02 December 2019
By Maynard Paton
Results summary for Getech (GTC):
- Revenue fell 15% to its lowest first-half level since 2010. At least the H1 operating loss did not increase from H1 2018.
- GTC continues to be dependent on oil and gas operators purchasing its “market leading” data — the income from which remains “lumpy”.
- The level of recurring revenue implies a lot of work is needed before GTC can sustain positive earnings.
- The accounts are still rather fragile, with cash flow shored up by tax credits and capitalised development costs becoming more significant.
- Delays to both a Sierra Leone project and a property sale have not helped support the £9m market cap. I have sold out entirely.
Contents
- Event links and share data
- Why I sold GTC
- Why I had owned GTC
- Results summary
- Revenue and loss
- Gravity & Magnetic Solutions
- Information Products and Software
- Geoscience Services
- Financials
- Valuation
- Portfolio Sale
Event links and share data
Event: Interim results and presentation for the six months to 30 June 2019 published 24 September 2019
Price: 24p
Shares in issue: 37,563,615
Market capitalisation: £9.0m
Why I sold GTC
- I am slowly trimming lower-conviction holdings from my portfolio, and GTC’s latest statement re-emphasised some drawbacks that I can no longer tolerate.
- In particular, GTC appears very dependent on a rising oil price and “lumpy”/one-off data sales to achieve near-term profits.
- The current chief executive was appointed three years ago, and an emerging question now is how much longer will he give his turnaround strategy? I note the optimistic tone of the director commentary has reduced.
Why I had owned GTC
- Developed “market-leading” geoscience/oil-exploration software that enjoyed multi-year contracts, a blue-chip client base and a recent track record of recovery.
- Chief executive recruited during 2016 had implemented a greater commercial focus and his high-flying CV had underpinned the prospect of significant turnaround potential.
- A £9m market cap could have offered notable upside if a rising oil price stimulated customer orders and led to much improved earnings due to a mostly fixed cost-base.
Further reading: My GTC Buy report | All my GTC posts | GTC website
Results summary
Revenue and loss
- The gist of these first-half results was revealed within August’s trading update.
- Revenue was indeed £2.5m, the ‘cost base’ was indeed £3.2m and the “net impact of the reduction in cost base and revenue” did indeed have a “neutral impact on the Group’s profitability position when compared to H1 2018”.
- The “profitability position” was in fact an operating loss of £572k — versus a (restated) loss of £583k for H1 2018.
- Revenue fell 15% to set the lowest first-half level since 2010:
| H1 2017 | H2 2017 | H1 2018 | H2 2018 | H1 2019 | |||
| Revenue (£k) | 3,055 | 4,160 | 2,879 | 5,140 | 2,461 | ||
| Operating profit (£k) | (399) | 544 | (583) | 1,030 | (572) |
- The revenue reduction was due largely to restructuring the group’s geosciences consultancy division.
- Given the group’s operating loss remained the same, the consultancy revenue lost was seemingly not profitable.
- GTC notably disclosed two new sales measures:
- The orderbook, which gained £1.0m from H1 2018 to £3.0m, and;
- Annualised recurring revenue, which gained £0.8m from H1 2018 to £2.3m.
- The introduction of these new sales measures perhaps means GTC’s revenue has become more predictable.
- The £3.0m orderbook represents 39% of the revenue generated during this H1 and the preceding H2.
- Recurring revenue of £2.3m represents 30% of revenue generated during this H1 and the preceding H2.
- For (full-year) 2019 revenue to match that of 2018 (£8.0m), the current second half will require revenue of £5.6m.
- During 2018, revenue was bolstered by a last-gasp $3.2m (£2.5m) data sale.
- Since the publication of these results, GTC has announced one data sale that will generate revenue of $1m (c£775k).
- Repeating the H2 2018 revenue performance may therefore be touch and go.
- GTC recognised some work was required to deliver an acceptable H2:
“Our H2 2019 sales and marketing campaigns for products are well underway, with active trials taking place for Globe and Software in SE Asia, Europe and North America… In data, a number of high-value opportunities are maturing as our customers present the business case to extend their gravity and magnetic data library…”
“Our focus remains on delivering a strong sales performance to 31 December 2019… H2 is busy with face-to-face customer meetings in many regions of the world.”
- Future prosperity still rests on the group’s oil and gas customers.
