Sales declined by 6% y/y, above our forecast of -11 %. Organic growth was -7%. The volatile system revenue fell 11% y/y, while we expected -20 %. Considering the tough comparison number for Q4 2022, which was strong due to component shortages earlier in 2022, we believe the quarter’s System sales is relatively strong. The recurring revenue (Cloud and Support) grew by 9% organically y/y, roughly in line with our expectations. We believe that is a relatively strong level, and the trend since 2021 has been strong. The ARR (annual recurring revenue) was SEK1 748m (1 552). While System revenue, as mentioned, tends to be volatile, making quarterly swings hard to interpret, the solid trend in recurring revenue is just what we like to see in Proact. Consulting declined by 18% y/y, slightly worse than expected, partly due to the lower System sales.

In general, management sees a decent market, although longer sales cycles still dampen sales to some extent. While the presence of new technology is a constant in Proact’s market and what typically drives sales, if the use of large AI models spreads from the large public clouds to enterprise customers’ in-house, Proact sees a possibility for above-normal growth. However, whether that will happen or not is too early to say.

The net intake of new cloud contracts was a record high SEK197m (124), mainly driven by BU West and Nordic & Baltics. That is a strong number, supporting solid Cloud revenue growth some quarters ahead (there is typically a 6-month lag from signing to revenue, and the contracts usually span three years). According to management, the strong number resulted from many deals rather than a few big ones.

The gross profit was 5% better than we expected, following a slightly lower gross margin but higher sales. As the sales beat was related to system sales, a slightly lower gross margin than forecasted is to be expected. The gross margin declined slightly y/y, likely due to the product mix within System sales, as the cost savings program initiated in mid-2023 should have had a positive effect on underlying gross margins.

Administration expenses matched our forecasts, while Sales and marketing expenses was 8% higher. Considering the cost-saving program taking effect in mid-2023, we expected a substantial decline in Sales and marketing expenses relative to the high level seen in 2022 – boosted by high commissions to sales personnel following the strong result. However, following a strong 2023 in the BU Nordic & Baltics, the sales commissions were also high this year. We expect overall SG&A for 2024 to be slightly above the level seen in 2023.

The higher-than-expected SG&A was mitigated by the higher gross profit and resulted in an EBITA of SEK91m (102) compared to our forecast of SEK90m. The EBITA margin was 6.7% (7.1%), somewhat below our forecast of 7.0%. The y/y decline in EBITA was expected due to the strong System sales in Q4 2022. While Proact has managed to increase its margin in recent years to 6-7%, the company has not been close to its target of 8% on a full-year basis. According to management, scalability as the cloud revenue grows along with a better product mix (meaning more services), are the key drivers towards the target.

As discussed in our last Update, the largest Business Unit, Nordics and Baltics, has historically continuously outperformed the other smaller BUs. In this quarter, we note that BU West and BU Central report rather strong margins. While it is too early to talk about the trend shift, partly as Q4 tends to be strong, we believe it is a positive sign. Many of Proact’s recent acquisitions have been made outside of the Nordics and Baltics, and seeing a strong performance in those markets is, in our view, important for the long-term case, which partly depends on further European M&A in Proact.

We raise our sales forecasts by 2% for 2024 and 2025, mainly due to slightly higher expectations on System sales. At the same time, we increased our Sales and marketing expenses assumptions by 2-3%, following a higher level than expected in the quarter. Overall, we lower our EBITA forecast for 2024-25 by 1%.

We expect modest organic growth of 3-4% for 2024-25 and EBITA margins of ~7%, below the company target of 8%.

We raised our Base Case somewhat to SEK115 (110) despite keeping our short-term forecasts unchanged.

Proact is trading at a discount of 30% to the median IT consultant on EV/EBITDA 2024 – Note that EBITDA somewhat overestimates the earnings in Proact relative to the peers considering its hardware-heavy business model. However, the discount is nevertheless significant. We believe a lower discount is reasonable. Also, on the other hand, EBIT (where the discount is a mere 5%) underestimates its earnings due to its relatively high M&A-related D&A. Proact has the advantage of a high share of recurring revenue supporting a premium. However, the company’s earnings have historically been volatile. We believe Proact could be on track to becoming a more stable business, which we believe would motivate a higher multiple.

We would argue that EV/EBITA is the most suitable multiple for Proact. However, the availability of forecasts on EBITA is limited. Proact is trading at 7.5x and 6.4x EBITA for 2024-25 respectively, implying a discount of about 15% to the median of companies with forecasts on EBITA.