SysGroup PLC (SYS)

[WickedLester]

Do any Fools have an opinion on this little company? I have just been taking a look at them and they look quite interesting to me at the current price.

Before I start I should warn you they are a real tiddler at £10m market cap but that never puts me off, I like small companies.

https://www.sysgroup.com/

They describe themselves thus:

We are an award-winning managed IT services, cloud hosting, and IT consultancy provider. We deliver solutions combining the best of industry leading technologies, specialist skills and capabilities.

Our aim is to focus on customers’ strategic and operational IT requirements, providing secure, cost effective services from a range of sourcing platforms: datacentre, private and public cloud.

Looking at the unadjusted headline figures they don't look that cheap and turnover fell last year which they blame on COVID which seems a fair excuse for this type of business, but what has interested me is the excellent cashflow which they seem to achieve every year (well for the last 3 years at least).

For example last year stripping out working capital movements and principle debt repayments they seem to have generated around £1.5m in cash.

They are operating a buy and build strategy and post year end have made two more acquisitions, one from their own cash reserves and one with a new debt facility which means they will be in a net debt position once again and if all the contingent consideration has to be paid then I think this could be around £6m. If these acquisitions perform as they did in the recent past then they will add over £1m in EBITDA next year.

The balance sheet is not great (that probably reflects the type of business it is) but is not appalling either.

They could be looking at adjusted EBITDA of over £4m next year depending on how badly the economy performs.

This little company looks like a strong and reliable cash generator to me and I wouldn't be surprised if it proved a tasty morsel for a larger player also interested in consolidating the market. If the board costs of over £500k pa are stripped out I think it could be worth at least twice the price to someone else.

I'm going to keep a close eye on these.

[torata]

I don't know that I can add any insight into them as a company, but one thing I try to do that I learnt from experience, and I thought Pauly Pilot/Scott (of TMF and stockopedia fame) was* good at, is to think of the reasons not to buy.

So putting on my devil's advocate hat here, based purely on what you say, and without having looked at them! (although I seem to remember the name from something I've read somewhere)

- You'd really be buying them as a hoped for takeover target? How likely is that? With what seems to be a nicely ensconced board, what would motivate them to sell? What is it other than the fact they are small and well run that might make them a takeover target?
- They seem to have relatively decent and seemingly strong revenue. But where's that going to get them? They've made a few acquisitions, but they have to bed them down properly, and even then is that going to bring them growth that's expected and attract attention? Most acquisitions don't bring the expected results.
- They've got no IP, nothing to distinguish them from any other small private or public company doing the same thing? So what gives either them an edge as a business, or any potential suitors a reason to chose them to go for?

torata

*I no longer have access to stocko.

[simoan]

Do any Fools have an opinion on this little company? I have just been taking a look at them and they look quite interesting to me at the current price.

Before I start I should warn you they are a real tiddler at £10m market cap but that never puts me off, I like small companies.

https://www.sysgroup.com/

They describe themselves thus:

We are an award-winning managed IT services, cloud hosting, and IT consultancy provider. We deliver solutions combining the best of industry leading technologies, specialist skills and capabilities.

Our aim is to focus on customers’ strategic and operational IT requirements, providing secure, cost effective services from a range of sourcing platforms: datacentre, private and public cloud.

Looking at the unadjusted headline figures they don't look that cheap and turnover fell last year which they blame on COVID which seems a fair excuse for this type of business, but what has interested me is the excellent cashflow which they seem to achieve every year (well for the last 3 years at least).

For example last year stripping out working capital movements and principle debt repayments they seem to have generated around £1.5m in cash.

They are operating a buy and build strategy and post year end have made two more acquisitions, one from their own cash reserves and one with a new debt facility which means they will be in a net debt position once again and if all the contingent consideration has to be paid then I think this could be around £6m. If these acquisitions perform as they did in the recent past then they will add over £1m in EBITDA next year.

The balance sheet is not great (that probably reflects the type of business it is) but is not appalling either.

They could be looking at adjusted EBITDA of over £4m next year depending on how badly the economy performs.

This little company looks like a strong and reliable cash generator to me and I wouldn't be surprised if it proved a tasty morsel for a larger player also interested in consolidating the market. If the board costs of over £500k pa are stripped out I think it could be worth at least twice the price to someone else.

I'm going to keep a close eye on these.

