Review of Q1 2023

Total sales beat our forecast of SEK192m and amounted to SEK209m (161), corresponding to 30% growth y/y. The y/y growth was driven by positive net recruitment, higher sales per employee and working day, and several acquisitions. The organic growth y/y was solid at 13.5%.

Regarding the market environment, management has nothing new to say relative to Q4 2022. Q1 was strong, and while management recognizes several macroeconomic risks, it feels confident about the group’s ability throughout 2023.

An IT consultant’s sales are a function of the number of employees and their revenue per working day. In reality, the number of revenue-generating employees, i. e., excluding administrative personnel etc., would be a better measure. However, we cannot access those figures, making the total number of employees a reasonable proxy.

While the numbers indicate modest organic net recruitment, as Absfront has 32 employees, it also suggests employee churn was healthy during the quarter.

The number of employees at the end of the quarter is a leading indicator for sales growth in the coming quarter. While sales is dependent on other parameters as well, the starting number of employees for the coming quarter is, together with the number of working days, the only relevant figures we know in advance.

The difference between the average number of employees and the number of employees at the end of the quarter can give us a clue about the employee churn. For example, during Q2-Q3 2022, CombinedX started and ended the quarter with more employees than the quarter’s average, i.e., a U-shaped employee curve. That indicates a high employee churn over those quarters. In Q4 2022, the average number of employees started to coverage towards the number of employees at the end of the quarter, implying a reduced employee churn.

Employee churn is typically costly for any company. However, as IT consultants’ sales generation depends on their employees in a nearly 1:1 ratio, we believe low employee churn is even more important in IT consultant firms.

The Sales-COGS/employees/working day is a proxy for the revenue generation of one employee during one working day, indicating how advanced services the company provides and how high its utilisation rate is. While sub-consultants and reselling software and hardware can alter accuracy in this measure, we try to consider that by subtracting the cost of goods sold, which typically consists mainly of expenses related to sub-consultants and reselling. Also, as we use the total number of employees, the share of administrative personnel can alter the number. A high share of administrative personnel might not be unwanted. For example, when focusing on expansion, the investments in administration are typically front-loaded.

The Contribution/employee/working day is sales-cogs-personnel expenses and indicates the profit contribution for the average employee per working day. We believe it is a proxy of how much revenue consultants generate compared to their seniority and, thus, salary. For example, a high Sales-COGS/employees/working day might not be worth much to shareholders if most are paid as salaries to senior consultants.

Overall, OPEX largely matched our forecast of SEK136m and was SEK139m (112). Other external costs was lower compared to our expectations. Personnel expenses came in above our forecasts as the cost per employee was slightly higher than we expected. However, that was offset by the higher sales per employee, resulting in a higher EBIT margin than expected. Also, the COGS exceeded our expectations following a higher usage of subconsultants.

EBIT was SEK25.3m, corresponding to an EBIT margin of 12.1% (10.1). Our forecast was SEK18.8m and 9.8%, and the beat was mainly due to stronger sales per employee. Free cash flow (excluding M&A) was SEK38m (19). Excluding changes in net working capital, free cash flow was SEK10m (10). As expected, from an IT consulting business, the cash generation is solid, and by the end of Q1 2023, CombinedX had a net cash position of SEK12m. While seeing a softer Q2, discussed in detail in the Estimate Revisions segment, management retains its 10% EBIT margin target for the full year 2023.

As common among IT consultants, CombinedX has low CAPEX, and the cash conversion tends to be strong.

As CombinedX aims to provide distinct specialist offers and brands, Nethouse's system development division is now being merged with Attentec to form a new specialist company focused on system development. Hans Dahlberg, the CEO of Nethouse, will become CEO of the new business, tasked with building a challenger in the Swedish system development market. During the quarter, Nethouse's system business expanded its important operations at the Swedish Transport Agency, providing a secure foundation for the new company, whose name will be announced later this summer.

As a result, the remaining Nethouse can concentrate entirely on IT operations and other infrastructure-related services. Johan Ripe has taken over as CEO, intending to gain large customers with high availability and regulatory compliance requirements.

While Q1 was a strong quarter, management’s guidance for Q2 is rather soft for several reasons:

We raise our sales forecast for 2023 and 2024 by 2% and increase our EBIT forecast for the same years by c7-8%. While lowering Q2 2023 following the soft guidance and leaving Q3-Q4 rather unchanged, the positive effect of the strong Q1 outcome dominates, resulting in an overall upward revision. Regarding 2024, our rise is mostly due to us strengthening our view of CombinedX’s ability to perform following the strong Q4 2022 and Q1 2023 reports.

We leave our Base Case at SEK60 (60), constituting a significant upside relative to the current share price. Despite the strong Q4 2022 and Q1 2023, the discount to peers remains solid – 30-40% on EBITDA 2023-2025. While CombinedX had a rough start as a listed company, we believe it is time for a revaluation.

CombinedX is trading at a significant discount to the peer average and median. While the company has a short track record which should motivate some discount, given our positive outlook on CombiendX operations and the strong two recent solid quarterly reports, we believe the gap will narrow.