Seamless Distribution Systems: Rebound in recurring revenues

Research Update

2024-05-07

07:20

Redeye revises its estimates following the Q1 2024 report, which came in above our expectations in terms of margins while sales were somewhat lower due to weaker performance in the SDD segment. We consider the rebound of recurring revenues, which increased by 11% sequentially, alongside the higher margins to be the highlight of the report.

Anton Hoof

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Q1 – Solid performance in the core segment

Net sales amounted to SEK56m, 9% below our expectations, primarily due to lower revenues in SDD. The decline is also in line with management’s strategy of focusing more on its higher-margin business in SDS. In terms of profitability, margins held up impressively, and EBITDA margin increased from 27% in Q4 to 40% in Q1. EBITDA amounted to SEK22m, compared to our estimate of SEK17m, and EBIT landed at SEK10m compared to our estimate of SEK8m.

Strong margin improvement

Although FX provided some boost to margins, the underlying margins remained strong due to solid cost control and revenue mix. With the acceleration of the decline in SDD sales in recent quarters, the positive impact of the revenue mix should be evident in the P&L throughout 2024, particularly in Q2 and Q3. Additionally, the company foresees the potential for further cost savings ahead, which should support margins in the coming quarters.

Valuation

Following the report, we have made a downward sales revision due to reduced sales in SDD, lowering sales by 8% in 2024e and 8-7% in 2025e-2026e. However, we have also slightly increased our margin assumptions, primarily due to the lower underlying opex in the quarter and the expected continued positive revenue mix going forward. Although SDS delivered a solid quarter, the primary focus remains on cash flow and the maturity of existing bonds in May 2025. We leave our valuation unchanged and our base case stands at SEK16, and the fair value range is SEK6-27.

Key financials

SEKm	2022	2023	2024e	2025e	2026e
Net Sales	245.4	264.7	234.1	248.9	260.4
Sales Growth	-14.8%	7.9%	-11.6%	6.3%	4.6%
netSalesGrowth	-14.8%	7.9%	-11.6%	6.3%	4.6%
EBITDA	9.8	62.0	92.3	95.3	99.7
EBIT	-48.6	17.0	46.7	61.2	63.3
EBIT Margin	-19.8%	6.4%	20.0%	24.6%	24.3%
Net Income	-75.4	-16.0	10.8	29.0	31.4
EV/Sales	0.7	1.2	1.3	1.1	1.0
EV/EBITDA	18.6	5.3	3.4	3.0	2.5
EV/EBIT	-3.8	19.2	6.6	4.6	3.9

Q1 numbers – Solid performance in the core segment

SDS reported net sales amounted to SEK56m, below our expectations of SEK61m. Regarding the sales mix, New sales landed on SEK15.4m compared to our estimate of SEK16m, Recurring revenues amounted to SEK37.4m in line with our estimate of SEK37m, and Re-occurring revenues amounted to SEK2.9m, below our expectations of SEK8m.

Looking at profitability, SDS’s EBITDA was SEK22.1m, above our expectations of SEK17m. EBIT was SEK10.1m, higher than our estimate of SEK8m. The deviation is explained by somewhat lower opex and higher other income (usually consisting of FX gains).

The operational cash flow amounted to SEK18m, and the company had a cash position of SEK9.6m at the end of the quarter. Although cash flow improved as expected sequentially, we still think there is ample room for improvement as net working capital is still above 30% of sales (LTM).

SDS Group: Forecast deviations
0.00	#REF!	0.00	0.00			Actual	Estimate
SEKm	Q4 22	Q1 23	Q2 23	Q3 23	Q4 23	Q1 24	Q1 24	Diff (%)
Recurring - SDS	30	35	36	38	34	37	37	1%
New sales - SDS	-12	17	20	11	17	15	16	-4%
Reoccurring - SDD	19	17	17	15	8	3	8	-165%
Net sales	37	69	73	64	58	56	61	-9%
Growth YoY (%)	-52%	10%	6%	-16%	56%	-20%	-13%	-7pp

Gross profit	15	49	52	44	48	51	48	6%
Gross margin (%)	40%	70%	71%	69%	83%	92%	79%	12pp

EBITDA	-34	14	19	13	16	22	17	22%
EBITDA (%)	-91%	20%	27%	20%	27%	40%	28%	11pp

D&A	-23	-11	-12	-12	-10	-12	-9	22%

EBIT	-57	2	8	1	6	10	8	23%
EBIT (%)	-152%	4%	11%	1%	11%	18%	13%	5pp

Net finance	-7	-7	-7	-8	-9	-9	-7	23%
PTP	-64	-4	1	-8	-3	1	1	24%
Net income	-66	-5	0	-8	-3	0	1	-59%
Source: Redeye (estimates), company data (historicals)

We believe the report is solid, with recurring revenues bouncing back from Q4 while the lower total sales are explained by SDD, which declined significantly y/y. SDD is a low-margin business, and the decrease in sales aligns with the company’s strategy of focusing more on its core business, SDS. Additionally, we are impressed by the company’s cost control; underlying opex was cSEK4m lower than our expectations. The company also communicated that it sees further room for cost reduction throughout the year, and with an improved sales mix (lower sales contribution from SDD), we believe the company can maintain solid margins going forward.

