A Portfolio of AIM Shares (5); Emis Group PLC and Craneware PLC

Note: For the preliminary filters used to select AIM stocks, see http://thejoyfulinvestor.blogspot.co.uk/2013_09_08_archive.html

Emis Group PLC

The Doctor, by Luke Fildes, 1881, courtesy Wikipedia

Emis Group PLC is the major software provider of patient information for GPs and pharmacies in the UK.

The company was founded by two GPs in 1980 to provide doctors with systems to improve patient care. In the 2012 Annual Report, Emis explains that it "is transforming the face of healthcare delivery for GPs and other healthcare practitioners. Our aim is to make good quality, timely, patient information available any time, any place, anywhere through interoperable systems."

The Leeds-based company was listed on AIM in March 2010. In August that year, Emis acquired RX Systems, which provides pharmacies with information technology. 80% of the company's revenues and profits come from the original business, with the remainder coming from RX Systems.

Emis is highly profitable, cash generating and it has increased its revenues by a compound 16% per annum since 2008.

The company is capitalized at 430 million pounds. Its shares are currently eligible for 100% business relief from inheritance tax. The company has a 'free float' of 72% - directors and former directors own the remaining 28% - and it trades on a modest bid to offer spread of 1.7%.  

Since floatation, Emis shares have moved erratically, reflecting concerns about government funding rather than the company's actual trading performance (Emis is in blue, the FTSE All Share in green).

Graph courtesy Yahoo, click to enlarge

At June 2013, Emis had 52.4% of the GP market, and its customer satisfaction, according to independent sources, is superior to both its main competitors, InPS and TPP.

 

	Emis	InPS	TPP	Other
UK market share June 2013	52.4%	22.0%	21.2%	4.4%
Customer satisfaction score	7.1	6.4	5.6	n.a.

Source: Emis Half-year report for 2013 

Emis is moving GPs' software to its own server, EMIS Web, "our transformational healthcare system". Other supports for GPs include a new mobile version of EMIS Web that can be used on tablets; EMIS IQ, which provides clinical and healthcare management information, and a website for patients (Patient.co.uk). The company is working on other systems for child health, community care and mental health.  

Emis's subsidiary RX Systems has 34.8% of the IT market for pharmacies with its ProScript programme. Nearly all its clients have acquired the new Electronic Prescription Service.  

As about 80% of Emis's revenues are recurring and 70% of its clients have been with the company for more than 10 years, the company has a steady business model.

 

Financial results are impressive in recent years: 

1. Pre-tax profit has galloped along, increasing by 20% per annum since 2009.  

2. Net margins run at 26% of revenues and the return on equity averages 30% these last three years.  

3. Emis paid off its debt with the proceeds of the 2010 floatation, and at June 2013, it held net cash of 15 million pounds. 

4. Operating cash flow, after deducting capital expenditure (including capitalised software development), covered the dividend 1.4 times.  

5. Emis has no defined benefit pension scheme to provide for.  

However, the company's balance sheet does include 53 million pound of intangible assets. This includes 31 million pounds for software development and for client relations (the remainder is goodwill). These 'assets' account for half the net assets of 61 million pounds. While any future impairment for a loss of client or an underperforming programme would not require a cash disbursement, the accounts do flatter the company's profitability. Or, to look at it from another viewpoint, the dividend cover of 2.5 times on an earnings basis over the past 5 years falls to 1.4 times on an operating cash basis. Cash conversion is a poor 56%.

 

Results for the first half of 2013 maintain the growth in revenues (+ 11%), but earnings per share are 4% down on the corresponding period for 2012. The main reason is the increased salary bill as Emis has increased its headcount by 20% year-on-year. Emis has hired staff for:

·         The rollout of EMIS Web.

·         A new Scottish hub.

·         Selling into the Welsh market where iSoft, with 13.4% of the market, has announced its withdrawal.

Emis has made two acquisitions this year. It purchased the shares it did not own (75%) in Multepos Computer Systems for 0.8 million pounds. Multepos provides software to pharmacies. And in August, it acquired Digital Healthcare (DH) for 3.1 million pounds. DH has 75% of the UK market for retinal screening programmes. We are not informed on the profit implications of these two acquisitions. 

The only forward-looking statements in the Half-year report are:

"•Overall H2 performance expected to be stronger than H1, driven by EMIS segment

•2014 will see reduction in the revenue and costs associated with EMIS Web roll-out" 

Consensus broker forecasts for 2013 and 2014 are for an increase in earnings of 10% a year: 

Broker forecasts	FY 2012 actual	FY 2013 forecast	FY 2014 forecast
Earnings per share	33p	34p	38p
Dividend per share	14.2p	15.7p	17.3p

At the current offer price of 667p, Emis shares are on an historic PE ratio of 20 and yield 2.1%. This price is in line with my valuation model's earnings calculator.* I have excluded the values generated by return on equity and equity per share. In the former case, it predicts earnings that look out of line with reality and broker forecasts, and in the latter, equity growth is flattered by the capitalisation of software development costs. Were I to include these valuations, they would substantially increase Emis's value.

*Based on 10% increase in earnings per share between 2013 and 2017; average PE ratio of 20; dividend payout ratio of 42% of eps; all discounted at 12.8% (3.8% yield on SLXX + 4% operating risk + 5% margin of safety). 

