Claranova — Factoring in potential COVID-19 risks

Claranova had already reported H120 revenues in February; revenues were 68% higher year-on-year and 19% higher on an organic, constant currency basis. We discuss divisional performance in more depth below. Adjusted EBITDA (on a like-for-like basis versus H119) increased only 3% y-o-y, due to a combination of higher marketing costs in two divisions and the inclusion of Personal Creations for five months, which was less profitable than the group average. At a group level, marketing investment increased 99% to €56.4m, of which 23% was organic, and R&D increased 42% to €10.0m, of which 23% was organic.

Exceptional items of €3.0m were recognised, including €1.7m in costs relating to the Personal Creations acquisition, €0.3m for group restructuring and €0.9m costs incurred in planning the buyout of minority interests in Avanquest.

The group applied IFRS 16 for the first time in this period; this had the effect of increasing EBITDA by €1.6m through the removal of lease expenses, increasing depreciation by €1.4m as right of use assets were recognised for the first time and increasing interest expense by €0.3m relating to the recognition of lease liabilities. Other finance costs included €1.3m in interest expense relating to the ORNANE (convertible bond) and Euro PP (private debt placement). The company also took out a €14m bank loan to finance the acquisition of Personal Creations during H120 and this added €0.3m in interest expense.

The effective tax rate based on reported PBT was 65%. The company is in the process of assessing its tax position in the US, particularly in the light of the Personal Creations acquisition, and is awaiting French tax authority approval for restructuring of the Avanquest subsidiaries. As these issues have not yet been resolved, Claranova has not recognised deferred tax assets related to accumulated tax losses. These have the potential to reduce future tax bills.

The company had a net cash position at the end of H120 of €27.5m. This was made up of a cash position of €91.4m, ORNANE of €28.1m (due July 2023), Euro PP of €19.7m (due June 2024), bank debt of €14.2m (four-year term from August 2019) and other debt of €1.8m.

To clarify the different profitability reporting measures, we include reconciliations from reported to Claranova adjusted measures, and reported to Edison normalised measures.

The company has renamed two of the three divisions. The Mobile division is now called Printing & Gifting, reflecting the acquisition of the Personal Creations online personalised gifts business in August 2019. The Internet division has been renamed the Software division, reflecting the business’s focus on selling own-IP software (as opposed to reselling third-party software).

The table below shows the revenue and adjusted EBITDA performance by division. As with group adjusted EBITDA on page 2, Claranova has treated H120 divisional EBITDA as if IFRS 16 has not been applied.

This was the first reporting period including Personal Creations. The company provided a breakdown of revenue and adjusted EBITDA:

In the Printing business, FreePrints is now available in 12 countries, with Poland and Austria added in H120. The company estimates that by the end of H120 the app had been downloaded 35m times (+39% h-o-h) and was used by c 15 million customers (+36% h-o-h). The focus has been on strengthening the core markets of the US, the UK and France, where the aim is to grow the customer base and average basket size while limiting the cost of customer acquisition.

In the Gifting business, the first phase of integration with the Printing business was completed in H120. This included relocating teams, undertaking a strategic review of the product portfolio and merging some back-office functions. The next phase will include technical integration, in particular developing a mobile offering for this business, and commercial integration. In the longer term, the company would like to expand this business outside of the US. Based on estimates from Technavio, the addressable market for personalised gifts is worth c $26bn, double the size of the photo printing market.

The Software business saw revenue growth of 14% y-o-y. Adjusted EBITDA declined 39% y-o-y and the margin declined from 15.3% to 8.0% due to a combination of increased marketing spend and a growing proportion of software sold on a subscription basis rather than one-off licensing.

The division increased marketing spend by 38% y-o-y, making up 22% of divisional revenues (vs 19% in H119). Recurring revenues (ie subscription licences) made up 42% of divisional revenues in H120, up from 35% in H219.

The division has also increased its investment in product development as it has shifted its focus to selling its in-house developed software as opposed to reselling third-party software. Several new product upgrades are due for launch in H220. As before, its focus verticals are PDF (Soda pdf), photography (InPixio), security (Adaware) and online payments (PayAware).

