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K3 Business Technology – Profits Warning: Reaction Overcooked?

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Ahead of interim results expected in mid March, K3 Business Technology (LSE:KBT) has, disappointingly, announced that “due to the deferral in signing certain significant retail deals, coupled with investment in the group’s Microsoft AX offering, K3 will generate pre-tax profits below current market forecasts”. This has seen the share price fall back to 112.5p. Is the reaction overcooked. I write as someone who recommended the shares at 148p before Christmas. Clearly my timing was not great.

The warning follows a 5th December AGM update in which the company reported that “the short term trading environment remains tough with customers continuing to defer spending decisions. Against this, our pipeline is strong, with a number of key deals whose successful closure will help to realise market expectations for the year”. That certain of these deals have now also been deferred is clearly a disappointing short-term development but, having spoken to CEO Andy Makeham last week, he reassured me that the issue with the deals is one of delay rather than cancellation and that they are still fully expected to eventually proceed.

The pain is that Microsoft, for its own financial purposes, tends to offer significant incentives for deals to conclude in December and June and that the deals that have slipped are now not modelled to close until towards the end of K3’s current (to 30th June 2013) financial year – meaning services from these deals will not benefit the current year. House broker, finnCap, has responded to today’s announcement by reducing its current year earnings per share expectations by 36% to circa. 20p (pre-tax profit of £7.2 million).

The company’s retail sector exposure (around 40% of the total business) is clearly not ideal. However, its adding of its own intellectual property to create tailored solutions and around 50% of the divisions earnings being recurring offer some reassurance and the company emphasises that a major new global retail solution that it is in the process of creating, built around Microsoft’s latest AX technology, “is progressing well and we are encouraged by early implementations and the growing pipeline of interest. Developing intellectual property and global channels to market, together with managed services, will help to drive K3’s medium and long term growth and is expected to yield significant returns in the future”.

The company added that, outside the retail space, it is presently “pleased” with performance, though, cautious on the retail outlook and development costs K3 is currently taking, finnCap has also reduced its next years earnings per share forecast by 26% to circa. 26.5p (pre-tax profit of £9.8 million). Even given the clearly extremely tough retail climate, Makeham is very confident in the company’s ability to make this and emphasised that the company’s profitability would still enable it to materially reduce net debt (£15.68 million as at 30th June 2012). This is very much a priority in the next two-three years – with the company aiming to reduce debt to just a couple of million over that time frame. On material debt repayment being demonstrated, the current price/earnings multiple of little more than 4x will fast look just plain silly and suggests the shares could double from here and still not be expensive. My timing in tipping at 148p in December could have been better but I continue to rate them as a value recovery buy.

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Comments

  1. Industry Insider says:

    You analysis is quite generous to K3. Insiders in the market who are competing with K3 are telling a very different story!

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