Producing more from less is one of the key ways to maintain living standards. And the good news is that by using labour-saving technology, Britain has managed to lift productivity – defined as GDP/hour worked – by around 2% a year over the past two decades. This is where SQS steps in.
With headquarters in Cologne, the firm is the world’s largest independent software tester. It has checked IT systems for a third of FTSE 100 firms, half the DAX 30, and counts blue chips such as O2, Volkswagen and Lloyds among its clients. It employs 1,249 fee-earners and 31% of its consultants are based offshore.
Meanwhile, the European market for these IT services is worth some €22bn a year, and is dominated by in-house teams, who comprise 80% of operations, and systems integrators such as Tata, who usually write and test the applications. But this traditional approach is compromised. There is no objective sign-off and the examiners usually lack specialist expertise.
In the first half of the year, SQS’s adjusted pre-tax profits fell 11% to e2.4m after it recruited 200 new staff to beef up its thriving managed services arm. Managed services contracts typically run for three to five years, compared to three to six months for its bread-and-butter testing projects, which make up 79% of sales. Of the 91 new clients won during the first six months, ten came through managed services, including the division’s biggest-ever deal, a contract with Deutsche Bank worth €15m over three and a half years. This pushed the unit’s revenues up to €5.2m, with the firm as a whole bagging orders worth €40m in total. Managed service’s target is to represent half of group revenues in the medium term, up from 7% today.
Gamble of the week: SQS Software (Aim: SQS)
Elsewhere, first half sales grew across all regions, including in its largest region, Germany, up 2.5%º to e33.2m. The City is predicting 2010 revenues and underlying EPS of €147m and €0.22 respectively, rising to €159m and €0.28 in 2011. Hence the shares trade on an undemanding p/e ratio of 9.6 times earnings – far too low for a leader in a growing sector.
Nothing is risk-free. If we get another recession, SQS’s project-based activities will suffer. It’s also exposed to the cyclicality of financial services (25% of sales), plus there are the usual foreign exchange considerations for UK investors, given 55% of turnover is derived in euros. And the stock is not always liquid, so be careful not to bid up the price. I’d value the stock at 235p per share, equivalent to a through-cycle multiple of eight-times earnings before interest, tax and amortisation.
Recommendation: SPECULATIVE BUY at 185p (market capitalisation £52m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments