One area unfairly punished by the credit crunch has been small-cap software. Sure, there are risks of slowing IT spend, especially in financial services, but the recent sell-off seems unjustified. I also suspect that the City hasn’t yet fully grasped the fact that the world is increasingly reliant on software. Due to the internet, IT has in many cases become an essential, rather than a discretionary, expense. Quite simply, if organisations wish to save costs, increase productivity, launch new products or grow revenues, then typically there is no alternative but to implement advanced technology.
IBS OPENSystems (Aim:OPN)
Take IBS OPENSystems. It is a dedicated supplier of software solutions to local authorities and UK housing associations. Its applications are used to manage the Government’s social housing programmes and run benefit payment processes for local councils.
So why did its share price dive in January? The firm unfortunately surprised the City by warning that its 2007 results would fall “slightly short of analysts’ expectations”. But the savage response looks overplayed.
Even though public sector purse strings are tightening, IBS’s turnover still rose 6% to £21m last year and is “expected to further expand organically in 2008”. One important factor underpinning this growth is the UK Government’s drive for efficiency in the delivery of public services, outlined in the Gershon Review. Moreover, at the results statement in March, underlying EPS of 13.1p were 6% higher than in 2006, while a 3.15p dividend (yield 2.6%) and stock buyback programme were also announced on the back of net cash of £12.7m (or 31p per share).
Secondly, the company continues to win share from its main rivals – such as Capita, Northgate Information Solutions and Civica – and generate healthy repeat business. Last year, it secured 18 new contracts (with clients such as Sandwell Homes, Wycombe DC and ISOS Group), achieving a hit rate of around 50% of all tenders, while also securing repeat orders for add-on modules from around 70% of its existing customer base.
Finally, the shares look too cheap for such a hi-tech business. Consensus estimates are for 2008 sales and adjusted EPS of £21.7m and 13.7p respectively, rising to £22.2m and 15.0p in 2009 – putting the stock on undemanding p/e ratios of 8.6 and 7.6.
So what do we need to watch out for? The main uncertainties relate to IBS’s small size and the impact of a severe recession. Even so, it appears to be a quality business with defendable positions in its niche markets. And with its shares so lowly rated, I could see it becoming a takeover target – as has already occurred to some of its peers, such as Civica, Chelford, CODA and ICM Computer Group. The next trading update is scheduled for 23 April.
Recommendation: BUY at 120p (market cap £45.8m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments