Converge’s Aggressive M&A Announcements May Re-Ignite Stock Price (TSX:CTS:CA)

Converge Technology Solutions Corp. (OTCQX:CTSDF) recently announced three to five more acquisitions per year and an aggressive expansion strategy in Europe. In my view, considering the growth of the digital transformation market opportunity and the state of the balance sheet, many investors will likely have a look at CTSDF. I obviously see risks from potential goodwill impairments and lack of expertise in foreign markets, however the results of my financial models indicate significant undervaluation.

Converge Technology: A Lot Of Services, Impressive Strategic Alliances, And Large Target Market

Converge Technology Solutions Corp. offers digital storage services as well as different types of digital structures along with artificial intelligence services, machine learning, data and information analysis, and the modernization of work platforms for different corporations. In a recent presentation, management provided a detailed list of the services offered by the portfolio of companies that form Converge Technology.

Considering the strategic alliances signed with massive software corporations, I believe that many investors would be interested in reading about Converge Technology.

I was quite impressed when I learned about the total market opportunity reported by Converge Technology. Only digital transformation is worth close to CAD2.8 trillion, and the market grows at close to 15% y/y. In my opinion, if Converge Technology invests a significant amount of dollars in the markets, and offers reasonable services, we could expect sales growth.

Balance Sheet

As of September 30, 2022, the company reported cash of CAD172.229 million in addition to trade and other receivables worth CAD637.764 million, inventories of CAD163.777 million, and prepaid expense close to CAD21.502 million. The sum resulted in an approximate total current assets of CAD999.620 million.

On the other hand, intangible assets were worth CAD454.117 million, with a goodwill of CAD502.575 million and total assets of CAD2.0 billion. The asset/liability ratio stands at close to 1x-2x, so I would say that the balance sheet appears in a good shape.

The list of liabilities reported included trade and other payables worth CAD686.629 million, borrowings of CAD371.690 million, and other financial liabilities of CAD43.073 million. Deferred revenue stood at CAD69.371 million with total current assets of CAD1.184 billion. Finally, other financial liabilities were worth CAD106.413 million, and deferred tax liability was worth CAD90.685 million with total assets of CAD1.38 billion.

Analysts’ Expectations Seem Quite Beneficial

Analysts expect 2024 net sales of CAD3.376 million accompanied by a net sales growth of 8.38%, in addition to an EBITDA of CAD237 million and a 2024 EBITDA margin close to 7.02%. The operating profit would stand at CAD155 million with an operating margin of 4.59%. Regarding the pre-tax profit, Converge Technology is expected to report CAD109 million. 2024 net income would be close to CAD78.9 million, with a net income/sales of 2.34%. Finally, free cash flow expected would be close to CAD178 million with FCF/sales of 5.27%.

European Expansion And Managed Services Could Bring A Fair Price Of Close To CAD9.65 Per Share

Under normal conditions, I would expect Converge Technology’s Phase 4 to be implemented successfully. Let’s note that management expects to acquire 3 to 5 companies, expand in Europe, and grow its management services offering. As a result, I believe that revenue growth and EBITDA growth could bring significant stock demand.

I am particularly optimistic about the company’s inorganic growth acceleration and proven expertise in the M&A markets. As shown in the slide below, the number of target companies acquired in 2022 was larger than that in 2021 and 2020. In my view, with a solid balance sheet, new acquisitions could be easily explained to stockholders and perhaps debt investors. In sum, I believe that we could also expect an increase in the FCF margins thanks to inorganic growth.

Converge Technology has developed an Inclusion and Equality program, through which it opens the possibility of discussion spaces for its employees as well as training courses. In the same way, it is following the trend of the largest companies in the world, which not only generates more comfortable work spaces for all employees, but also provides a bridge of communication between the values ​​of the new generations and the generations that currently occupy command positions. I would expect that investors would be a bit more interested in the program, so perhaps there would be more demand for Converge’s stock.

In addition, Converge has developed a women’s program within the company, which also promises to create spaces for sharing opinions and opening up opportunities for women within the company to advance. According to the company’s statements, currently 18% of corporate positions are held by women, and the future perspective is to increase this number of positions to bring the percentage closer to half of these positions held by women.

Ultimately, we could add the adaptation of its operations to the environmental terms proposed by the 2030 Agenda to Converge’s future commitments, which include radical reductions in gas emissions and carbon footprint. Although its operations are mostly digital, the company has physical facilities to support cloud data storage and different platforms it offers with its services. To meet these objectives, it is developing waste reduction systems from its operations as well as dialogue channels with their client companies to report damage from industrial operations and the possibility of reducing their impact. In my view, sufficient publicity about these intentions would bring stock demand, which may lower the company’s cost of equity.

In this scenario, my assumptions include 2033 net sales of CAD5.560 billion with a net sales growth of 5.70%. I also expect 2033 EBITDA of CAD393 million, with an EBITDA margin of 7.06%. 2033 free cash flow would be close to CAD211.3 million, accompanied by FCF/sales of 3.80%.

With a WACC of 9.30%, the NPV of FCF would result in CAD1.023 billion. Also, with an EV/EBITDA multiple of CAD8.76 million, terminal value would stand at CAD3.439 billion in addition to the NPV of TV of CAD1.293 billion. Besides, I expect an enterprise value of CAD2.316 billion, with cash of CAD176 million and debt of CAD477 million. Finally, the equity valuation would stand at CAD2.015 billion, with a fair price of CAD9.65 per share and an IRR of 5.27%.

Bearish Case Scenario: Goodwill Impairments, Lack Of Experience In Foreign Markets, or New Markets Could Bring The Fair Price Down To CAD3.35.

Although it has active operations in some areas of Europe, mainly in Central Europe, the company, in addition to being based in the United States, has most of its operations within national territory, which shows that it has not yet had a great expansion. In my opinion, failed expansion in Europe because acquisitions don’t work out could bring revenue expectations down. As a result, in my view, the valuation of the company would most likely decline.

Lack of experience in foreign markets or new markets could also be a risk for management. Let’s keep in mind that different languages, the creation of new commercial channels and corporate agreements, different needs of clients, and the adaptation of its services to new technological conditions could represent challenges for Converge Technology.

Besides, with goodwill of close to CAD502 million, I would be expecting impairments from some of the acquisitions signed in the past. As a result, I believe that the book value per share may decline, which would bring Converge’s fair valuation down.

Under my bearish case scenario, 2033 net sales would stand at CAD2.644 billion accompanied by a net sales growth of -5.55%. 2033 EBITDA would stand at around CAD119 million with an EBITDA margin of 4.50%. In addition, 2033 free cash flow would be close to CAD157.9 million together with a FCF/sales of 5.97%.

If we assume a discount of 17.5%, the NPV of FCF would stand at close to CAD848 million. I also assume an EV/EBITDA multiple of 7.06x, which would imply a terminal value of CAD840 million and a NPV of TV of CAD143 million. The enterprise value would stand at CAD990 million. Besides, the equity valuation would stand at CAD689 million, with an IRR of -3.81% and a fair price of close to CAD3.35 per share.

Conclusion

Converge Technology expects to acquire many more companies from 2023 like it did in 2022 and 2021. Management also noted that expansion in the European market and the offering of managed services could be more aggressive in the near future. Under normal conditions, and considering the total target market, I would expect, like other analysts, FCF generation and revenue expansion. I obviously see risks from goodwill impairments and lack of expertise in foreign markets, however the current stock price appears too low.

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