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7digital Group — Broadening the base

7digital Group — Broadening the base

7digital’s interims show good progress in developing its B2B offering, with revenues up by 52% on H117 (including acquisitions). This reflects strong demand from brands for music as an adjunct to other products and services, as a differentiator and in order to improve brand loyalty. With an expanding portfolio of commercial content and the brand relationships, 7digital is well placed to exploit its independence and build a sizeable business. With management reiterating its expectations of the group moving into profit in H218, our revenue and EBTIDA forecasts are unchanged. We expect EBITDA to move ahead strongly in FY19e, given growing revenues on a lower fixed cost base. This puts the shares on a rating well below software peers, currently valued on a P/E of 21.6x.

Fiona Orford-Williams

Written by

Fiona Orford-Williams

Director, TMT

7digital Group

Broadening the base

Interim results

Media

1 October 2018

Price

4.5p

Market cap

£18m

Net cash (£m) as at 30 June 2018

0.7

Shares in issue

399.6m

Free float

84%

Code

7DIG

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(23.1)

(6.3)

(29.4)

Rel (local)

(21.8)

(4.9)

(31.2)

52-week high/low

6.4p

3.9p

Business description

7digital Group provides an end-to-end, white-label digital music platform and access to global music rights that enable its clients, which include businesses in the radio, electronics, social media and telecoms industries around the world, to offer music streaming and download services to their own customers. Its global customer base includes musical.ly, Onkyo, Panasonic, MediaMarktSaturn, TDC, Global Eagle, Fender and i.am+.

Next events

tba

tba

Analysts

Fiona Orford-Williams

+44 (0)20 3077 5739

Neil Shah

+44 (0)20 3077 5715

7digital Group is a research client of Edison Investment Research Limited

7digital’s interims show good progress in developing its B2B offering, with revenues up by 52% on H117 (including acquisitions). This reflects strong demand from brands for music as an adjunct to other products and services, as a differentiator and in order to improve brand loyalty. With an expanding portfolio of commercial content and the brand relationships, 7digital is well placed to exploit its independence and build a sizeable business. With management reiterating its expectations of the group moving into profit in H218, our revenue and EBTIDA forecasts are unchanged. We expect EBITDA to move ahead strongly in FY19e, given growing revenues on a lower fixed cost base. This puts the shares on a rating well below software peers, currently valued on a P/E of 21.6x.

Year end

Revenue (£m)

EBITDA (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

EV/ EBITDA
(x)

P/E
(%)

12/16^^

11.2

(4.3)

(5.6)

(4.9)

0.0

N/A

N/A

12/17^^

16.8

(1.6)

(3.8)

(2.3)

0.0

N/A

N/A

12/18e

21.8

2.4

(1.0)

(0.2)

0.0

7.2

N/A

12/19e

26.5

6.5

3.0

0.7

0.0

2.7

6.4

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. ^^restated.

Good momentum in demand

Interim figures show top line growth of 52% over H117, bolstered by acquisitions in 2017. Licensing revenues (typically generating over 90% gross margin) accounted for 65% of H118 group total and were up 49%. Over 70% of the licensing revenue was generated on a monthly recurring (MRR) basis, as opposed to set-up fees, with MRR up 36% year-on-year. Commercial appetites for using music to enhance the consumer offering continue to grow and broaden, and sales momentum for 7digital’s licensing is positive. The customer range is widening, from PEEX in live music enhancements through to a ‘global provider of music to the retail and hospitality industries,’ to Triller, the AI-powered music video platform. The group is also rolling-out MediaMarktSaturn’s ‘Juke’ digital music service to more countries. Increasing penetration of connected devices in and out of the home provides a further growth strand to the positive backdrop.

Improving margin trend

Much of management’s efforts have recently been focused on the integration of the three platforms (two from companies acquired in 2017). This has been an extensive project that has required expert technical resource. Once complete, scheduled for October 2018, management anticipates that group costs will reduce by £5m annualised, bolstering our modelled EBITDA margin improvement.

