Larger predators will soon notice Arcontech’s smart strategy

Aim-traded financial software provider Arcontech (ARC:87.5p) flagged up its eye-catching annual results when the board materially increased earnings guidance in a pre-close trading update (‘Lock in this 9 per cent free cash flow yield’, 26 July 2023).

At the time, house broker FinnCap raised its adjusted pre-tax profit and earnings per share (EPS) estimates by 49 per cent to £1mn and 7.3p, respectively; the driver behind the subsequent 33 per cent share price rally. The directors didn’t disappoint investors with their outlook on results day.

Having added one new client in the 12 months to 30 June 2023, chief executive Matthew Jeffs revealed that Arcontech is “working on several active opportunities with both existing and prospective Tier 1 clients where our software has been installed for testing”. Encompassing both server-side (high-margin) and user-based solutions, these opportunities have involved work to facilitate integration and accommodate in-house client development, so adding optionality to the company’s product range and creating potential for additional deployment in the wider marketplace.

Chairman Geoff Wicks adds that “a number of potential new customers are now at an advanced stage”, a point worth noting given that Arcontech earns an incremental operating profit margin of more than 60 per cent on new contract wins. Bolstering the team in London with two highly experienced sales professionals and engaging with consultants based in Singapore has been key to extending the sales reach and enhancing the pipeline of near-term contract opportunities.

Wicks also highlighted that Arcontech has been extending the terms of its contracts with larger clients. Just under half of recurring revenue is now subject to multi-year agreements and  “further discussions are under way” to lock in customers. The client base includes major financial institutions Barclays, JPMorgan and Morgan Stanley which use the company’s software products and solutions for collecting, processing, distributing and presenting time-sensitive financial markets data.

Strong cash generation and conservative forecasts

The business remains highly cash generative, hence why net cash increased by £0.4mn to £6.4mn in the latest 12-month period, a sum worth more than half Arcontech’s market capitalisation of £11.5mn. FinnCap expects annual free cash flow of £0.8mn (2024) and £0.9mn (2025) to further boost the cash pile to £6.8mn and £7.2mn, respectively, over its two-year forecast period and that’s after factoring in hikes in the annual dividend per share to 3.7p (2024) and 3.9p (2025).

It’s also reassuring to see that the board is taking a proactive approach to engaging with prospective acquisition targets, albeit the search continues to deploy the company’s burgeoning cash pile. The focus is on finding complementary solutions, such as a trading platform, which could be integrated into Arcontech’s solutions and existing office, at an attractive valuation. A well-executed acquisition should deliver earnings upgrades, too.

Although analyst Michael Hill at brokerage FinnCap is conservatively pencilling in a modest £60,000 increase in current-year revenue to £2.8mn, he points out that several of the contracts in Arcontech’s pipeline could exceed that entire uplift if secured, as seems increasingly likely. That’s worth noting given that he has factored in £0.4mn higher operating expenses into his forecasts for the new financial year to reflect investment made in new staff hires across the salesforce and development and support team. The increase in overheads will prove a drag on profits unless the contracts are landed, but equally the investment made is markedly increasing the business opportunity, too, a point that will not have gone unnoticed with larger predators. Buy.

■ Simon Thompson’s latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com at £16.95 each plus P&P of £3.75, or £25 plus P&P of £5.75 for both books.