Systems Union - Target Price of 150p for 2004

In three weeks time Systems Union Group (SUG) will be announcing a Trading Update for the year to the end of December. Despite tricky trading conditions across the software market generally I am expecting boss Paul Coleman to deliver a bullish message. Especially so due to the recent acquisitions he has concluded.

The Group's shares are currently trading at 95.5p and have been oversold of late. Now I reckon that they are looking undervalued, certainly when compared to others in the software sector.

Yesterday SQC Research published a Profile on the Company, setting a Target Price of 150p to be easily achieved by end 2004.

The New Year should bring Systems Union another major leap in its fortunes.



SQC Research profile begins

Company Background
Systems Union is a leading, global IT company. By revenue, it is one of the top 25 software houses in Europe and the eighth largest in the UK. Operating globally, it works with numerous well-known organisations ensuring they achieve their business objectives, from real-time financial management software for companies, large and small, through to web-systems to improve internal efficiency. Systems Union designs, develops, produces and distributes financial and business software for international and domestic markets.

Company Activities
The Group’s principal activity is the design, development, production and distribution of financial management and business intelligence software, sold under the SunSystems, Pegasus and MIS brands to international and domestic markets. E-commerce, Internet hosting and support services are sold through REDtechnology.com.

The Group, which has Headquarter offices in Farnborough, Hampshire, is a global union of systems companies that are focused on providing solutions to meet the business needs of their customers. As a result of significant investment in research and development, the Group has a comprehensive range of leading products and services.

Systems Union now operates through two divisions: the Financial Management Division comprises SunSystems; Pegasus Software; Foundation Systems; and REDtechnology.com; whilst MIS AG is within the Business Intelligence Division.

Existing businesses: SunSystems

Author of SunSystems financial and business management software solutions for international and domestic organisations

21 offices and 200 channel partners giving a presence in 76 countries

Over 18,000 customer sites and 250,000 customer seats in 194 countries

45 of the 50 largest corporations in the world use SunSystems

75 of the FTSE100 use SunSystems

Quarter of the Fortune 500 use SunSystems

Multi-national software solutions: global and localised

30 languages, multi-currency, multi-location, multi-GAAP

Single ledger, single product set, reporting, analytics, real-time

Value-added product, service and support to numerous organisations

Key strengths: low total-cost-of-ownership, low risk, global reach

Core financials based on SunSystems 4 and SunSystems5

Primary verticals: hotels, insurance, energy, aid agencies

Considerable global distribution network

Largest supplier of business software into Hong Kong and Japan.

Existing businesses: Pegasus Software Limited

Author of Opera II, Payroll and Capital Gold accountancy and business software solutions

30,000 customers predominantly in the UK

250 channel partners

Targeted at medium-sized firms

Award winning support systems

Plans in-hand to move international

Existing businesses: REDtechnology.com

Web development and hosting company

300+ customers, predominantly mid-sized UK based organisations

Create web systems

ConductIT, FileIT, PromoteIT

Hosting with 24x7 support

Operational Structure
A very important factor about the Group is its global reach and international support infrastructure. As the biggest revenue provider, SunSystems is divided into three geographic regions, with coverage further widened by channel partners in countries within those regions:

EMEA (Europe, Middle East and Africa), handling 50% of Group revenues, with offices in Farnborough, Paris, Frankfurt, Madrid, Milan and Dubai;

The Americas, 17% of Group revenues, with offices in Miami, Los Angeles, Houston, New York, Ottawa, Toronto, Buenos Aires, Mexico City and Sao Paulo; and in

Asia-Pacific, 22% of Group revenues, offices in Hong Kong, Sydney, Canberra, Melbourne, Singapore, Tokyo and Shanghai.

Pegasus Software and REDtechnology operate primarily in the UK, albeit plans are in hand to offer Pegasus products in selected overseas markets under the SunSystems brand

Latest results (Interims – 26th August 2003)
The Group reported increased earnings for the six months ended 30th June 2003, despite difficult IT sector trading conditions that resulted in a comparative decline in revenue. Revenues declined by 9% to £34.0 million (2002: £37.5 million) whilst total costs reduced by 11% to £30 million (2002: £33.7 million). Pre-tax profits rose 23% to £2 million (2002: £1.6 million). The EBITDA margin increased to 12% (2002: 10%). Adjusted earnings per share improved to 3.4p (2002: 3.2p). The Group’s Directors will consider declaring a dividend from the full year results.

