Looking at the full year results it’s time to update my valuation and see if MF’s sell recommendation based on slowing ARR growth is justified given the current market value. I won’t double up on my comments on the Q4 Update (8/4/21), focusing on new information and insights.
FY21 Result
· Sales: +35% is healthy but a sharp drop on +66% and +78% growth in FY20 and FY19. Similar with MRR growth of +32% for FY21 Vs +57% & +82% for FY20 & FY19. Is growth slowing? Yes, but not as much as this implies due to a slow +10.5% Covid impacted H1 growth, H2 growth recovered to 19% for the half and Megaport Virtual Edge (MVE) only went live in March, which provides additional growth opportunities in FY22 along with the recently announced acquisition of InnovaoEdge.
· Margins: Improved from 50.9% to 53.7% which is a good improvement but not as impressive as the increase from 36.1% in FY19. North America (NA) drove the improvement up to 41% from 33%. Asia Pacific (AP) and Europe (EU) were flat at 70% and 59% respectively. The AP market is the most mature but still growing at 25%, it’s margins are a benchmark for the other regions and I still expect them to improve (see management comment below), so margins in the mid 70% range for the whole company once mature seem possible.
· Opex: Up 10% to $55.4m driven by employee costs and insurance associated with scaling for growth. Well below sales growth rates, leading to improved profitability.
· Non-Opex: Up 76% to $18.2m with FX losses making up $13.5m and Equity compensation $9.8m offset by income tax benefits -$6.6m. I ignore FX as a net zero impact long term and Equity compensation I consider in dilution, not the business performance.
· EBITDA (Normalised): -$13.3m is a solid improvement on -$21.1m last year and according to management they hit a EBITDA positive run rate at the end of the year, so FY22 should be EBITDA positive (ignoring FX and Equity compensation presumably).
· NPAT: -$55.0m Vs -$48.7m last year but note FX losses were $9.7m more this year, so an improvement excluding FX.
· Balance Sheet: Net Cash remains strong at $120.6m, operating cash flows improved to -$8.6m Vs -$21.7m and FCF still a long way from being positive at -$31.1m but better than -$49.9m last year. The deferred tax asset doesn’t include all losses available to offset future tax, which total $195.6m (or DTA of $58.7m @30%).
· Capex: MP1 is capital intensive in both capitalised network equipment (PP&E) and capitalised software development (Intangibles). FY21 additions of $24.7m were well down on $41.6m in FY20. Covid wasn’t flagged as an issue in this area and FY20 was 2.5x the prior year which may reflect more on an FY20 investment flurry in the US which went from $4.7m in FY19 to $18.6m in FY20, possibly normalising to $10.2m in FY21… hard to judge.
· Management Comment: Vincent English said, “Megaport achieved Group EBITDA break-even in June 2021. This is a strong validation of our business model, and there is additional operating leverage based on the investments to date. Asia-Pacific is Megaport’s most mature market and generated a profit after direct network cost margin of 73% at June 30, 2021. Europe achieved an EBITDA positive position for the entire fiscal year in 2021, and North America, which represents the largest target addressable market, is growing at the fastest rate with 47% growth year-over-year in monthly recurring revenue”
· My Comment: Obviously a disruptive year, Covid delaying decisions and investment in underlying network management, focusing on operating and urgent needs. Hence I wouldn’t like to call down MP1’s growth prospects because of the year gone. The HoH changes provide more insight than YoY, but MP1 is a very long term play, building infrastructure that will endure for decades to service business moving to and working on the cloud. Growth in NA is where it needs to be and margins continue to grow along with product offering and impressive leadership needed to maintain it’s innovative lead.
Valuation
Results looks great – but at what price!
IV = $19.85 (Bull case)
I won’t repeat assumptions from my 10/2/21 valuation, only flag amendments and add additional points and add the model assumptions for the attached detailed valuation.
Model Assumptions:
· Sales: I expect FY22 sales growth higher than FY21 with a Covid recovery and the introduction of Megaport Virtual Edge (MVE). MP1 is still very early in it’s growth runway in a very large and rapidly growing market, enabling it to 10x sales in the next 10 years from current and new product introductions.
· Margins: With AU hitting 73% GM in June 2021, I see these steadily increasing to mid-70% for the whole business by 2031, with more visibility on the direct cost drivers there could be more upside on these assumptions.
· EBITDA (Normalised): Ignoring share-based compensation and depreciation (ie looking at operating cash flow), I see Opex growing well below sales growth rates but above system rates, 8% average, improving EBITDA (Normalised) as a % of sales from, -17% in FY21 to 59% in FY31 due to strong operating leverage. Note this is more bullish than my previous valuation which assumed 40%, but Opex spend has been lower than I expected and gross margins are higher than I expected initially which drives the improvement.
· Tax: Note that due to accumulated tax losses, tax is not payable on profits until 2027.
· Capex: Network as a Service (NaaS) businesses need to build the network and so capital costs are significant, but the MP1 business model offers expansion in revenue across existing network infrastructure, hence less capital is needed for the same revenue growth going forward. As such I have capital spend linked to sales growth but at a reducing rate.
· Opportunity/Risk: This is a bull case and MP1 has ready access to capital from markets so I am not discounting for risk. However, I am applying an opportunity premium of 25% for the “Bevan factor”, which relates to the expanding opportunities for products and services the business has as exemplified by the introduction of MVE and acquisition of InnovaoEdge.
· Share Count: I am allowing 1% average increase for ESOP and have already added the shares issued for the InnovaoEdge purchase. Further issues for growth or acquisition I assume to provide EPS accretive returns on the assumptions already made in this model.
· Discount & Terminal Value: I retain a long term market average discount rate of 10% but the most significant variance to the valuation is a reduction in the terminal value multiple. I have dropped it from an EV/EBITDA of 20 to 12 which is equivalent to a P/E of 17 and perpetual growth rate of 3.5%. The reduction in terminal value assumptions is to take a less bullish view on growth rates in the terminal year, a balance to aggressive growth assumptions up to that year.
Management: A key component supporting a bullish view on MP1 is management. Firstly with Bevan Slater as founder and Chair you have THE leading business builder in Australia in this industry with a significant portion of his personal wealth (12m shares) backing its success. Skin in the game is a big one for MP1 with 16.7% insider holding and I also see confidence in future performance in their remuneration offering. ESOP exercise prices $8.43 to $14.50 for total of 1.85m shares at a weighted average exercise price of $13.08 and expiry date of December 2023. Below current prices, but not significantly tells me the management see strong results to continue.
Conclusion: Like my previous valuation this is a Bull case, but there is a strong track record in business performance and leadership to support a positive view of the company’s future. My valuation has dropped from $29.92 to $19.85 due to reduced terminal value assumptions, if these had remained the same my new value would have been $29.88 despite a significant rework of sales and margins.
I own MP1 and following this review intend to hold my position but expect significant volatility in share price because my valuation and the current share price asks a lot of the company and many will see the risk weighted return as unfavourable – which makes a market
