It's time for tech investors to look at smallcaps. Sure, stock prices of the 'Mag 7' more than doubled last year, but now PERs appear stretched (re 30x) and 'trees rarely grow to the sky'.
So what about smallcap software?
Well here you get the best of both worlds. Strong top line growth, attractive gross margins, predictable recurring revenues, high retention rates, and importantly cheap valuations.
Take brand compliance, rights and royalty management software developer Fadel Partners (FADL) , who released an in-line year-end trading update today, saying that after signing a host of new logos (eg PepsiCo, Kimberly-Clark, Sanofi and Philip Morris), contract renewals and customer scope expansions (eg Hasbro), FY23 turnover climbed 10% year-on-year to $14.5m (vs $13.2m in FY22) - boosted by an impressive 31% jump in recurring revenues to $11.4m (78% of group) and augmented by a positive end to the period from services ($3.1m eg training).
Perhaps even more encouraging was the sequential improvement, with H2 turnover coming in at $9.1m compared to $5.4m H1, whilst equally H2 EBITDA broke even vs a -$2m loss in H1, reflecting the successful integration of new sales and marketing hires, robust pipeline conversion, and disciplined cost control.
Elsewhere the balance sheet closed in good shape too, ending Dec'23 with net cash of $3m (vs $7.3m June) - which should be sufficient to fund the business until it becomes self-financing in early FY25 (or sooner).
In terms of the numbers, house broker Cavendish have a 260p/share target price based on sales increasing to $17.6m (+21% LFL) and $22.2m (+26% LFL) respectively over the next 2 years - equivalent to modest EV/sales multiples of 1.6x and 1.3x.
CEO Tarek Fadel commenting: "The successes in 2023 have further consolidated our position as a leader in the digital content services and intellectual property market. The growth in recurring revenues, the opportunity to increase our revenues from our existing and prospective clients and the encouraging pipeline, alongside resuming delayed professional services engagements, underpins our revenue growth plans for 2024. Further, our prudent management of costs should ensure we reach EBITDA breakeven earlier than we had planned."
One point, however, for investors to bear in mind is liquidity. Post IPO, FADL stock is 'REG-S' restricted until Apr'24. Meaning some UK brokers (eg Hargreaves Lansdown) are unable to separately identify US citizens from UK nationals, and so can't trade the shares until the REG-S status is lifted. That said, this is not an issue for either AJ Bell or Interactive Investors.
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