The IoT business saw revenue growth of 28% y-o-y and the adjusted EBITDA loss widened from €1.9m to €2.6m. Sprint contributed €1.0m of revenue in H120 compared to €0.9m in H119, which implies that the remainder of the business grew 50% y-o-y. At the end of H120, the IoT business had 280 customers (+146% h-o-h; direct and via Sprint) and 96 resellers (+153% h-o-h). By March 2020, 463 end customers had deployed a myDevices solution.

The ‘No Dead Zone’ panic button has proved popular with hotel chains and prior to the COVID-19 disruption, more than 100 hotels had installed it in more than 10,000 hotel rooms from January to March. This product did not contribute revenues in H120 but should start to contribute in H220.

New partners signed in H120 include BASF, Eolane and Henry Schein. The Sprint/T-Mobile merger has finally completed; Claranova expects both entities to market myDevices solutions to their customers.

The division will continue to focus on growing its network of resellers and deploying solutions for temperature control and alert buttons, targeting growth from increasing:

The company has seen a limited impact to date from the efforts to contain the virus, mainly due to the fact that a large proportion of its revenues are generated from customers buying products online. Staff are working from home in the main. Management has undertaken a risk review and the following are the main areas that are already seeing or could see an impact:

We have revised down our revenue forecasts to reflect challenges posed by COVID-19 restrictions (in particular the closure of the Gifting facility) and we have reflected the higher level of costs in H120. The combination results in an 11.8% cut to FY20 revenues and an 8.1% cut to FY21. More specifically, we have moderated the rate of growth for Q320, as restrictions only started to take effect in March, and cut our growth forecasts more severely for Q420, assuming no contribution from Personal Creations while the factory is closed. We assume a resumption of more normal trading from Q121.

Due to the level of fixed costs, at the EBITDA level, we forecast a 56.4% decline in FY20 and an 8.7% decline in FY21. Note that our previous forecasts did not include the application of IFRS 16, which adds c €3.2m to EBITDA in both years as lease expenses are stripped out. Normalised operating profit is a more appropriate comparison as this includes the depreciation of right of use assets. We forecast a 70.5% decline in FY20 and a 17.9% decline in FY21. We continue to forecast a net cash position at the end of FY20, albeit lower than previously forecast. The main reason for the reduction is the lower EBITDA forecast.

In Exhibit 5, we show Claranova’s valuation and operating metrics versus four peer groups: photo printing companies, online software retailers, IoT companies and French software companies. As Claranova is a combination of the first three groups and there are material minority investors in each business, we use a sum-of-the-parts approach to fully capture the value of the group.

Based solely on average peer group EV/sales multiples for FY20e, we arrive at a sum-of-the-parts valuation for Claranova of €9.95 per share. However, we believe that these multiples are not reflective of the growth and profitability prospects for each division. In Exhibit 6, our sum-of-the-parts valuation is based on adjusted FY20e EV/sales multiples by division. This produces a valuation of €11.04 per share (down from €13.34). We have used an EV/sales multiple for Printing & Gifting of 1.4x at a premium to its peer group (0.9x) reflecting its higher growth prospects. We have used a multiple for Software of 2.0x that is at a large discount to its peers (3.9x) reflecting lower growth and profitability than peers. For the IoT business, we use a multiple of 4x, significantly higher than peers (0.5x) due to its early stage nature and faster growth. The EV/sales multiple for FY21e and the EV/EBITDA multiples for FY20e and FY21e are implied based on the EV/sales multiple used for FY20e.

Clearly, if the company does not achieve our forecasts, there could be downside to the share price. In the short term, the main factor that could provide upside to our estimates would be a faster return to normal trading than forecast. Post COVID-19 restrictions, other factors would include faster than expected growth of the Software business (which, in turn, should lead to better profitability), returning Personal Creations to profitability on a consistent basis, and launch of the PayAware solution.