Valuation: Waiting for move into profit

On a FY19e P/E of 6.4x, 7digital trades at a considerable discount to software peers (UK sector, excluding outliers, on 21.6x). With a strong trading backdrop and improving margins, confirmation that the group is indeed moving into profit and is turning cash flow positive should start to close the valuation gap.

Momentum building

Progress across segments

Exhibit 1: Summary H118 figures

£'000s

Revenue

% change

Operating profit/loss

% change

Operating margin H118

Operating margin H117

MRR

4,323

36%

Set-up fees

1,702

101%

Licensing

6,025

49%

5,908

68%

98.1%

87.4%

Content

2,057

84%

34

10%

1.7%

2.8%

Production

1,257

28%

632

16%

50.3%

55.6%

Central costs

(9,410)

43%

Total

9,339

52%

(2,836)

14%

-30.4%

-40.6%

Other income

243

-18%

Operating loss

(2,593)

11%

-27.8%

-38.2%

Amortisation of intangible assets

1,689

269%

Depreciation

80

-55%

Share-based payments

30

EBITDA

(794)

-51%

Source: Company accounts

Forecast adjustments

While our revenue and EBITDA forecasts are unchanged, we have made an upwards adjustment to our expected amortisation charge to reflect the capital spending on the platform integration project. This has reduced our forecast PBT for FY18e breakeven to a loss of £1.1m; for FY19e a reduction from £3.4m to £3.0m.

Cash at the half year end was £0.7m. The short-term funding requirement to meet restructuring payments is to be met by loans from two of the group’s largest shareholders. With management indicating a strong rebound in operating profit in H218, the cash position should also strengthen, albeit that this is likely to be weighted to Q418. We have built a little more caution on this front, with our modelling suggesting an operating cash outflow for the year of around £0.9m, with a swing to operating cash flow positive for FY19e predicated on the stronger move into profit.

Exhibit 2: Geographic split of H118 revenues

Exhibit 3: Activity split of H118 revenues

Source: Company accounts

Source: Company accounts

Exhibit 2: Geographic split of H118 revenues

Source: Company accounts

Exhibit 3: Activity split of H118 revenues

Source: Company accounts

In order to achieve our revenue and EBITDA forecasts for the full year, the turnaround in H218 is relatively demanding, requiring revenue of £12.4m and EBITDA of £3.2m. The combination of the new business momentum and the cost reductions, which should start to take hold in Q418, nevertheless makes this outcome achievable in our view. On a full year basis, management is indicating overhead savings of £5m, consisting of £2m in staff costs and £3m platform/other overhead savings.

Increasing internationalisation

There has been a substantial shift in the regional breakdown of revenues, largely reflecting the acquisition of 24-7 from MediaMarktSaturn (MMS) in May 2017. As part of this transaction, 7digital not only acquired 24-7’s roster of clients (the largest of which are Juke and Danish telco TDC), but also agreed the additional project work for MMS. Juke has been launched in Germany and the Netherlands and Spain is set to follow over the next few months. MMS’s ambition is to expand this service to 15 countries. In H117, the UK was the largest region, at 43%, with Europe accounting for another 18%. Lower UK revenues, the acquisition and new business won have dramatically altered the profile, shown in Exhibit 1 above.

With the broadening out of the range of customers across the retail, telecoms, automotive, broadcast radio, and connected devices, amongst others, the addressable market is expanding and is not restricted to any limited geography. With its platform-based solutions and relatively fixed cost-base, and its relationships with the music industry majors, 7digital should be able to continue to grow its revenues strongly and benefit from increasing operating margins.

Content and Creative also in growth mode

Exhibit 3 shows the split of revenue by activity, MRR and set-up fees combined comprising Licensing. Historically, we had assumed this revenue stream atrophying as digital music downloads decrease (and streaming increases). However, this assumption did not take into account the growth in sales of Hi-Res audio, which now accounts for over £1m of revenue.

Creative is winning projects from a broader set of customers across audio and video, including one for a major music label producing video content.

