Pro­gress­ing to greater things: a buy­out, maybe?

Financial Mail - Investors Monthly - - Analysis - Larry Claasen

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.

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