And as interesting as it all may be, of course what you really want to know is how to make money out of this growing phenomenon.
With that in mind, today I want to show you why I think iomart is probably the best play in what is quite an exciting investment sector right now.
The shares of this humble Glaswegian company trade on London’s AIM. And though they’ve had a pretty good run over the last year or so, I remain convinced that there’s a lot more to come from this wee upstart.
Why iomart is on my shopping list
Iomart was established way back in 1998 – as far as the technology sector goes, that’s a reasonably long time. And the company has carved out a fantastic niche for itself. Though it started out as a telephony and internet hosting company, it’s ploughed a considerable amount of energy (and money!) into cloud computing.
What iomart has is a network of data centres across the country. Today, everyone from banks to telecoms rely on these large humming centres of densely-packed computers to power their web servers and to store vast quantities of customer information. Iomart counts Stagecoach, the London Stock Exchange and BskyB among its prestigious customers. What these companies are finding is that the vast IT systems they have built up over decades – with all their customer data and software stored on servers in-house – can be supplanted by services offered online by companies like iomart. It also saves these companies a fortune on their energy bills.
This business is really starting to pay off for iomart. And the company is finally putting behind it years of back-to-back losses.
2. Growth by acquisition
Largely speaking, there are two ways to grow a business: organic growth, and growth by acquisition. Normally, I’m a bit wary of acquisitive management teams. I often wonder whether growing the business is really in the interests of shareholders. And though integration plans look good on paper, very often they come unstuck upon delivery.
But in this case, shareholders should be jumping for joy…
For starters, the types of firm that this company has been taking over aren’t exactly mega-business. We’re talking about firms valued in the low millions here. And that makes the bolt-on businesses easy to integrate.
What’s more, in this industry, cost savings can be considerable. In the world of data hosting (and cloud), business can be pretty easily integrated…. and massive costs can be taken out of the equation. Take the three acquisitions iomart made last year. It bought Skymarket, which generated revenues of £543,000, yet contributed a staggering £258,000 to the bottom line. Then there was Melbourne, a business that added £2.6m to turnover and a whopping £517,000 to the bottom line. While the acquisition of HostingUK, was probably the ‘worst’ performer, it still turned a profit of £119,000 on revenue of about half a million.
These figures are fantastic – the strategy is working well.
3. Operational gearing
The sort of cost savings involved in data hosting and cloud computing that I’ve just described don’t relate only to acquisitions. Overall, this business was able to generate a 29% increase in profits, with only a 10% increase in costs.
Having established a suite of products, increasing capacity is relatively straightforward. For instance, in March it added 600 ‘racks’ (that is, racks of servers) at its Maidenhead data-centre. In one, relatively simple step, it added 25% to the overall business capacity. Bish, bash, bosh… that’s operational gearing for you!
Of course, there’s little point in increasing capacity if you haven’t got clients ready to take the offer. And it has… according to analysts Cannacord Genuity, iomart is likely to see an 18% growth in client demand year-on-year. And that’s without any acquisitions!
Small and medium sized enterprises (SMEs) are falling over themselves to get hold of data storage and cloud-type solutions for their IT needs.
It makes sense. Many business owners (myself included) just hate the whole IT ‘thing’. If you can just outsource the lot, then so much the better. And anyway, many workers are increasingly using different types of devices. The only way to keep any semblance of control over data is to centralise it. And that leads right into the hands of iomart.
What’s more, iomart offers a unique guarantee that the customer service will be up and running 100% of the time – that is, no downtime. Now what in-house IT team can provide that sort of guarantee?
5. Cash flow
The obvious benefit of operational gearing and growth is cash flow. Though this business is investing heavily, it’s also pulling in a lot of cash.
I always compare the cash flow statement (changes in the company cash position) to the reported profits figure. That’s one of the best ways of picking up on ‘Enron-style’ accounting shenanigans, where reported profits aren’t confirmed by cash generation.
