1Spatial — Update 29 June 2018

FY18 financial performance reflected good execution on the company’s turnaround plan, which commenced in March 2017. This plan was based around a shift towards a client-led solutions provider model, with the company’s 1Integrate product at the core and focusing on 1Spatial’s traditional customer base of heavy-duty GIS users in the government, utilities and transport verticals.

Revenues grew by 12% y-o-y to £16.9m driven by higher licence revenues (up 73% to £2.5m) and service revenues (up 9% to £7.2m), while support and maintenance revenues were broadly flat at £7.2m.

Geographically, revenue growth (by destination) was driven by the UK (revenues £5.0m, +15% year-on-year) and Europe (£7.3m, +13% y-o-y), whereas the US remained broadly flat at £2.6m on a tough comparative period, which had benefited from a $1.7m deal with a US government agency. The company also reports winning three clients in the US since the start of this year (average value $120k) and therefore looks well set to resume a growth trajectory, driven by increasing adoption by government agencies in the region.

Despite the higher contribution from licensing, gross margins dropped back a touch to 53% from 55%, which reflects the fact that, with the change in model, a higher proportion of engineering cost is being expensed through the P&L rather than capitalised as R&D. Capitalised R&D expenditure dropped from £3.5m in FY17 to £1.0m in FY18.

As a consequence, while EBITDA improved to £0.4m from a loss of £0.9m last year, operating cash flow from continuing operations improved by £1.9m to a £0.7m inflow versus a £1.2m outflow last year.

Year-end net cash stood at £0.3m (£1.3m cash, with £1m borrowings from a £2.5m facility) which, with careful management, should be sufficient to support the business through our forecast period.

The turnaround is by no means complete, but by continuing with its GIS solutions provider model, we believe that 1Spatial can continue on a similar robust growth trajectory and generate the operating leverage to deliver profitability and cash generation.

Management reports that the pipeline is healthy. 1Spatial has differentiated IP in its 1Integrate product and a well-proven ability to deliver value in its core government, utilities and transport verticals. The global Geographic Information Systems (GIS) technology market is large (estimated at $9bn) and growing at a double-digit rate.

The key constraint on growth is likely to be the company’s ability to recruit the appropriate engineering staff, with Brexit making it more difficult to recruit staff from Europe in an already tight recruitment market for engineers in Cambridge. The company is planning to establish teams elsewhere in the UK and Ireland to widen the recruitment net and is considering plans to open up an offshore development centre to help ease this constraint. Acquisitions, which bring on board both skilled staff and client relationships, are also likely to be explored.

Management has introduced a number of new growth initiatives with the results.

New data types could support penetration of new verticals: the company has recently added two new data types to the 1Integrate platform: linear referencing systems (LRS) data, which could strengthen the company’s offering in infrastructure and transport; and computer-aided design (CAD) data, which are expected to open up opportunities in the facilities management market. With respect to the latter, the company has recently completed an $80k proof of concept (PoC) with a very large US technology vendor to clean and integrate CAD-based GIS data. The company is now in the process of engaging with this client to carry out work on a number of other campuses, while other opportunities have also since emerged in this vertical.

Moving 1Integrate capability to client devices: whereas 1Integrate has typically been deployed on the server to correct and integrate data collected in the field, the company is in the process of developing client-based (mobile, desktop or web) business applications, to address clients’ specific data collection needs. Embedding 1Integrate into the business application will correct and validate data collected at source. In addition to opening up new revenue opportunities, customer lock-in should benefit from the expanded use of 1Spatial’s technology in the workforce/workflows of an organisation.

Building on GIS solutions portfolio

With the shift to a solutions provider model now well embedded, the next step in management’s strategic plan aims to leverage the company’s core IP and expertise to transform 1Spatial progressively into a differentiated, scalable business in geospatial/location master data management.