Overall, we think the report aligns with previous ones, illustrating the company's ongoing strategy of replacing low-margin sales in SDD with higher-margin and recurring revenues in SDS. However, it is also clear that the company’s cost savings are starting to yield fruit, resulting in higher margins compared to previous quarters. On the negative side is the cash flow, where the company seems to continue to have challenges in converting short-term assets to cash. This is also highlighted in the report and is something the management aims to improve going forward.

After the quarter, SDS received another order of SEK9m from an existing customer in Oman. This order means that SDS will assist the customer in selling mobile broadband devices, and revenues from the order will be recognized in the current quarter. Moreover, an additional recurring supporting fee of 15% of the order value will kick in thereafter.

Recurring revenues give stability in turbulent times

SDS's recurring revenues rebounded in the quarter and amounted to SEK37.4m, compared to SEK35.1m in Q1 2023 and SEK33.6m in Q4. This marks a return to its growth trend after an interruption in Q4, following three consecutive quarters of sequential growth. We consider recurring revenues important for the investment case, as they offer higher margins, enhance business stability, and reduce the financial risk profile, potentially lowering investors’ risk premium.

As the interest in Riaktr's products, Smart S&D, and Smart Capex continues to grow, along with continued New sales, we anticipate that recurring revenues will increase and make up a larger proportion of total revenues. As SDS's revenues increasingly shift towards recurring revenues, we expect to see improved margins and enhanced stability, which will make SDS a more attractive investment opportunity moving forward.

Financial situation

While SDS delivered a solid quarter in terms of sales and margins, the main focus remains on the financial situation and the upcoming maturity (May 2025) of the existing bond. The existing bond terms mean that SDS can have a leverage ratio of 7x EBITDA, excluding capitalized costs, as of 31 December 2023 and 6x thereafter. For the full year of 2023, SDS's EBITDA was SEK32m (excluding capitalized costs), resulting in a ratio of 6.8x by the end of December, leaving little room for error. Additionally, SDS has exercised its right to defer two interest payments on the bond loan in the second half of 2023, incurring an interest rate of 2% on the deferred amount. These deferred payments can be repaid in conjunction with the bond maturity in May 2025. We estimate that SDS had a net debt/EBITDA ratio of ~5x at the end of Q1.

Financial forecast

On the back of the report, we have made a downward sales revision, lowering sales by 8% in 2024e and 8-7% in 2025e-2026e. The downward revisions are due to lower sales in SDD while we keep our estimates for SDS unchanged. Given that we pencil in lower sales for SDD going forward, we also expect a higher gross margin going forward. Regarding costs, we are making minor revisions. In total, we have increased our EBITDA estimates by 15% for 2024e and by 3-4% for 2025e-2026e, respectively.

Forecast adjustments
SEKm		2024e	2025e	2026e
Net sales	Old	255	271	279
	New	234	249	260
change (%)		-8%	-8%	-7%
EBITDA	Old	80	92	96
	New	92	95	100
change (%)		15%	3%	4%
EBIT	Old	43	58	60
	New	47	61	63
change (%)		9%	5%	6%
Source: Redeye

Although the growth rate for 2024e-2026e may appear conservative, it is largely influenced by the anticipated negative growth in the SDD business. However, we expect the growth in the SDS business to offset this decline. While SDD operates with relatively low margins, we anticipate that the sales from the SDS business will contribute to overall margins and offer scalability. As a result, we expect a gradual improvement in margins in the coming years, even with a flat top-line growth.

SDS Group: Financial forecasts
SEKm	2022	2023	Q1 24	Q2 24e	Q3 24e	Q4 24e	2024e	2025e	2026e
Recurring - SDS	121	143	37	39	42	42	160	180	190
New sales - SDS	40	65	15	18	16	19	69	69	70
Reoccurring - SDD	84	56	3	1	1	0	5	0	0
Net sales	245	265	56	59	58	61	234	249	260
Growth YoY (%)	-15%	8%	-20%	-19%	-9%	5%	-12%	6%	5%

Other income*	34	26	7	0	0	0	7	0	0
Total revenue	279	291	63	59	58	61	241	249	260

COGS	-97	-72	-5	-5	-5	-4	-18	-12	-13
Gross profit	149	193	51	54	54	57	217	236	247
Gross margin (%)	61%	73%	92%	92%	92%	93%	92%	95%	95%