Pre Acquisition Finances
Cash and investments at 30th June 2003 stood at £28.2 million (31st December 2002: £25.2 million) and no debt. At that date the Group remained cash generative and debt-free with net current assets of £28.6 million. It also continued to hold an investment in 9 million of its own shares, which were carried at a valuation of £6.3 million.

Shareholders’ Funds stood at £82.52 million, worth 79.4p in net asset value per share. In the event of any major acquisition I anticipate that the Company will use the 9 million shares that are held in treasury as part of the purchase consideration, thereby reducing any extra equity dilution.

MIS Acquisition (announced 10th October 2003)
In a major corporate move to expand the solution portfolio and create a new Business Intelligence Division the Group, on 10th October 2003, announced its intentions to acquire MIS AG.

The £23.7 million cash offer for the Frankfurt Stock Exchange quoted company was over 90% accepted by the 18th December 2003 closing date. This acquisition is seen as a major coup for the Group and helps it to create a significant new division, with massive upside potential.

MIS, headquartered in Darmstadt (near Frankfurt), Germany, is a leading business intelligence software solutions company with approximately 460 staff (including 260 consultants) and a worldwide presence. In the year ended 31st December 2002 it reported revenues of £33.3 million, EBITDA break-even and a loss before tax of £3.7 million. However, for the half year ended 30th June 2003, the company reported revenues of £17.6 million, an EBITDA of £1.5 million and, at that date, had net assets of £10 million.

Founded in 1988, MIS develops and distributes business intelligence software solutions for planning, reporting and analysis that enable companies to drive performance in dynamic marketplaces. These solutions can be seamlessly integrated into existing IT implementations, offering complete scalability from department to enterprise levels. MIS' DecisionWare, the company's flexible software tools, and professional consulting services support rapid implementation and productivity.

More than 23,000 end-users in 1,000 large and medium-sized companies around the world use MIS' solutions, for business-critical initiatives ranging from real-time sales analysis and consolidation to risk management and long-term planning. Clients include Fraport, Bayer, Deutsche Post, E.ON Energie, Hapag-Loyd, Henkel, Mannesmann, FIAT, Hewlett Packard, smart, Honda, 3Com, Daimler Chrysler, TetraPak, Aventis, Pirelli, Villeroy & Boch, RWE, FujiFilm and accenture.

MIS, which has strategic partnerships and alliances with over forty companies including Microsoft, KPMG, Psipenta and PricewaterhouseCoopers, has seven offices in Germany, seven offices in Europe and thirteen representative organisations worldwide.

Reasons For and The Benefits of the MIS Acquisition
MIS has a highly regarded and experienced management team that will remain with the enlarged group. Peter Raue, Chief Executive Officer of MIS will remain in that position and will also be the Chief Executive Officer of the newly created Business Intelligence Division within the Systems Union Group. Paul Coleman, Group Chief Executive Officer, will become Chairman of the Supervisory Board and Tony Sweet, Group Chief Financial Officer, will also join the MIS Supervisory Board.

MIS will take the leading role in establishing and managing a new global business intelligence division within the international software group, as it will help the enlarged Group to accelerate its expansion plans. It will be able to use Systems Union's global infrastructure and significant distribution network to further strengthen its market position.

The business intelligence market represents a key growth segment in enterprise applications sector and it is estimated by AMR Research (September 2003) to be worth $11 billion by 2007 with a CAGR of 7%. IDC (May 2003) sees the financial analytics market growing at 8.8% between 2003-2007.

The continued growth in the business intelligence market is being driven by a number of factors including: accelerating financial reporting cycles; the need to give managers timely access to financial information; and the need for a comprehensive picture of performance across the business and the ability to pinpoint profitability issues and opportunities and ultimately drive shareholder value. Senior finance professionals are demanding more from financial management solutions to facilitate proactivity and this has led to increasing demand for tools such as planning, forecasting and budgeting to integrate into core financial solutions. Systems Union realised that it needed to extend its financial management solutions portfolio as a critical success factor.

