This is not investment advice and is general in nature. Do your own research before taking any positions in the securities listed below. You should consider your financial situation and goals before making investment decisions.
How SOCO came on the radar
Whilst most of my portfolio is mid-cap companies, for small caps I prefer the following characteristics:
Limited-to-nil history of institutional ownership. If the small-cap players got in & then out – chances are that I am wrong.
Illiquidity due to inside ownership, but not illiquidity for its own sake
Company growing above the industry norm. That is to say:
Yes, it is great if the company is in a booming sector but these opportunities rarely come cheap. More likely than not it is a great business in an ok sector (e.g. $NOL as I reference in earlier articles)
In this instance - $SOC meets these initial criteria and so I began digging further
Overview of SOCO - Potential to be more Microsoft services for Fed Govt.
Founding: SOCO Corp is an IT consulting firm founded by Tom Rock, Sebastian Rizzo, Carlo Liviani and two other Founders who are no longer active in the business (Anand Raju and Stevan Simovic).
Over its 10 years operating history, $SOC has grown to c.100 employees, 125 active client base and now has a 7-year track record in Fed Gov.
Structure: Whilst the company has a vanilla structure; they do separate out the IP (Wide Net Pty Ltd) from the trading company (Thesoco Pty Ltd).
They do have a small related party entity, So Suite, which is a side start-up that founders own and Steven Simovic runs. Given its small size,I can understand it was carved out - otherwise I have not seen any egregious RPTs in $SOC
What they do: In terms of what type of IT services, $SOC focuses on the typical consulting services (e.g. providing a strategy for data management) and some managed services (e.g. providing cloud services)
Big, crowed TAM: Whilst the companies reliance on Microsoft is HUGE, it is fair to say - this is the space where almost all Microsoft Partners make their $
IPO In terms of the IPO, deal costs were approximately 20% of the overall capital raise (Yuck!) but this is a cost that all founding shareholders wore because they remained in the business
Operations today: $SOC has a big reliance upon Microsoft and Fed Govt. They are a Microsoft Gold Partner (which only 1% of providers have) and 66% of revenue comes from Fed Govt.
Evolving operations: However, I think the catalyst for this business growing into a higher quality business is as follows
Growing their partnership with Google Cloud (progress on AWS has been slow)
Expanding the number of State clients; notably with the QLD Government
Building out the Private & semi-gov order book (ALS, CASA, Clean Energy Regulator etc ) with a big tilt towards mining services and engineering
Ownership: Like a lot of small caps, Founders/Insiders represent the vast majority of the register with the two holding companies (Ulin & Beostemis representing the Anand & Stevan)
Difficulty with IT Consulting Industry
Unlike some other start-up plays, this is big established sector and it is not an easy sector to grow into:
There is no shortage of international players (IBM, DXC etc) with a presence in Australia as well as the bigger Australian players (e.g. Data #3 and Telstra Purple)
The majors make razor-sharp margins in exchange for fairly decent client retention (e.g. <2% NPAT margins)
The overall industry growth is anemic (e.g. 2-3%)
Depending upon the government entity, the big players can take a fair chunk of the overall pie
$SOC - What are its fundamentals like?
Whilst these industry trends are not worth forgetting - this is only a $35m Business. So below is what I see as the positive/negative things about $SOC.
Positive Factors
Revenue Growth was not a flash in the pan - Even though Revenue has grown from $5m in 2020 to $17m in 2022, this all was underpinned by strong customer growth in earlier years (e.g. $SOC's customer growth c.28% p.a. was delivered 2016 to 2021). In particular - QLD has been a huge growth engine for them
Worst of IPO costs have been washed through - With $4.7m of cash in the bank, a minimal working capital or capex requirement, they will not have to return to the market.
Higher margin business - As mentioned above, this is a much higher margin business than say $CNW (e.g. 4%) or say $DTL (e.g. 2%)
Strong cash conversion - As evidenced by their intention to pay out 40-60% of NPAT in dividends, $SOC has close to 100% cash conversion
Personnel roll-out has stabilised- Between 2020-22, there was a seismic growth in staff. However most importantly a) these staff were retained b) staff approval ratings are at c.94%
Negative Factors
Jaws is important: Whilst this applies to all businesses, it is particularly true for IT consulting businesses that tightness in labour markets & wage inflation can really hurt their margins. Additionally - we are in an environment that is seeing a tightness of labour & subdued IT spend
Multiple is not cheap per se: Brennan recently bought MOQ at a 6.1x EV/EBITDA takeover multiple. In comparison - $SOC trades today at 7.5x ($SOC has a $30m EV and FY23 EBIT of $3.0m less $1.0m of IPO Costs). So it's not expensive but it is not in bargain territory compared to MOQ (which might I add was an arguably inferior business)
Lack of visibility on their pipeline: Whilst I have no doubt that the existing structure will likely stay in place to grow their niche in small Government-linked Microsoft
Conclusion: In short, I will throw a small allocation into $SOC, but I consider it high(ish) risk.
I think $SOC's growth has been truly impressive and I do not consider today's $35m MC/ $30m EV really demanding. However, what I need to see happen with this business is simple:
Further evidence that they can grow billable employees (only 2x FTEs advertised at the moment vs. 200% growth in the last 2 years)
Greater penetration in QLD (or VIC) state Gov and their Mining & Engineering clients. I do not think we can solely rely on the small Federal Contracts
Stabilisation of c.10% NPAT margin now IPO costs have washed through. Or more specifically that they are still pursing more cloud work (not just lower margin consulting work)
As always - wading into the small-cap space is always fraught with risk but that's what I am doing.DYOR.
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