Personnel	-84	-84	-24	-25	-25	-25	-98	-106	-111
External	-64	-43	-8	-8	-9	-9	-33	-35	-37
Other costs*	-24	-29	-4	0	0	0	0	0	0

EBITDA adj	10	62	22	22	21	24	92	95	100
EBITDA adj (%)	4%	23%	40%	37%	36%	39%	39%	38%	38%

Non-recurring	0	0	0	0	0	0	0	0	0

EBITDA	10	62	22	22	21	24	92	95	100
EBITDA (%)	4%	23%	40%	37%	36%	39%	39%	38%	38%

D&A	-58	-45	-12	-11	-11	-11	-46	-34	-36

EBIT	-49	17	10	10	10	12	47	61	63
EBIT (%)	-20%	6%	18%	17%	17%	20%	20%	25%	24%

Net finance	-24	-31	-9	-8	-8	-8	-33	-25	-24
PTP	-72	-14	1	2	2	5	14	36	39
Net income	-75	-16	0	1	1	4	11	29	31

EPS	-7.2	-1.0	0.0	0.1	0.1	0.3	0.7	1.9	2.0
EPS, diluted	-7.2	-1.0	0.0	0.1	0.1	0.3	0.7	1.9	2.0
Source: Redeye (forecasts), company data (historicals)
*Other income/costs consists of exchange gains/losses.
*Redeye do not factor in any potential impact from exchange rate fluctuations in our forecasts.

Valuation

We derive our fair value range from a fundamental DCF framework for three scenarios, base case (most likely), bear case (pessimistic), and bull case (optimistic), using a WACC of 13% across all scenarios.

SDS Group: Base Case sensitivity

				WACC
	15.8	14.5%	13.5%	13.0%	12.0%	11.0%
	25%	8	9	10	12	15
	30%	9	11	12	14	17
Terminal	40%	12	14	16	19	23
EBITDA-m	45%	13	16	18	21	26
	50%	15	18	19	23	28

Source: Redeye

Bear Case: SEK6(6)

Sales CAGR 2023-2027e of -1% and 2027e-2032e of 0% (3%)
Avg. EBIT-m 2023-2027e of 13% (10%) and 2027e-2032e of 13% (20%)
Terminal growth of 2% and a terminal EBIT-m of 25%
WACC: 13%

Base Case: SEK16(16)

Sales CAGR 2023-2027e of 1% and 2027e-2032e of 3% (4%)
Avg. EBIT-m 2023-2027e of 17% and 2027e-2032e of 22% (25%)
Terminal growth: 2% and a terminal EBIT-m of 29%
WACC: 13%

Bull Case: SEK27(27)

Sales CAGR 2023-2027e of 6% and 2027e-2032e of 4% (7%)
Avg. EBIT-m 2023-2027e of 22% (18%) and 2027e-2032e of 27% (30%)
Terminal growth: 2% and a terminal EBIT-m of 35%
WACC: 13%

Investment thesis

Case

Expanding within the installed base

Thanks to current challenges, both market sentiment and investor confidence have soured, and the share is trading below our bear case. However, despite these obstacles, we acknowledge a compelling long-term case where the current depressed share price presents an attractive entry point. We anticipate a gradual improvement in margins as the company executes its strategy of prioritizing standardized product offerings. This strategic shift will enhance the scalability of the business, ultimately leading to a more efficient and profitable operation. Additionally, we expect recurring revenues to continue their upward trajectory, thereby augmenting the overall stability of the business. This positive trend in recurring revenues is likely to mitigate risk and reduce the associated risk premium, ultimately enhancing the investment proposition.

Evidence

Proven playbook for growth

SDS gained its first contract from MTN Group (Africa’s largest mobile operator group) in 2006 and currently serves 18/20 of its operators and MTN has become SDS’s largest customer. Therefore, we think SDS has a proven playbook for this type of expansion. This should come in handy when increasing sales to more recent customers such as Telenor, Vodafone, and Orange – all won or acquired in recent years.

Supportive Analysis

The global prepaid and top-up market is worth around USD600bn, fueled by Africa's exceptional prepaid penetration rates (>90%). This large and growing market is set to benefit from population growth, improved connectivity, and user penetration in Africa. The digitalization of Africa enables SDS to launch additional and more advanced services and solutions.

Challenge

Slow-moving customers with bargaining power

We assume the size of SDS’s customers – some of the largest mobile operator groups in Africa and the Middle East – give them the natural upper hand around the negotiation table. Moreover, we anticipate bureaucratic and long purchase processes and scepticism towards new and innovative products thanks to their size. This could hamper topline growth.

