Initiation of coverage (update) Observit: Profitable software company gearing up
21 Jun 2023
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Equity research Observit
The software company Observit has developed a management system for large networks of surveillance cameras with a focus on public transportation. The company is market-leading in Sweden, with clients such as Nobina. With a strengthened team, expansion, upsales and a new customer segment are expected to drive growth. We calculate a fair value per share of SEK 0.28.
A modern and intelligent solution that streamlines work and processes
The company’s management system/VMS has been designed to effectively manage extensive networks of surveillance cameras installed in or on vehicles, such as buses. The system has also been developed to optimise the processes for accessing and transferring video footage. Leveraging the functionalities of the software, bus operators can reduce the expenses for on-board camera surveillance by up to 55% compared to competing solutions.
Since 2016, Observit has grown the number of licences from about 10,800 to more than 36,400 in 2022. That corresponds to an annual growth rate of 22.4%. Sweden (and, to some extent, other Nordic countries) has historically been the key focal market. In Sweden, we estimate the company’s market share in public transport by bus to 35-45%. The customers include prominent players such as Nobina, Arriva and Koelis, demonstrating the strength of the offering and the customer benefit. In parallel, with solid revenue growth, the company has been profitable since the financial year 2014/15.
Accelerated growth with expansion and an added customer segment
We believe that the main growth driver over time will be the geographical expansion with bus operators as sales partners. That is because the market potential increases by 18x. At the same time, sales cycles are lengthy. The procurement procedures for traffic contracts typically span 1-4 years, starting from the tender process to contract award and commencement of service. Therefore, the geographical expansion is expected to begin bearing fruit in 2024-2025 and beyond. In the short term, we believe that the main growth drivers will be (i) the upsales of additional services to existing operator customers and (ii) the new customer segment in commercial transport. Growth in the short term will be achieved with an extended portfolio of value-added services at higher pricing, significantly shorter sales cycles, and a tripled sales force.
In our base case, we expect recurring software revenue (ARR) of SEK 17.1m at the end of 2023, corresponding to a growth of 18.8%. In 2023, we expect net sales (incl. hardware) of SEK 45.2m, growing on average by 39.2% until 2027 and 26.4% until the last forecast year, 2032. In parallel, the EBITDA margin is expected to increase from 11.9% in 2022 to 14.8% in 2027 and 24.5% in 2032. At that point, 35.5% of net revenue is software revenue, and ARR amounts to approximately SEK 148m.
A fair value per share of SEK 0.28 is calculated by combining a DCF model with a multiple valuation. Our valuation corresponds to an EV/Sales in 2023 of 3.4x and an EV/EBITDA in 2024 of 23.4x. A reference group of software companies is currently valued at 7.4x sales in 2023 in the median. Initial sell pressure in the share on the first day of trading is a risk (and opportunity).
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