Focus Solutions is a company which counts its clients among banks, mortgage lenders, pension providers, independent financial advisors and the like covering the width and breadth of the financial services market. Given this, you would be forgiven for thinking this company is like a myriad of others that found themselves in the wrong industry at the wrong time.
Focus Solutions, however, are doing well (AIM-listed, £10.02m Cap). The company develops, supplies and supports software solutions (United Kingdom patented) for clients in the financial services industry in the UK and Ireland. The software makes for a vastly more efficient sales process by driving down admin and ownership costs, in most cases reduced by over 50%. The demand among clients is primarily driven by the need to comply with existing and forthcoming regulatory compliance as well as the stakeholder pressure to become more efficient. Since the company’s software allows for easy adherence to FSA integrated regulatory reporting the financial industry players are tempted. Current clients include such household names as HSBC, Barclays, Abbey, Lloyds TSB, Woolwich, Prudential, and Norwich Union.
Focus Solutions is a steady operator, the company has achieved an annual compound revenue growth rate over the last five years of just over 12%. This is likely to be sustained going forward (broker Daniel Stuart and Co are forecasting 14% revenue expansion next year). Focus have just announced a strong project pipeline totalling some £8.7m acquired in financial ’08, partly due to a new product launch called “focus:360”. In December ’08 the company acquired The Coaching Platform Ltd who provide training and consultancy solutions to the financial industry participants. Focus is claiming cross-selling opportunities and enhanced competitive advantage due to the purchase. This is somewhat uneasy to quantify as neither the precise purchase price terms nor the target’s current profitability have yet been indicated by Focus. I would expect this data in next annual report due July ’09.
The company’s revenue for the financial year ’09 stood at £9.6m with net income line being improved markedly in the last three years as the company finds its feet; it now moves steadily towards the 20% of revenue mark. EPS for financial ’09 are up 28% on last year (adjusted for effects of deferred tax income of £576,000 realised in financial ’08). The company is highly profitable ticking up a Return on Equity of almost 22% in financial ‘09.
Focus ended the year with total assets of £10.3m (£7.9m in ’08) of which £4m was cash (£1m in ’08). This dramatic increase in cash balance is due to much improved cash in-flow from operating activities of £4.4m (-£1.2m in ’08) which resulted from working capital efficiencies. Current Ratio is a very respectable 3.1 providing plentiful liquidity. With the entire capital base being funded by equity we have no financial leverage; this makes for a much lower risk company, particularly praise-worthy during current trading environment.
The market is currently pricing Focus at 36 pence a share. Is this a fair assessment of the company’s prospects? I do not believe so for several reasons extra to the ones already mentioned.
Focus are focused on tweaking its business model a fraction over the next three years to allow for greater proportion of recurring revenue stream; this is being achieved by charging clients on a per user per month basis. If successful, this will render the company less revenue-volatile, hence commanding lower cost of capital. The company is also aware of the fact it has large portions of revenue coming in from few clients; the number of clients paying over £1m was reduced in financial ’09 as compared to financial ’08 from 2 to 1. The work here continues. Focus, like many other technology companies, is dependant on new product development and innovation; the company has increased its R&D expenditure in ’09 to 16% of revenue (10% of revenue in ’08). Whether this research will deliver value remains to be judged, however. Focus sees opportunities in Europe; these have not yet been specified, but a sales director has already been hired (in January ’09). Finally, the founder, John Streets owns over a quarter of the company and is still very much involved in running the business.
Given the company’s current profit margins, current re-investment needs and moderate future growth potential the discounted cash flow valuation model points to intrinsic company value of around 50-55 pence a share.
For those investors considering Focus Solutions several points to think through would include the following. The company is tiny in size and therefore is heavily reliant on key executives to deliver on its potential. The problem of very few of very large customers still remains. An example would be a new HSBC contract worth over a quarter of the company’s revenues for financial ’10. In the latest report the Chief Executive Officer emphasizes more than once his intention to pursue growth by acquisitions, as well as other means. These potential acquisitions carry identification, overpayment, and integration risks. And finally, the company is discussing a prospective maiden dividend in the near future. By declaring a dividend the management may be telling its investors something they would rather not hear, namely that the company is nearing stable growth.
Focus Solutions could very well serve as a cautious and moderate growth opportunity in an investor’s portfolio provided one believes the challenges indicated above could be conquered by the, seemingly able, management.