- GTC said (my bold): “Global economic uncertainty and geopolitical tensions continue to drive crude price volatility, and Getech’s oil and gas customers remain careful in the release of their investment budgets.”
- However, the presentation slides suggested capital expenditure within the oil and gas sector could soon recover:
- The oil price rallied from $30 to beyond $80 between 2016 and 2018, driving an improved performance at GTC:
- However, the oil price has traded between $50 and $75 during 2019.
Gravity & Magnetic Solutions
- GTC continues to describe its gravity and magnetic data as “market leading”:
“At the heart of our product suite is our portfolio of market-leading Gravity & Magnetic (G&M) data. These data are used by our oil & gas and mining customers to model variations in the Earth’s crust, which in turn helps them to visualise the Earth’s structures and understand the evolution of natural resources.”
- Income from such data sales remains “lumpy”:
“G&M data sales are typically high-value, high-margin and lumpy, and demand for G&M data in H1 2019 has continued despite oil price uncertainty.”
- Valuing such “lumpy” income is difficult — especially as a single data sale can represent up to 30% of revenue in any one year (e.g. 2018).
- Applying a conventional P/E to unpredictable data-sale income may be a tad ambitious.
- Management claimed during a 2017 company presentation that selling off-the-shelf data was a “100% profit activity” and that the data “does not go stale”.
- Such comments sound great, although once such data is purchased the customer seems unlikely to purchase the same data ever again.
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Information Products and Software
- This division develops the Globe product, which serves “a broad group of super-majors and large independent oil & gas companies” and allows them to “model the Earth’s geological evolution and predict the location of oil & gas.”
- Globe is upgraded every year and the majority of customers have “signed-up to multi-year contracts.”
- Globe and other software products presumably represent the bulk of GTC’s recurring revenue.
- Recurring revenue of £2.3m compares with a reported ‘cost base’ of £3.2m for these six months — or £6.4m for a full year. Staff costs alone last year came to £4.5m (point 14).
- This Globe/software part of the business therefore needs to expand significantly for GTC to reach a more predictable level of profit.
- Until recurring revenue can cover group costs, profitability will be dictated mostly by (“lumpy”/one-off) data sales.
Geoscience Services
- The 2018 results revealed this division had been restructured at an ‘exceptional’ cost of £197k and that the associated savings would amount to £500k a year.
- The associated savings were not obvious in these results given the group’s £572k operating loss was similar to that of H1 2018.
- This division’s involvement in the Sierra Leone licensing round has become very protracted.
- The Sierra Leone work started during October 2017, and the deadline for licence applications was originally June 2018.
- Various delays have since occurred, and these results revealed the application deadline had been delayed (again) until February 2020.
- GTC claims the Sierra Leone work will enable the firm to “broker a high value portfolio of seismic and well data to prospective investors”.
- GTC has not revealed how much revenue has been — or will be — earned from this Sierra Leone project.
- The 2018 annual report (point 12) hinted that a write-off could occur were a “successful licensing round” not to complete during 2019.
- Perhaps the Sierra Leone work has been delayed because the interested oil companies are not entirely convinced about the area’s exploration prospects.
Financials
- GTC’s accounts remain underwhelming due to the absence of H1 earnings.
- At least GTC received payment for the $3.2m data sale recorded at the very end of 2018.
- A favourable £2.5m working-capital movement meant free cash flow for this H1 was £1.6m, which took the cash position to £3.0m
- Borrowings of £0.9m left net cash at £2.1m.
- The borrowings are secured on GTC’s Leeds office, which includes “a grand neo-Jacobean style carved wooden staircase” and “a superb glazed ‘peacock cupola’ dome”, and is in the books at £2.4m.
- GTC placed the office on the market during the first half of 2018, and twelve months ago the group claimed: “A number of parties have expressed interest…”
- However, a buyer for the office has yet to come forward due to “Brexit-related uncertainties”. Reducing the asking price could always counter such “uncertainties”.
- GTC really could do with selling the office. Cash in the bank is useful to have when current earnings are so hit and miss.
- The Leeds building was purchased during 2006 for £2.5m.
- GTC continues to capitalise certain software development costs.
- For this H1, development costs of £569k were capitalised on the balance sheet rather than expensed immediately against earnings.
- The associated depreciation and amortisation charge was £437k.
- Account for tangible asset expenditure of £25k as well, and the ‘excess’ capitalised expenditure during this H1 was a notable £157k.