All I would say is that you mention adjusted EBITDA quite a lot, as do the company in their results. I'm with Charlie Munger on EBITDA i.e. each time you see it replace it with BS Earnings. A large proportion of adjusted EBITDA is amortisation of intangible assets. I personally don't like companies that don't show operating profit in the main financial highlights at the top of their results and you can see why when you dig into it; the margins are awful as is Return on Capital. I also dislike the constant adjustments to EPS which leads to a large gap between adjusted and basic figures.

You can't argue with the cash in the bank though and the recurring nature of revenue and cashflow. It means the expensive new variable rate debt facility (base rate+3.25%) isn't going to kill them. Not for me, especially given the illiquidity and a 14% spread.

All the best, Si

[WickedLester]

- They've got no IP, nothing to distinguish them from any other small private or public company doing the same thing? So what gives either them an edge as a business, or any potential suitors a reason to chose them to go for?

This is one point I'd agree with, they have no ip, but I'd hope there is some value in customer relationships etc. I don't always expect a company to have IP before I invest.

All I would say is that you mention adjusted EBITDA quite a lot, as do the company in their results. I'm with Charlie Munger on EBITDA i.e. each time you see it replace it with BS Earnings. A large proportion of adjusted EBITDA is amortisation of intangible assets. I personally don't like companies that don't show operating profit in the main financial highlights at the top of their results and you can see why when you dig into it; the margins are awful as is Return on Capital. I also dislike the constant adjustments to EPS which leads to a large gap between adjusted and basic figures.

I'm not sure I'd agree entirely with all your points. I actually think adjusted pbt is quite a good way of measuring the business performance because they are writing off intangibles far faster than they are replacing them although the point you make has got me thinking; will they have to replace them at a much faster rate in the future just to stay in business which would obviously affect cashflow?

I also wouldn't agree that margins are "awful". I make the net profit margin last year about 3% which is not great but I wouldn't call it awful. I agree return on capital is not great although it's not something I usually worry about (mainly because I like discounts to net assets, although not goodwill).

Also, thanks for raising the point about the debt facility. I hadn't looked into that. If rates really do end up at 5 or 6% next year then that debt is going to be very costly.

On balance I think I'll leave it on the watchlist and see how they get on.

[simoan]

All I would say is that you mention adjusted EBITDA quite a lot, as do the company in their results. I'm with Charlie Munger on EBITDA i.e. each time you see it replace it with BS Earnings. A large proportion of adjusted EBITDA is amortisation of intangible assets. I personally don't like companies that don't show operating profit in the main financial highlights at the top of their results and you can see why when you dig into it; the margins are awful as is Return on Capital. I also dislike the constant adjustments to EPS which leads to a large gap between adjusted and basic figures.

I'm not sure I'd agree entirely with all your points. I actually think adjusted pbt is quite a good way of measuring the business performance because they are writing off intangibles far faster than they are replacing them although the point you make has got me thinking; will they have to replace them at a much faster rate in the future just to stay in business which would obviously affect cashflow?

That's fine because you can have two investors come at the same company from two different angles. I don't like large adjustments to the statutory numbers, especially when they occur on such a regular basis, year after year. As you say, what happens when they've written down the intangibles and having nothing left to amortise? I've no idea but there's a pile of goodwill they can maybe get there teeth in to as well. Quite a lot of goodwill for the size of the company too.

I also wouldn't agree that margins are "awful". I make the net profit margin last year about 3% which is not great but I wouldn't call it awful. I agree return on capital is not great although it's not something I usually worry about (mainly because I like discounts to net assets, although not goodwill).

Well, I don't invest in any company with such low margins, especially in the inflationary times we live in. It's a complete red line for me. Such low margins indicate a company of busy fools rather than a good business with pricing power. I'm sorry but for a company to turnover £14.7m and only make £725K of operating profit is pretty awful. Having said that it looks like a record year because most years operating profit has actually been negative! So in FY22 they had £14m of costs eating up virtually all the revenue which means just a 5% rise in cost inflation would completely wipe out FY22 operating profit. I don't know about you, but that prospect is not appealing and there's only so long you can use amortisation to report an "adjusted" profit.

All the best, Si

[simoan]

BTW I forgot to add that I don't like capitalisation of development costs. This ensures a constant stream of amortisation and means the cost bypasses the income statement, embellishing profits. You have to take a view on it s it is common practice in IT companies, but I take the view that not all IT developments lead to a meaningful revenue generating product and some developments should at least be partially expensed.