MIS was identified by Systems Union as being an attractive addition to the group because it had a powerful business intelligence solution portfolio, impressive brand equity in the business intelligence market, a strong global customer base and complementary market positioning. In acquiring MIS Systems Union is seeking to deliver against its corporate global scale, global reach and global solutions objectives as follows:

Global Scale

Increase group revenues by increasing the global availability of MIS products

Provide significant incremental revenue opportunity for MIS solutions, through Systems Union it will be able to target its existing 18,000 customer sites in 194 countries, with a powerful new portfolio of business intelligence products including budgeting, planning, forecasting and consolidation. It will also be able to access SunSystems' 200 channel partners in 76 countries

Leverage future acquisitions made by the enlarged group – given Systems Union's stated objective to significantly grow the business via acquisition, any new additions to the group will provide further leverage for sales of MIS products

Global Reach

Strengthen Systems Union's global presence

Strengthen the Group's position in the very important German market

Global Solutions

Competitive edge: the Group would be offering both BI and Financial Management solutions to its client base

Provide enhanced penetration of the growing business intelligence market

Deliver an enhanced solution portfolio to market very quickly because of existing integration capabilities

Financial effects of the MIS Acquisition

The Directors of Systems Union expect the acquisition to enhance adjusted earnings per share (before the impact of goodwill amortisation) in the first full financial year following completion.

The £23.7 million consideration for the MIS transaction will be paid in cash and will be financed from Systems Union's internal cash resources and new borrowing facilities of £15 million.

Commenting upon the deal Paul Coleman, Group Chief Executive Officer, said:

“I will be delighted to welcome MIS into the group. Peter Raue and his management team have built a very strong contender in the global business intelligence market and its excellent customer base and strong solution portfolio will be a very valuable addition to the group. As well as continuing to operate independently in the business intelligence market as a separate division within the enlarged Systems Union group, the complementary nature of the existing Financial and Business Management Division (comprising SunSystems, Pegasus and REDtechnology) will provide an excellent platform from which to extend MIS' global market coverage.”

Peter Raue, Chief Executive Officer of MIS, commented:

“We will be very pleased to take the leading role in establishing and managing a new global business intelligence division within the international software group, as it will help us to accelerate our expansion plans. We will be able to leverage off Systems Union's global infrastructure and comprehensive distribution network to further strengthen our market position. The Management Team of MIS is excited by this move and we look forward to joining forces with Systems Union Group in the global marketplace with great confidence.”

Foundation Systems Acquisition (announced 5th December 2003)
In a further move the Group announced, on 5th December, an expansion of its Financial Management Division, by the £2.5 million cash acquisition of Foundation Systems Ltd. The company, which is a leading value added reseller of SunSystems business software solutions, will operate as a separate subsidiary of Systems Union Group alongside Systems Union Holdings (author of SunSystems), Pegasus, REDtechnology and, now, MIS AG.

Founded in 1982 Foundation Systems employs 50 staff and works with over 450 mid market organisations in the UK within both the private and public service sectors covering all aspects of business and commerce. For the year ended 31st December 2002, it generated revenues of £7.3 million and profit before tax £526,000 and had net assets at that date of £445,000.

The company provides solutions based around SunSystems, Ascent and SharpOWL. It partners with ASR Computers, Albany Software InHowes Computer Solutions, Easy Software (UK), and Intex Solutions in being able to provide HR, Procurement Management, Payroll, PSA and BACS solutions. It is a Systems Union Principal Channel Partner and in March 2002 it was presented with the SunSystems 5 'Channel Partner of the Year' Award and in May 2002 it became the first fully accredited Solutions Partner for SunSystems PSA.

Post Acquisition Finances
Following the impact of the two recent acquisitions, I consider that the Group cash balance now stands at £17.9 million, that gross debt is £15 million and that the 9 million treasury shares are still intact (value £8.6 million against a Balance Sheet carry value of £6.3 million). Net interest must be some 25 times covered, and the Group continues in a net cash position.

