Sygnity: sell (reiterated). Workable Strategy and Expensive Multiples
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SGN PW; SGN.WA | IT, Poland
About Sygnity
Sygnity creates IT solutions and offers advisory services to customers across many different industries. The Company generates approximately PLN 215m in annual sales. Headquartered in Warsaw, Sygnity earns more than 95% its revenues in Poland.
SGN vs. WIG
Sygnity's share price has skyrocketed more than 240% over the past year compared to a gain of less than 5% registered by the broad WIG index. Unfortunately, there are no good reasons that we can see in the Company's fundamentals for such massive outperformance.
Sygnity unveiled a new strategy plan in February 2023, centered around three pillars. The first pillar focuses on long-term earnings growth, which we have partially factored into our valuation models by assuming EBIT margin expansion from 12.0% in FY2021/22 to 19.5% in the residual period. In our baseline scenario, we assume mid-single-digit revenue growth in the next three years (CAGR 2022-25 = 7%), driven by better pricing and contract acquisition.
On the downside, Sygnity wants to phase out low-margin contracts, which may have negative implications for revenues, and, as a tech employer, it faces continued pay pressures despite an economic slowdown.
After 11% upward revisions each, our updated FY22/23 and FY23/24 EBITDA forecasts for Sygnity currently stand at PLN 47m and PLN 49m, respectively. On the updated estimates, SGN is trading at 19.5x '23E EV/EBITDA and 18.1x '24E multiple, i.e. at premiums greater than 125% relative to its peers, far outperforming the local competitors, Asseco Poland and Comarch, which represent much more compelling investments at the current levels due to their size and liquidity.
We maintain a sell call for Sygnity with a new target price of PLN 20.70 and implied downside potential of 49%.
Earnings Prospects Under the New Strategy
Sygnity's new strategy plan is centered around three pillars. The first pillar is to improve business by adjusting pricing to the current market conditions and ending unprofitable projects (the flagship e-Taxes contract was quoted as one example of such a project). The two other pillars are organic growth and acquisitions.
Our impression of the new strategic goals is that they sound reasonable but are not very well defined. Sygnity has not specifically pinpointed the areas of its focus, nor has it identified any specific new target customer groups, and as such it has not set a clear path to medium-term earnings growth.
M&As
Sygnity has appointed a dedicated team of M&A professionals with the view to taking pro-active measures in that area. Looking at the current financial standing, with net debt/EBITDA = 0.3x at the end of FY21/22, we put the M&A funding potential at >PLN 150m. That being said, mergers and acquisitions involve a high degree of risk and we prefer the organic route for Sygnity.
On the question of price, Sygnity says it wants to target companies with portfolios of ready solutions, proven business models, and predictable revenues, which suggests potentially sizable price tags in the future deals.
Key Risks
Mergers & Acquisitions
Growth through acquisitions represents one of the three pillars of Sygnity's new strategy plan. There is a substantial amount of risk involved in business acquisitions, both at the stage of carrying out the transaction and in terms of achievable synergy.
Sygnity is aiming to ultimately acquire between 3 and 5 software companies per year – this is a very high number of transactions at the same time for the IT sector, indicating heightened risk of failure for each.
Goodwill Impairment
Sygnity recorded goodwill in the amount of PLN 157.2m as of 30 June 2022, representing more than half of the balance sheet total. A deterioration in the Company's financial standing could lead to impairment of that goodwill, which in turn could lead to a violation of debt covenants.
No Dividends
Sygnity’s net debt is relatively low, with the IFRS 16 ending FY2021/22 balance at approximately PLN 12m, equivalent to 0.3x adjusted EBITDA. At the same time, the Company has a relatively small asset base after several years of curbed capital expenditures.
A return to replacement capital expenditures after a period of restructuring, coupled with higher expenses on customer acquisition, could result in negative changes in working capital, leading to curbed medium-term dividend payments despite good cash flow generation.
Supplier Risk
Sygnity serves as a local partner to global technology companies, integrating their solutions into customer systems and providing a range of services from training, to maintenance, upgrades, and extensions.
If global software providers were to change the terms of their partner policies, for example by limiting the number of local partners, or by bringing implementation services in different markets in house, this could have a negative effect on revenues.
Increase in Labor Costs
Payroll accounts for a major part of Sygnity's operating expenses. Even at the height of the coronavirus pandemic, salaries in the Polish technology industry have been on the rise for the last several years. According to research by No Fluff Jobs, the median monthly pay range offered to senior tech talent was PLN 18-25k net in 2022, marking an increase of 19% from the year before. The compensation offered to junior talent was up 8% on average to PLN 6-9.5k net a month.
Analyst:
Paweł Szpigiel
Equity Analyst, Expert
+48 509 603 258