And you’ll be delighted to know that this business generated cashflow of £14.8m, even though it only reported profits of £9.1m. In my book, that’s a very, very good sign.
6. Earnings visibility
Great cash flow is one thing, but what a great business achieves is long term predictable cash flows. And that’s exactly what iomart has. Customers tend to be very loyal.
I’ve already mentioned that many business managers hate dealing with IT. And that means they don’t tend to chop and change IT solutions if at all possible. Customers are ‘sticky’ – and that’s just what you want.
Now I’m sure you’re familiar with Moore’s law. It basically says that computer processing tends to double in speed every year. But the beauty is, costs don’t necessarily go up – certainly not in proportionate terms. Data storage is the same. I’m constantly amazed at how cheap hard drives and memory cards have become.
Now, just imagine iomart’s position here. The raw product it’s selling (computer processing and data storage) is getting cheaper. But do you suppose that it passes on all these cost benefits to customers? Of course not. Customers are clamouring for its services, after all. What a fantastic business! Costs down, and revenues up… margins are bulging!
8. Big enough to have an impact… yet small enough for massive growth potential
Though iomart is one of Europe’s leading cloud computing service providers, this is still a relatively small company. Yet in terms of business deals, this company is punching well above its weight. Just recently iomart announced a big deal with one of North America’s biggest IT solutions providers, SHI International Corp… a $4.5bn giant. Iomart is to provide cloud-based back-up solutions for its US clients.
And yet we’re looking at a lowly 260 million quid Glaswegian enterprise trading on London’s junior AIM market. Iomart is a small fish, swimming in a big pond… that can be dangerous. But in this case, I think it’s a great opportunity. Iomart may not be well known right now. But it’s moving in all the right circles. And as the story continues to grow, you can be sure a wider pool of investors will start sniffing around.
I mean, only this week IBM took over a US cloud services provider for a staggering $2bn. How much could iomart be worth in due course?
9. Scarcity value
There simply aren’t many iomarts about. And in many ways, iomart is going to make sure of that! It’s unashamedly picking off competitors as it goes.
But what if the hunter becomes the hunted? While a takeover of iomart itself may bring cheer to many shareholders, I would think that it would be at the expense of the long-term growth story. I’d rather see it stay independent and continue its quest.
Still, let’s not jump to the gun. For the moment let’s stay on track…
10. Outperforming forecasts for over three years
All the time that iomart has been successfully integrating all these new businesses, it’s serially beaten analyst forecasts. And the fact is, there’s still a long way to go for consolidation of this industry. Lloyds banking group has put in place a £20m facility to help the group in its takeover quest. And at the moment, it’s only drawn down £9m of this.
This means that we might well see more outperformance as the group consumes more competitors.
If this all sounds like a high risk strategy, then you’re right; it is.
This is high risk, high reward…
High growth often comes with added risk. Like I said before, integrating third party businesses can prove tricky. Accounting black holes often appear.
And takeovers often leave the balance sheet looking rather dicey. In iomart’s case, of £62m of assets on the balance sheet, around £32m is goodwill. I don’t consider goodwill an asset of any particular merit – it’s more of an accounting entry to balance the books. It’s not an asset against which any bank is likely to lend cash if needs must. You’d do well to be aware of it.
Also bear in mind that this is very much a UK-centric company. Of its £43m of turnover, £39m of it is generated in the UK. Not much diversification there!
And then of course there’s the price you’re asked to pay for this stock. Trading on 24 times this years projected profits, the firm is not exactly cheap. Three years of outperformance has had investors bidding up for this stock.
The good news is that ratio falls to 21 times, if the forecasts for 2015 are to be believed.
While still punchy, it is at least a little more realistic.
Overall, I’m prepared to take a chance here. This stock could fill an important gap in my portfolio. Cloud computing is going to be big. This could be a chance to pick up a potential world leader. It may be worth paying the price!
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