Progressing to greater things: a buyout, maybe?

uge Group is a very different company now from what is was a few years ago. When it started out, it was a least cost-routing firm, a business that bought bandwidth from large telecom operators at decent discounts and then sold it off to its own clients in smaller units at lower prices than they could get from the operators themselves.

But over the past few years the group has become a distributor of niche products — largely pushing electronic goods such as PABX and Fax2Email services — to small and medium-sized businesses. It also provides its own voice service over its own network, and offers a standby telecommunications service that ensures a company will be unaffected in the case of copper cable theft or internal network failures.

Due to this change it has signed up resellers (Huge Group calls them business partners) to distribute these products.

However, the transition has not been easy. For one thing, the group had to build its distribution network from scratch. This has resulted in the expansion of its network from only 63 business

Hpartners in July 2010 to 552 partners today. But even after signing on these partners it was a slow process getting them to make a major contribution to earnings. “There is a lag between the time business partners are appointed and the time sales of new connections accrue from them,” Huge Group CEO James Herbst pointed out last year.

After a long slog, the group’s latest results show that its strategy has been starting to pay off. Revenue has risen 6% to R216m but operating profit shot up 44% to R22.9m for the year to end-February 29.

This is a big turnaround from the previous year’s numbers, when revenue was unmoved at R204m and operating profit had fallen from R17.9m to R15.9m. This is in a sector that has started to take strain. The impact of the group’s distribution network can be seen in it boosting its client base from 9,400 a year ago to 12,700. The surge in client numbers has reduced its customer concentration risk, as its largest client makes up only 1.3% of its business.

Its other measures also show that the group has been on an upward trend. Gross margins after direct expenses — such as consumables and distribution costs — have risen from 40% to 41%. The group cut staff cost 2% and depreciation increased 3.5%, as a result of an increase in capital expenditure on router equipment, which was a direct result of increased sales activity.

The group is in a good state, but what’s next for it?

A buyout by one of the larger telecom operators looks as if it could very well be on the cards. At least that’s what it has hinted at in its results. The group says the Huge Telecom (its major subsidiary) telephony service largely has the nature of an annuity — the revenues repeat every month.

It then goes on to point out that if this annuity revenue were to be “consolidated by an industry participant higher up the value chain”, only termination costs (the rate operators charge each other) to competitor networks and commissions to resellers would have to be incurred. It reasons that this would result in “higher attributable profit after tax for each unit of revenue” because Huge Telecom’s after-sales service and maintenance costs are low in relation to total revenue. HUGE GROUP

The group has been trading under a cautionary since April 28 2015, but this is related to its making of acquisitions. In October it announced it was buying ICT provider Centracom in an R82m deal; however, this acquisition has yet to be finalised.

As an investment Huge Group looks attractive. Its share price has risen 56% to R5.09 over the past year. The only real question is how much (if any) of an upside it still has. With a p:e of 27.55 and trading at well over its NAV of R2.56/share it is starting to seem close to being fully priced.

Though it looks pricey, if it manages to find a buyer there could still be some upside.

Mobile operators have to move on from just being airtime factories, and having a direct channel to small and medium-sized businesses could just be the shift the group is looking for.

IM recommends readers keep close tabs on Huge in the next few months as the nature of corporate action that might unfold could inform authoritatively on the company’s longer-term prospects. Should there be a lull in corporate action there may well be an opportunity to pick up Huge stock at lower levels.