To explain the concept, it is important to understand the broader discipline of Master Data Management (MDM), whereby data from multiple sources are integrated, updated, cleaned, corrected and standardised to create a single “golden source” that can be relied upon. This is a well-established but rapidly evolving industry, which Transparency Market Research estimates was worth $3.8bn globally in 2017 and will grow at a 27% CAGR through 2024 to reach $21bn. According to Gartner, the leading vendors are SAP, IBM, Oracle, Informatica and Stibo Systems.

The opportunity for 1Spatial stems from the complexity and specialist nature of geospatial data, which is not always well addressed by the mainstream MDM providers. 1Spatial’s open architecture software can manage both geospatial and non-geospatial data, thereby enabling clients to master, define and maintain accurate geospatial information from multiple data sets. While the company will need to invest in developing a platform to fully capitalise on the opportunity, it is already working on a number of proofs of concept (PoCs) with customers in this area.

While the initiative is still at an early stage, we believe that successful execution could open up opportunities for accelerated, scalable growth (e.g. platform vs service sales, leveraging channel partners) and potentially for a strategic premium to become priced in. We expect to learn more at the company’s forthcoming investor teach-in day (13 June).

Our P&L model (for the ongoing geospatial business only) is set out in Exhibit 2.

While we believe the demand environment could support 10%+ growth, we factor in the tight recruitment situation and consequently set our revenues estimates at a more cautious level (5% and 5% growth for FY19e and FY20e respectively). We understand that management has good visibility on more than 80% of our FY19 £17.8m revenue forecast.

We forecast a significant expansion in adjusted EBITDA, driven by the improving sales mix (licensing revenue growth) and operational gearing, with opex remaining relatively flat. Again, we believe there is scope for upside, with success in driving licensing income the most significant swing factor.

At the operating profit level we forecast continued losses this year, with the company moving into profitability in FY20e. This is primarily as a result of high levels of R&D amortisation stemming from significant capitalised investment in previous years. 1Spatial still capitalises development costs, but with a shift in model to a much less significant extent than previously (£1m in FY18 vs £3.5m in FY17) and the amortisation charge now significantly outweighs the level of capitalisation. (We forecast £1.1m of capitalised R&D in FY19 vs a £1.6m amortisation charge.)

Ultimately, we believe that a solutions provider of this nature should be targeting 15%+ operating margins, while moving into MDM could provide the opportunity for margins to scale materially north of this (20%+) over time.

We forecast that 1Spatial will operate at net cash flow break-even in FY19 before starting to generate cash again in FY20. While the company registered a small £0.5m increase in working capital in FY18, both receivables and payables reduced significantly, indicating the implementation of a more disciplined approach. We see scope for further improvements, through an improving licensing mix and securing a higher level of upfront payments for services, but at present forecast that working capital levels will grow in Iine with sales.

As previously discussed,1Spatial’s £0.3m net cash position is somewhat tight, but with continued careful management should be sufficient to see the company through to positive cash generation.

Our estimate changes are shown in Exhibit 3. Our previous estimates included the contribution from EnablesIT, which was disposed of in March for a minimal amount (see our March 2018 update note, Core GIS business robust/disposal of Enables). We include only the continued geospatial business in our estimates, where we leave revenue almost unchanged and lift EBITDA by 35%.

1Spatial’s shares still trade on typical recovery multiples, with a low EV/Sales multiple (FY19e: 1.35x) but high P/E (loss in FY19e, 83.8x in FY20e) due to the current compressed margin status. However, our confidence that the company will consolidate its recovery has strengthened; we feel our estimates are conservative and revenue upgrades should gear strongly to earnings if they come through.

Consequently, we believe1Spatial should progressively shake off its recovery multiple as further evidence that it is consolidating its recovery and moving into profitability comes through. Looking beyond this, the location master data management opportunity provides the potential for an operationally geared acceleration in growth. While it is too early to price in such an acceleration at present, we believe the company’s potential in this space could prompt some strategic interest.

On this basis, we believe that an FY19e EV/Sales multiple of 2.0x (vs 1.35x for GIS on current forecasts) would be easily justifiable, implying a value of c 5p per share.