CTSDF - Converge Technology Solutions' Stock Wilts As We Await Special Committee

2023-04-26 14:38:48 ET

Summary

• Converge Technology Solutions Corp. provides a variety of IT consulting and software services to organizations worldwide.
• The firm has produced some organic growth but closed ten acquisitions in 2022.
• Converge wants to become a $5 billion company in three to four years, so will need further acquisitions to reach that milestone.
• Given macroeconomic headwinds, continued technology industry layoffs, and a high cost of capital environment, I'm on Hold for Converge in the near term.

A Quick Take On Converge Technology Solutions

Converge Technology Solutions Corp. ( CTSDF ) provides businesses with an array of technology and IT consulting services and software solutions.

The firm has produced moderate organic growth and made a number of acquisitions in 2022, with plans to become a $5 billion company in the next three to four years.

However, given ongoing macroeconomic uncertainties, continued technology industry layoffs and a high cost of capital environment, absent a major announcement by the company's Special Committee, I’m on Hold for Converge in the near term.

Converge Overview

Gatineau, Canada-based Converge Technology Solutions Corp. was founded in 2016 to provide organizations with IT and cloud software solutions for their information requirements.

The firm is headed by Group Chief Executive Officer Shaun Maine, who was previously Chief Operating Officer at Pivot Technology Solutions and COO at ProSys Information Systems.

The company’s primary offerings include the following:

• Advanced analytics

• Application modernization

• Cloud platforms

• Cybersecurity

• Digital infrastructure

• Digital workplace

• Managed services

• Talent services.

The company acquires customers via its direct sales, marketing and business development efforts as well as through strategic alliances and partner referrals.

Converge’s customer base is currently 21% technology, 21% healthcare, 18% government, 10% finance and 30% other.

Converge’s Market & Competition

According to a 2021 market research report by 360 Market Updates, the global market for digital transformation strategy consulting was an estimated $58.2 billion in 2019 and is forecast to reach $143 billion by 2025.

This represents a forecast CAGR of 16.2% from 2020 to 2025.

The main drivers for this expected growth in IT consulting are a large transition from on-premises, legacy systems to cloud-based environments with complex architectures.

There is also expected growth in the number of industries adopting digital transformation strategies, such as manufacturing, finance, and retail, as well as a growing demand for improved customer experience.

IT consulting firms can also leverage their expertise to help companies develop and maintain new or better business models which are better suited to the digital world.

Also, the COVID-19 pandemic likely pulled forward significant demand to modernize enterprise systems resulting in increased growth prospects for digital transformation consultancies.

The growth of IT consulting is expected to continue due to the evolving digital landscape, increased demand for improved customer experience, the need to develop and maintain new or better business models, and the accelerated demand for modernization due to the pandemic.

Major competitive or other industry participants include:

• Globant
• Thoughtworks
• EPAM
• Slalom
• Accenture
• Deloitte Digital
• McKinsey
• BCG
• Ideo
• TELUS International
• Cognizant Technology Solutions
• Capgemini
• Computer Task Group
• Company in-house development efforts.

Converge’s Recent Financial Trends

• Total revenue by quarter has grown per the following chart, mostly due to inorganic acquisitions during 2022:

• Gross profit margin by quarter has trended slightly higher in some recent quarterly periods:

• Selling, G&A expenses as a percentage of total revenue by quarter have varied per the chart below:

• Operating income by quarter has produced no discernible trend recently:

• Operating leverage by quarter has shown positive results recently:

• Earnings per share (Diluted) have fluctuated markedly recently:

(All data in the above charts is IFRS.)

In the past 12 months, Converge’s stock price has fallen 65.12% vs. that of Cognizant Technology Solutions’ ( CTSH ) drop of 28.94%, as the chart indicates below:

For the balance sheet , the firm ended the quarter with $118.1 million in cash and equivalents and only $1.0 million in current debt, due within twelve months.

Over the trailing twelve months, free cash generated was $13.0 million, of which capital expenditures accounted for $17.7 million. The company paid $4.1 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Converge

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

As a reference, a relevant partial public comparable would be TELUS International (TIXT); shown below is a comparison of their primary valuation metrics:

(Source - Seeking Alpha.)

Commentary On Converge

In its last earnings call ( Source - Seeking Alpha ), covering Q4 2022’s results, management highlighted revenue growth for all of 2022 at 57% year-over-year along with organic gross profit of 10.6%.

Notably, the firm acquired firms representing an additional $1.2 billion in revenue, accounting for a significant portion of the revenue growth performance, with organic revenue growth of 8.6%.

The company produced reduced net revenue due to an accounting change that required the firm to only report revenue net of costs when including certain OEM software license reselling.

Revenue has continued to be negatively impacted by supply chain constraints, which are not unique to Converge, but management seeks to shift its customer base to higher-value services.

SG&A as a percentage of revenue has trended lower in some quarters and higher in others, so there is no discernible trend here.

Looking ahead, management’s goals are for the firm to become ‘a $5 billion company in the next three to four years and to improve our EBITDA margins towards 10% through the growth of our services and managed services businesses.’

To accomplish that goal, Converge will need to continue with a focus on future acquisition activity. New acquisitions not only bring new clients but new cross-selling opportunities, adding greater value to the acquisition.

The company's financial position is strong, with ample cash, virtually no debt and positive free cash flow.

Regarding valuation, the market is valuing Converge well below that of TELUS and Cognizant, likely due to its lower net income margin.

The primary risk to the company’s outlook is a macroeconomic slowdown combined with further supply chain constraints on its customer base.

Also, Converge is exposed to the uneven technology sector, which has proven to be problematic for other IT consulting firms as tech companies reduce headcount and other spending in the wake of over-expanding during the pandemic period.

In the past twelve months, the firm's EV/EBITDA valuation multiple has dropped substantially, as the chart from Seeking Alpha shows below:

In November 2022, the firm formed a Special Committee to evaluate all potential avenues to unlock shareholder value "in response to expressions of interest that have been received by the Company."

To date, there has been no new information and the stock has fallen further since that committee formation announcement.

Given ongoing macroeconomic uncertainties, continued technology industry layoffs and a high cost of capital environment, absent a major announcement by the company's Special Committee, I’m on Hold for Converge Technology Solutions Corp. in the near term.

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