Valuation: Substantial discount to streaming peers

Exhibit 4: Music and video streaming peers

Name

Market cap (m)

Sales growth 1FY (%)

Sales growth 2FY (%)

EBITDA margin 1FY (%)

EBITDA margin 2FY (%)

EV/Sales 1FY (x)

EV/Sales 2FY (x)

EV/EBITDA 1FY (x)

EV/EBITDA 2FY (x)

P/E 1FY (x)

P/E 2FY (x)

7 DIGITAL GROUP

17.9

29.5

21.8

11.0

24.5

0.5

0.4

4.5

1.7

(16.1)

6.7

PANDORA MEDIA

2,438.4

5.7

12.5

(7.2)

(1.1)

1.8

1.6

(24.6)

(144.3)

(15.6)

(27.9)

SIRIUS XM HOLDINGS

28,053.7

6.2

5.9

37.9

38.7

6.0

5.6

15.7

14.5

25.4

22.5

BRIGHTCOVE

298.1

7.5

8.1

1.3

4.7

1.6

1.5

124.7

31.4

(96.5)

78.3

LIMELIGHT NETWORKS

594.7

10.0

9.9

18.1

20.3

2.7

2.5

14.9

12.1

35.1

25.0

QUMU CORP

25.7

(10.4)

8.9

(13.7)

(3.0)

1.1

1.0

(8.3)

(34.5)

(3.8)

(8.2)

ZIX CORP

299.0

6.4

6.4

27.9

32.7

4.0

3.8

14.4

11.6

17.8

15.8

TIVO CORP

1,605.9

(14.9)

0.1

28.6

33.5

3.2

3.2

11.0

9.4

11.9

10.2

SEACHANGE INTERNATIONAL

64.3

(13.2)

5.1

(5.3)

6.9

0.4

0.4

(8.2)

6.0

(10.1)

22.4

HARMONIC

468.9

12.1

11.6

8.1

10.0

1.3

1.2

16.3

11.9

56.7

25.0

Average - video streaming

N/A

7.2

20.7

17.5

2.1

1.9

14.1

14.1

21.6

19.0

Source: Edison Investment Research, Bloomberg. Note: Prices as at 26 September 2018.

Our peer set consists of music discovery and video streaming quoted companies globally. Subscription radio company Sirius XM has recently bid for Pandora (a music streaming and discovery company, with areas of direct comparison with 7digital’s business) at $10.14/share. The table above shows multiples calculated on the then current share price of $9.01, implying that 7digital is trading on an even greater discount, despite its imminent expected move into profit. It should be noted, however, that there is a considerable discrepancy in scale between the two businesses.

Exhibit 5: Financial summary

£'k

2015

2016

2017

2018e

2019e

31-December

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

10,392

11,216

16,801

21,750

26,500

Cost of Sales

(3,308)

(3,446)

(4,766)

(5,821)

(5,812)

Gross Profit

7,084

7,770

12,035

15,929

20,688

EBITDA

 

 

(2,102)

(4,310)

(1,608)

2,400

6,500

Normalised operating profit

 

 

(2,862)

(5,603)

(3,761)

(1,000)

3,000

Amortisation of acquired intangibles

0

0

0

0

0

Exceptionals / FX

(128)

313

(1,124)

(1,100)

0

Share-based payments

(137)

(172)

(86)

(60)

0

Reported operating profit

(3,127)

(5,462)

(4,971)

(2,160)

3,000

Net Interest

11

(13)

(55)

25

2

Joint ventures & associates (post tax)

0

0

0

0

0

Exceptionals

(4,767)

0

0

(0)

0

Profit Before Tax (norm)

 

 

(7,618)

(5,616)

(3,816)

(975)

3,003

Profit Before Tax (reported)

 

 

(7,883)

(5,475)

(5,026)

(2,135)

3,003

Reported tax

(3)

(12)

380

0

(300)

Profit After Tax (norm)

(7,621)

(5,628)

(3,816)

(975)

2,702

Profit After Tax (reported)

(7,886)

(5,487)

(4,646)

(2,135)

