Two tech small caps to watch
Information Security Architects (ISA) Holdings has been around since the 1990s. It started out by reselling firewall and antivirus technologies. A few decades later, it operates in cybersecurity at a time when corporates are terrified of ransomware attacks and private information leaks. Fear sells — just ask politicians.
ISA just reported revenue growth of 33% for the year ended February 2024. It derives 88% of its revenue from subscription models. If you’ve spent any time looking at technology companies, you’ll know how valuable this is in terms of revenue visibility. Clients are looking for consumption-based security solutions and ISA is only too happy to oblige, giving itself a revenue model that Microsoft has perfected.
Gross margin fell from 53% to 49%, with this period including some significant lowmargin product sales in the mix. Operating expenditure was up 12%, mainly driven by people costs and growing at a rate far below revenue growth. It also helps that the share of profits from equity-accounted investment Dataproof Communications jumped 63%. Ignoring equity-accounted earnings, the profit before tax (PBT) margin was a meaty 22.3% in this financial year. It was 24.7% in the comparable year, with the gross margin mix effect explaining the difference. Either way, those are great margins.
There’s no shortage of growth, with the jump in revenue driving headline earnings per share (HEPS) growth of 35.5. If you’re wondering what the cash quality of earnings looks like, brace yourself for the payout ratio here. ISA is paying out every cent of HEPS as a dividend this year, just like last year. That’s right: both HEPS and the total dividend per share came out at 18.9c.
The market cap is about R300m and the share price is up 35% in the past year, tracking the growth in HEPS. It’s flat over five years and only slightly above 2017 levels, so don’t make the mistake of thinking you’re buying a chart that only ever goes up. The share price of R1.75 suggests a trailing dividend yield of 10.8% and a p:e multiple of 9.25. Liquidity is a challenge though, so be wary of the bid-offer spread that can ruin the party if you don’t manage it carefully. For those willing to accept limited liquidity, ISA looks interesting.
Operating in growth areas
A slightly larger (R450m market cap) option for tech small-cap enthusiasts is 4Sight Holdings. The company has only been listed since 2017 and has put more effort than ISA into selling the sizzle as well as the steak, with a fancier website and enough tech buzzwords to give you a serious headache the next day if you turned spotting them into a drinking game.
Jokes aside, there’s a lot to be said for the ISA approach of making it clear that there’s a core strength in the group. You have to wade through tons of management consulting-flavoured bumf on the 4Sight website to get to the useful information.
The results also aren’t straightforward, as the financial year-end has changed from December to February. This means that the latest period covers 14 months, which limits comparability to the prior period. If you dig a bit further, you’ll find that the company also released results for the 12 months to December 2023. This should theoretically make it easier to compare performance with the prior year, but there’s also an odd scenario where the extra R159m in revenue earned in January and February added less than R3m to profit. This means that the margins for the 14-month period are far worse than the 12-month period.
Though it’s not clear whether this is normal seasonality or not, the margins for the 14-month period look more reasonable when compared with the prior period. Gross margin decreased from 43.7% in the prior period to 40.6% in the 14-month period. The PBT margin (excluding associates) was 3.9%, which is higher than the comparable period at 3.3%. These are structurally much lower margins than we’ve seen at ISA, highlighting differences in the business models.
The 4Sight share price has a 52week high of R1.20 and a low of R0.25. It is up more than 210% in the past year. Using the 12-month HEPS of 5.4c, the p:e multiple is more than 15. Total dividends came in at 5c, but that’s more appropriate to compare with the 14month HEPS of 6c.
Both have impressive cash quality of earnings and are operating in growth areas, but ISA’s margins and simplicity make it look like a relative bargain. (I don’t have a position in either.)