Investors will note: 

1. Emis shares are presently 32% below their 12-month high of October 2012 and 12% above their March 2013 low. 

2. The only significant director transaction (by the CFO) was to purchase shares at 663p in September. 

3. The build-up in staff, in a labour intensive business like Emis's, is often the prelude to future growth in revenues and earnings. 

4. There is a 32 million pound 'overhang' in intangible assets that could cause an impairment. 

5. Emis has historically been valued by the market at 20 times earnings, on average. Were earnings to disappoint investors, the shares would be doubly hit by a reduction in the numerator and a lower valuation (PER) of those earnings. 

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Craneware PLC

 

University of Florida Cancer Hospital, courtesy Wikipedia

And now to another AIM-listed business that provides software solutions to the healthcare industry. This time, in the United States.

Craneware was founded in 1999 and its founders are still in charge. While the company's business is all in the United States, its head office is in Edinburgh. It has offices in Atlanta, Nashville, Boston and Phoenix. Craneware claims a 25% market share of the billing, pricing and claims software used by US hospitals. It has achieved this penetration without offices on the West Coast, New York, the Mid-West or Texas.  

Craneware has a good record of growing revenues, earnings and equity since it came to the AIM in 2007. Cash conversion is good and at June 2013 the company had net cash of $30 million, equivalent to 15% of its market valuation of 124 million pounds. 

The company's shares are currently eligible for 100% business relief for inheritance tax, it has a 'free float' of 75% - the founders and directors retain 25% of its shares - and it trades on a bid to offer spread of 4.5%. 

Craneware's shares (in blue) have performed well since its 2007 listing, though like Emis, they have been volatile:

 

Graph courtesy of Yahoo, click to enlarge

Craneware acquired ClaimsTrust Inc. in 2011 for $16 million, $6 million in shares and a further $10 million in cash. In the year prior to acquisition, ClaimsTrust had revenues of $8.5 million and $0.9 million profit before interest, taxes, depreciation and amortization. Craneware justified the acquisition on two grounds: it brought 125 new customers to the group; and its product range, specialising in resolving contested claims from Medicare, fitted well with Craneware's. 

The company has, like Emis, established long-term business relationships with its clients. Contracts normally last for 5 years, and this gives it a very stable revenue base. Craneware has performed very well and it is in excellent financial health. Consider: 

1. Earnings per share have increased by a cumulative 16% per annum since floatation on revenues that have increased by 22% p.a.

2.  Net margins average 26% these past two years and equity per share has increased by 19% per annum. 

3. Return on equity, at 22%, understates the return on the assets employed, once net cash of $30 million is deducted. 

4. Net operating cash flow covered the dividend paid by over two times since 2009, leaving a surplus of $18 million that more than covered the outlay for ClaimsTrust Inc. 

5. The company has no defined benefit pension scheme to provide for.

However, pre-tax profits for 2013 were $0.6 million, or 5%, below 2012. The company gives two reasons for the shortfall:

         i.            For the first year since floatation, Craneware did not gain a major new customer.

       ii.            The 2012 result included $3.5 million in non-recurring revenues and a favourable accounting adjustment of $0.9 million.

The Chairman is optimistic (from the 2013 Annual Report):

"The strengthening of sales activity has continued and trading in the first few months of the new financial year has been healthy. With a product suite that addresses many of the fundamental financial issues besetting healthcare providers in the US, an invigorated sales team and a more stable trading environment, we are confident Craneware has the platform to deliver increased shareholder value in the years ahead."

And

"Our products consistently outperform our competitors' solutions, delivering transparent and highly measurable cost savings and efficiencies to our customers. With a high proportion of the market still relying on manual processes and an ever increasing level of auditing pressure on hospitals, the Board is confident of Craneware's ability to grow its revenues and profits."

 

The CEO notes that the company is on the lookout for further acquisitions.

Prior to the latest results, brokers forecast an 8% increase in eps for each of 2014 and 2015. At the offer price of 465p a share, Craneware is trading on a PE ratio of 24 and yields 2.4%. My valuation model values the shares at about 440p.*

*Eps growth of 10% p.a.; equity per share growth at 15% p.a.; ROE of 20%; average PE ratio of 21; dividend payout ratio of 54%; all discounted for 2014-18 at 12.8% (3.8% yield on SLXX + 4% operating risk + 5% margin of safety).

Prudent investors will note: 

1. Revenue growth has slowed to 5% p.a. these last two years. Craneware has explained that market conditions have been difficult with the changes related to Obamacare and heightened controls on public health expenditure. This has led to a consolidation in hospital groups that has affected new business and, in some cases, resulted in lost business. 

2. Craneware is in the odd position of running a US business from Scotland. Only one of its directors is American, and he is a non-executive. And one-quarter of the company's employees is based in the UK.  As the most competitive market in the world, America requires top management to be at hand, not at 3,000 miles.

3. The company has plenty of cash to spend on acquisitions that could increase its customer base and product offering. $42 million revenues in the US healthcare context are but a fleabite.  

4. The shares are trading just 4% below their 12-month high of 485p and 45% above their June 2013 low of 330p. The share price is highly volatile. 

5. Director transactions are mixed. One director sold 100K pounds shares in September at 402p while another purchased 50K pounds at the same price at the same time. No other transactions are recorded for the last year.