Assuming that the enlarged EBITDA is £15.5 million, a 2.5 times multiplier would be worth £38.8 million, less the borrowed £15 million, gives £23.75 million of headroom. That should be able to fund an acquisition programme of up to £50 million.

Shareholders
The Company has over 4,500 shareholders. The total number of ordinary shares of 5p each in issue is 104,950,013. Over 500 employees have options on a total of 12,114,798 shares. Accordingly the total diluted capital would be 117,064,811 shares in issue.

Major Shareholders (as at 18th December 2003): Artemis Unit Trust Management, 13,885,000 shares, representing 13.2% of the Company’s equity; M&G Investment Management (part of Prudential Plc), 10,303,382 shares, 9.8%; Jupiter Asset Management, 6,926,218 shares, 6.6%; ISIS Investment Management, 5,868,330, 5.6%; Henderson Investors, 4,852,250, 4.6%; Universities Superannuation Scheme, 3,013,750, 2.9%; Framlington Investment Management, 2,550,000, 2.4%; Unicorn Asset Management, 2,360,376, 2.2%; and Williams de Broë, 2,211,726, 2.1%. In total 13 shareholders, including the Directors, control 72,837,860 shares, representing 64.5% of the equity.

Directors hold 15,866,828 shares, representing 15.1% of the equity: ALR Morton, 10,860,520 shares, 10.4%; PJ Coleman, 150,000 shares, 0.1%; ACS Sweet, 10,000 shares; and JL Pemberton, 4,846,308 shares, 4.6%.

Current Trading and Prospects
A Trading Update Statement will be announced on 13th January 2004, however with the Interim Results announcement, Paul Coleman, Chief Executive Officer, commented -

“We are encouraged by the current level of potential orders and are reasonably optimistic that revenues will improve in the second half. However, we have already initiated further cost efficiency measures to ensure that if income levels remain consistent with the first half, there should be an improvement to earnings. Our focus will be to concentrate on growing the business organically and by acquisition using the resources available to the Company.”

Conclusion ‘currently undervalued, this is a winner in the making’
The takeover of the Frankfurt quoted MIS group has suddenly opened up a big new and potentially very lucrative market for the enlarged Group. In one blow it now has a strong foothold in the massive Business Intelligence marketplace. Using its extensive global distribution base the Group will take considerable cross-selling benefits from increasing its SunSystems solutions portfolio whilst offering its clients a strongly enhanced service.

The recent acquisition of Foundation Systems, an existing principal SunSystems reseller, sees the Group expanding its distribution base in the UK, including an opportunity to introduce the Pegasus products into this channel. Other such channel partner acquisitions could well be possible and will prove to be earnings enhancing.

Boss Paul Coleman is making all the right moves as he sets his cap at increasing the size of his Group’s business, seeking $250 million then $500 million revenues in the near term.

This Group continues to be a ‘winner in the making’ and its shares are currently oversold and obviously undervalued.


Profit Estimates
For the Year to end December 2003 the estimate is £5.35m, worth 7.4p per share in earnings. For 2004 the estimate is £8.20m, worth 8.9p in earnings per share.

Target Price for 2004 raised to 150p, Stop Loss at 80p

(FT AIM - market capitalisation £100.23 million - 5 market makers in up to 10,000 shares)

FT Sector: AIM

EPIC Code: SUG

Price: 95.5p

52 Week Trading: High: 127p Low: 54.5p

Shares issued: 104,950,013 (ordinary shares of 5p each)

Market Cap: £100.23m

Shareholders’ Funds: £82.52m, worth 79.4p in net asset value per share, as at 30th June 2003

Gearing (estimated): Net cash of £2.9m after acquisitions and shares in treasury £8.6m

Results: Finals - March Interims - August AGM - April

Marketability: Five market makers deal in up to 10,000 shares on a 5p spread

Joint Brokers: Panmure Limited (020 7020 4000) and KBC Peel Hunt (020 7418 8900)

Company Contact: Paul Coleman, Chief Executive Officer (01252 556000) or Tony Sweet, Chief Financial Officer (01252 556000)


SQC Research profile ends.



I hope the above is of interest to investors in Systems Union Group shares.

Regards

Mark