to rise rather than flatten
• Progress on any M&A opportunities
• Continued traction on deployment implementation

Other Observations

• The lack of M&A in recent periods has probably allowed for a period of technical stability to enable digesting/integrating/embedding of the acquired technology into the broader solution suite and customer - a good thing
• Recent announcements appear to be contract extensions or new deployments of the HSN Solution Suite

Red Flag Risks

• Loss of customers - a big red flag given historical trend of retention
• Hint of challenges in technology deployment

Portfolio Positioning

• Current portfolio has too much cash from forced divestments of high growth/high gain companies in the portfolio due to being acquired
• HSN provides (1) a better position to deploy that scarce cash while looking for new opportunities to invest in (2) a ballast to a tech and growth-skewed portfolio (3) a steady dividend stream
• Is not the best place to deploy scarce capital as there are more exciting opportunities for growth, but it is prudent to inject a bit of strong stability and strong cash flow generation into the portfolio, with the potential for decent price upside
• Added 0.5% today at $4.71 to the existing 0.62% position, bought at $4.47
• Ultimate position size could be 2.5-3.0% over time.
• Has not tested 52-week lows of $4.32 for some time and is nowhere near the 52-week highs of $6.10 - have funds availability to top up if the market tanks and 52 week lows are re-tested

Discl: Hold 1.1% IRL