GEARED FOR SUCCESS26 Nov 2017 13:38
By Andrew Hore | Fri, 24th November 2017 - 16:22 on iiiI
A digital winner?
There are companies more like AMS prior to profitability when the share price does not reflect confidence in a sharp move into profit, and subsequent profit growth.
An example of a business that is progressing towards profit, although the expectation of that profit has been moving further away, is 7digital (7DIG). The company provides the technology that enables streaming of audio and video content by its radio, online, social media and telecoms clients.
7digital had been expected to make a profit this year, but it was pushed out to next year. This has been a consistent element of the company's history since the core business reversed into UBC in 2014, and even before then. The reversal valued 7digital at �16.5 million and it was partly financed with a placing at 27p a share.
The current market capitalisation of the combined company is less than the deal value and even more cash has been raised since then. The share price is around one-fifth of that reversal placing price.
Part of the delay in the move to profit can be put down to the decline in revenues from download customers as well as slower than hoped for growth in streaming revenues.
Yet, this is an enormous market because streaming surpassed CD sales in 2015. The acquisitions of Snowite and 24/7 Entertainment, helped to boost revenues and move them nearer to breakeven level. The focus on larger, more financially stable customers helps to increase the quality of earnings.
Revenues are expected to rise from �19.1 million to �24.9 million in 2018 and this is expected to enable an underlying loss of �2.9 million, after a step change in costs during 2017, turn into an underlying pre-tax profit of �2.1 million. That �5 million turnaround is based on an improvement in gross margin on the higher revenues and holding back overheads so they barely increase. Cash should be generated from operations in 2019 but the need for additional debt should be limited.
At the current share price, 7digital is trading on less than five times forecast earnings for 2018, and that falls to three on the 2019 forecast. It is understandable that investors are cautious because of the past disappointments.
It is sensible to discount the forecasts, but the current rating appears to be too pessimistic, particularly if 7digital can start generating cash so that no more share issues are required for working capital.