Positive update by Sage fails to impress the City

Apr 15 2008 by Andrew Mernin, The Journal

Sage Analysis:  

Cazenove Software and IT Services Research:

Valuation and Recommendation

Sage shares are trading on 13.7x calendarised 2008e PE and 9.4x EV/EBITDA, compared to the sector on 15.0x and 8.5x respectively. We continue to rate Sage Outperform, believing the company offers mid single digit organic growth as well as growth via acquisition, plus a certain level of security with c.70% of revenues of a recurring nature. Whilst we recognise the potential risks of negative macro economic conditions, we would argue that Sage is relatively defensive compared to the majority of the Software & IT Services sector. Operating cash flows remain steady, and typically >100% profit conversion from EBITA. Net debt gearing was only 33% last year, with interest cover of 8.0x. The company has renewed its discipline around its acquisition strategy (following the delays in Emdeon, which is tracking at least one year behind original expectations). A new Healthcare CEO should help drive growth and margin improvements, but we doubt an appointment is imminent (although we understand the company is actively interviewing). Meanwhile, the most recent Sage acquisition, Tekton, goes back to the old Sage model of small bolt-on acquisitions. Tekton has a vertical specialisation that offers an upgrade path for existing Sage 50 CIS customers.

Merrill Lynch

Sage published a trading statement for its 1H 08 results. As expected the statement was just a one-liner. Results are in-line with analyst expectations (1H 08 revenue £617mn (ML £620mn), EBITA £145mn (ML £147mn). Given the concerns after the weak Intuit results in February we see this as a positive, especially as we believe the company will comment for the full year results (8 May) that in the first half Sage has not seen any material weakness in its business.Sage remains our favourite defensive UK software name. The company is benefiting significantly from recent currency moves which will more than balance any negative developments in its licences revenue business (30% of total revenue). Our price objective for Sage is 270p. This would put the stock on 17x our Sep 08 EPS estimate, which is the middle of its historic trading range. Our price objective is based on our DCF model, with long term revenue growth assumptions of 6.5%, operating margins of around 24%, 2% terminal growth and 9.2% WACC. The risk to our price objective is a slow-down in the economy, a significant increase in the cost of borrowing, which would limit the company’s ability for further acquisitions and competition from competitors with new business models like salesforce.com.