2,702

Minority interests

0

0

0

0

0

Discontinued operations

0

0

0

0

0

Net income (normalised)

(7,621)

(5,628)

(3,816)

(975)

2,702

Net income (reported)

(7,886)

(5,487)

(4,646)

(2,135)

2,702

Average Number of Shares Outstanding (m)

108

114

170

399

399

EPS - normalised (p)

 

 

(7.1)

(4.9)

(2.3)

(0.2)

0.7

EPS - diluted normalised (p)

 

 

(7.1)

(4.9)

(2.3)

(0.2)

0.7

EPS - basic reported (p)

 

 

(7.3)

(4.8)

(2.7)

(0.5)

0.7

Dividend (p)

0.00

0.00

0.00

0.00

0.00

Revenue growth (%)

1.8

7.9

49.8

29.5

21.8

Gross Margin (%)

68.2

69.3

71.6

73.2

78.1

EBITDA Margin (%)

N/A

N/A

N/A

11.0

24.5

Normalised Operating Margin

N/A

N/A

N/A

-4.6

11.3

BALANCE SHEET

Fixed Assets

 

 

1,127

2,676

6,481

8,137

8,137

Intangible Assets

423

2,201

6,157

7,813

7,813

Tangible Assets

704

475

324

324

324

Investments & other

0

0

0

0

0

Current Assets

 

 

6,212

4,664

13,980

8,491

10,131

Stocks

0

0

0

0

0

Debtors

4,556

3,826

7,002

7,866

7,841

Cash & cash equivalents

1,656

838

6,978

625

2,289

Other

0

0

0

0

0

Current Liabilities

 

 

(3,201)

(6,223)

(11,951)

(10,636)

(9,349)

Creditors

(3,031)

(6,080)

(11,917)

(10,602)

(9,315)

Tax and social security

0

0

0

0

0

Short term borrowings

0

0

0

0

0

Other

(170)

(143)

(34)

(34)

(34)

Long Term Liabilities

 

 

0

(2,057)

(2,078)

(2,078)

(878)

Long term borrowings

0

0

0

0

0

Other long term liabilities

0

(2,057)

(2,078)

(2,078)

(878)

Net Assets

 

 

4,138

(940)

6,432

3,913

8,041

Minority interests

0

0

0

0

0

Shareholders' equity

 

 

4,138

(940)

6,432

3,913

8,041

CASH FLOW

Op Cash Flow before WC and tax

(2,102)

(4,310)

(1,608)

2,400

6,500

Working capital

(2,439)

3,400

2,188

(2,178)

(1,263)

Exceptional & other

(150)

(465)

(676)

(1,100)

0

Tax

(3)

(12)

294

0

(75)

Operating cash flow

 

 

(4,694)

(1,387)

198

(878)

5,162

Capex

(848)

(447)

(4,881)

(5,500)

(3,500)

Acquisitions/disposals

1,828

109

297

0

0

Net interest

11

(7)

55

25

2

Equity financing

0

0

10,694

0

0

Dividends

0

(1)

0

0

0

Other

0

(4)

135

0

0

Net Cash Flow

(3,703)

(1,737)

6,498

(6,353)

1,665

Opening net debt/(cash)

 

 

(5,312)

(1,656)

(838)

(6,978)

(625)

FX

48

919

(358)

0

0

Other non-cash movements

0

0

0

0

0

Closing net debt/(cash)

 

 

(1,656)

(838)

(6,978)

(625)

(2,289)

Source: Company accounts, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by 7digital Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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Level 4, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

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10017, New York

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Level 4, Office 1205

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Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Destiny Pharma — Porphyrins ring time on antibiotic resistance

Destiny Pharma’s H118 financial results were less about the numbers and more about the preparation for XF-73’s US Phase IIb study in the prevention of post-surgical infections. Destiny’s operating loss was £2.7m, largely due to the build-up to the US Phase IIb study, which is expected to continue into FY19. The net loss was £2.3m. Cash at the end of H118 was £15.1m, which we estimate provides a runway through to 2020.

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