Challenge

Higher interest rates

SDS issued a SEK200m bond in 2021 to finance the acquisition of Riaktr and replace existing loans. The bond has an expected maturity of three years and carries a three-month STIBOR plus 8.75% interest. Standalone, the 8.75% gives rise to annual interest expenses of SEK17.5m. In this higher interest environment, each 1%-point STIBOR increase incurs an additional SEK2m in expenses.

Valuation

Forecasting improved margins

Our DCF analysis indicates a Base Case of SEK16 per share (Bull: SEK27; Bear: SEK6) based on a 2% sales CAGR during our forecast period (2021-2034e) and a 29% terminal EBIT margin.

Quality Rating

People: 2

The high CEO turnover incurs a negative effect on this rating. However, most of the management team has stayed in the company for an average of more than five years and appears to have relevant skills and sector experience. We appreciate a sound long-term growth strategy and believe the latest acquisitions have strengthened the core offering. Moreover, we think the board appears to be objective and practical and is composed of shareholder-oriented directors. Last, we believe the company lacks a firm controlling owner, which also hampers this rating.

Business: 3

The business model is repeatable and scalable, and the company has a history of successful expansions into new markets. We believe the company operates in favourable market structures, which provide a meaningful runway for growth. However, we are a little uncertain regarding the underlying market’s profitability due to lacking data. SDS’s products offer great customer value and solve a genuine need for a focused customer group: mobile operators in emerging markets. We think SDS currently enjoys market leadership and has a moat built-in to its business model: switching costs. However, this rating is hampered by high customer concentration and exposure to emerging markets.

Financials: 1

While the company is currently unprofitable and facing some financial uncertainty, there are some positive developments to note. Specifically, the company is in the process of transitioning towards a business model that emphasizes recurring revenues with higher margins. This shift should help to support more sustainable profitability over the long term. That said, to score higher in our rating, the company will need to address its financial situation and work towards achieving greater stability in its operations.

Financials

Income statement
SEKm	2022	2023	2024e	2025e	2026e
Revenues	279.2	290.9	241.3	248.9	260.4
Cost of Revenue	96.8	71.9	17.6	12.4	13.0
Operating Expenses	172.6	157.0	131.4	141.1	147.6
EBITDA	9.8	62.0	92.3	95.3	99.7
Depreciation	3.2	3.9	1.7	1.7	0.00
Amortizations	51.6	37.0	41.1	29.9	36.5
EBIT	-48.6	17.0	46.7	61.2	63.3
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	23.5	30.9	33.2	25.0	24.0
Net Financial Items	-23.5	-30.8	-33.2	-25.0	-24.0
EBT	-72.1	-13.8	13.5	36.2	39.3
Income Tax Expenses	3.3	2.2	2.7	7.2	7.9
Net Income	-75.4	-16.0	10.8	29.0	31.4
Balance sheet
Assets
Non-current assets
SEKm	2022	2023	2024e	2025e	2026e
Property, Plant and Equipment (Net)	12.6	7.1	7.3	7.9	7.9
Goodwill	106.7	106.4	106.4	106.4	106.4
Intangible Assets	105.2	101.1	89.0	86.6	78.7
Right-of-Use Assets	9.8	7.1	4.3	1.8	1.8
Other Non-Current Assets	1.1	1.3	1.3	1.3	1.3
Total Non-Current Assets	235.3	222.9	208.3	203.9	196.1
Current assets
SEKm	2022	2023	2024e	2025e	2026e
Inventories	2.0	1.6	1.4	1.5	1.6
Accounts Receivable	64.1	64.4	56.9	60.5	63.3
Other Current Assets	79.3	113.2	100.1	106.4	111.3
Cash Equivalents	7.2	3.7	31.0	58.5	93.2
Total Current Assets	152.5	182.8	189.4	226.9	269.3
Total Assets	387.8	405.8	397.7	430.8	465.4
Equity and Liabilities
Equity
SEKm	2022	2023	2024e	2025e	2026e
Non Controlling Interest	0.00	0.00	0.00	0.00	0.00
Shareholder's Equity	82.3	100.5	111.3	140.3	171.8
Non-current liabilities
SEKm	2022	2023	2024e	2025e	2026e
Long Term Debt	3.9	212.1	212.1	212.1	212.1
Long Term Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Other Non-Current Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Total Non-Current Liabilities	3.9	212.1	212.1	212.1	212.1
Current liabilities
SEKm	2022	2023	2024e	2025e	2026e
Short Term Debt	9.1	9.1	9.1	9.1	9.1
Short Term Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Accounts Payable	40.2	26.0	23.0	24.4	25.6
Other Current Liabilities	221.1	17.9	11.7	12.4	13.0
Total Current Liabilities	301.6	93.1	74.3	78.4	81.6
Total Liabilities and Equity	387.8	405.8	397.7	430.8	465.4

Rating definitions

The team

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