- For full year 2018, such ‘excess’ capitalised expenditure came to £119k (point 12).
- The divergence between capitalised development costs and the associated depreciation and amortisation charge arguably flatters GTC’s reported earnings (and losses).
- The 2018 annual report (point 12) disclosed capitalised development costs have a useful life of between five and ten years:
- Five to ten years is a long time. My research suggests most software companies that capitalise development costs (and many do not capitalise any development costs) apply a useful life of no more than five years to such expenditure.
- The longer the useful life of an intangible asset, the lower the annual amortisation charge against earnings.
- GTC provided an updated ‘cost base’ for this H1:
- As the cost base calculation includes depreciation, tangible capital expenditure really should be included as well.
- That said, the small amounts of tangible capital expenditure (£25k for this H1, £78k for 2018) do not make a great difference.
- The cost base for this H1 was 10% lower than for H1 2018.
- The smaller cost base reflects the reduced cost of sales associated with the lower level of consulting revenue.
- But administrative costs did climb 7%:
- Unlike previous statements, these results did not refer to the group’s “85% fixed” cost base. Past results have implied future revenue improvements could lead to significant profit advances.
- GTC continues to enjoy R&D tax credits. Tax of £39k was refunded during this H1, and a further £140k is expected during H2.
- The balance sheet carries no pension complications.
Valuation
- A 24p mid-price supports a £9.0m market cap.
- The £2.4m Leeds office is surplus to requirements and might suggest the underlying business is valued at closer to £7m.
- Book value — which includes goodwill and other intangibles of £7.7m — is above the market cap at £12.3m.
- Near-term earnings remain at the mercy of “lumpy” data sales, the timing and value of which are unpredictable.
- As noted earlier, applying a conventional P/E to data-sale income may be a tad ambitious.
- For GTC to really succeed, recurring revenue from Globe and the other software products has to grow to cover the cost base.
- However, covering staff costs of £4.5m — let alone the full cost base — seems a tall order at present with recurring revenue at only £2.3m.
- A more radical business approach would be to ditch Globe and sell only data. Employee overheads could then be vastly reduced and the group might then operate at a reasonable profit — assuming a few data sales each year.
- However, such an approach would probably have no need for the high-flying chief exec, who has instigated the shift to recurring revenue and is on a useful £250k a year.
- An emerging question now is just how long the chief exec will give his turnaround strategy.
- The boss was appointed in mid-2016 and deserves credit for cutting costs, righting the balance sheet and trying to expand the recurring revenue side of the business.
- But three years on, GTC’s earnings remain shaky while notable progress continues to be dependent on greater spending from oil and gas customers.
Portfolio sale
- I sold my entire GTC position following these results.
- I am slowly extricating lower-conviction holdings from my portfolio (c.f. Castings), and this latest statement re-emphasised some drawbacks that I can no longer tolerate.
- In particular, GTC has struggled to sustain an acceptable level of profit.
- Immediate earnings remain dictated by “lumpy“/one-off data sales, the timing and value of which appear unpredictable.
- Meanwhile, recurring revenue seems a long way off from covering the cost base — let alone helping to generate a decent profit and funding a dividend resumption.
- In addition, GTC appears very dependent on a rising oil price — to prompt greater oil exploration and follow-up demand for GTC’s exploration software — for future progress.
- The level of capitalised development costs is not encouraging. Nor is the protracted Sierra Leone work.
- Some of the director commentary has been rather optimistic, too. For example, the 2018 results mentioned “acquisitional growth” and “potential to reinstate the dividend”.
- The director commentary no longer mentions GTC’s “fixed” cost base and the potential for amplified profit growth should revenue recover.
- A lot depends on the high-flying chief exec to implement his turnaround plan.
- Appointed in 2016, the chief exec could jump ship if GTC continues to struggle and/or a lucrative job offer appears elsewhere. The chief exec was the finance director of Salamander Energy before its £314m takeover.
- I first purchased GTC at 62p during 2013 and then at 59p during 2014.
- I bought more at 25p during 2017 following this company presentation.
- All told, I paid an average of 51p, collected dividends equivalent to 4p along the way and ended up selling at 23p to register a thumping 47% loss.
- The chart above (annoyingly) shows I could have exited each purchase for a quick profit.
Maynard Paton
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Disclosure: Maynard no longer owns shares in Getech.
