An Aussie microcap that could double from here

Prophecy International (ASX: PRO) is an Australian listed micro-cap that has had a long but chequered history as a listed company since 1998. Originally a bespoke software business riding the dot-com bubble rollercoaster, it morphed into a roll-up of independent software businesses in the mid-2010s. Its past has soured investors’ appetites and left the business largely forgotten (by institutional investors) over the past 5 years.

However, since the appointment of current CEO Brad Thomas in 2017, Prophecy’s business has turned around under his disciplined stewardship – successfully divesting non-core assets, managing cashflows and a lean balance sheet whilst reinvesting into two core products, eMite and Snare.

eMite is a leading global contact centre analytics solution that provides call centres with software that delivers real-time visualisation of key performance indicators and analytics dashboards to improve call centre productivity.

Snare is a cybersecurity software product line that provides centralised log management, security monitoring, threat detection and security information and event management to government and large enterprise organisations.

The thematic for cybersecurity is strong, however, our original investment thesis was predicated on the success of eMite which will be the focus of this wire.

Totus has followed Prophecy since 2017 and invested in the business over the last 18 months. We believe an inflection point has been reached with eMite with the adoption of cloud-based call centres becoming increasingly important in a post-covid world.

Whilst a micro-cap (market cap $80m), Prophecy ticks a lot of boxes in our investment process.

Industry tailwinds

Digital transformation is a key thematic that the Totus Alpha Fund (TAF) has benefited from in recent years. The transition of enterprises’ computing infrastructure to the cloud has been underway for several years with Amazon’s AWS and Microsoft’s Azure winning from this trend (both owned by TAF).

One segment that is less sexy and less talked about is the shift of on-premise call centre infrastructure to cloud-based contact centres. eMite is at the centre of this generational shift providing software analytics software on top of leading cloud infrastructure players Genesys and Amazon Connect.

“Contact Centre Analytics Market was valued at USD 970.15 Million in 2019 and is projected to reach USD 2955.91 Million by 2027, growing at a CAGR of 16.12% from 2020 to 2027.” - Verified Market Research

Simple and easy to understand product

eMite is an out of the box customisable solution that allows contact centre managers to run their call centres, providing actionable insights from both real-time and historical data to help improve contact centre efficiency, performance, and customer experience (CX).

Traditionally, call centres have been run based on delayed data insights. Analytics are predominantly done via excel or in-house developed solutions that require costly software engineers and data scientists to run and maintain. eMite removes all this complexity by collating and correlating multiple data feeds from call centre infrastructure providers and customer-related data feeds in real-time to generate live analytics and performance dashboards.

Source: eMite

What grabbed our attention was that unusually for a micro-cap, customers include global enterprises such as Airbnb, 1-800-Flowers, Goldman Sachs and Humana (a large US health insurer) who just signed a 3-year contract with $1.8m annual recurring revenue (ARR).

We have spoken to an array of customers, from a small Australian-based home insurer to a global finance organisation who have all spoken highly of the product and described the tangible benefits it has provided their organisations, such as cost efficiencies and increased customer satisfaction.

Conservative accounting

While there are endless opportunities of high-flying tech companies listing on the ASX lately, it would be hard to find one who is conservative in their accounting practices and growing fast whilst not burning a pile of cash.

Prophecy took the conservative approach in FY19 to change its accounting policy to expense all its R&D and over the past 5 years has generated a cumulative $1.5m of Free Cash Flow.

Whilst the capitalising of expenses is not a sin, it tends to overstate NPAT in relation to FCF in the short term and it is FCF generation that creates shareholder value over the long term. Totus successfully invested early in both Objective Corporation (ASX:OCL) and RPM Global (ASX:RUL) which both, coincidently, expense all their R&D. 

Source: Totus Capital, Company Accounts

Management execution

We have followed Brad for the last 5 years and he has delivered on his objective to transition eMite into a Software as a Service solution for large enterprises. The business has grown organically from generating $2m of perpetual based contract revenue in FY17, eMite is now run rating at over $10m ARR in October 2021.

Brad has done this on a skinny capital base whilst investing in the product and growing a global sales and marketing team. In October, after almost 5 years of delivering on the strategy and global customer wins accelerating, Prophecy raised $7.7m of equity to double down on their sales and marketing initiatives – which we keenly supported. Importantly this was only the second time PRO has raised funds since 2015 and the first time under Brad’s tenure.

Insider ownership

Chairman Ed Reynolds, Prophecy Founder Brian Calvert and key management personnel hold 22.6% of the shares on issue, making insiders highly aligned with minority shareholders.

Inflection point

Pattern recognition is crucial when looking for potential opportunities. Our best investments have been in software businesses (such as Objective Corporation and Microsoft) that are transitioning from the perpetual licence revenue model to a SaaS-based model.

During these business model transitions, revenue usually faces headwinds in the short term and makes the business look like its growth has stalled despite the underlying value driver (ARR) steadily increasing below the surface.

We believe we are now at a point of inflection where eMite’s ARR growth of 80% YoY will translate into overall group revenue growth (which has gone sideways over the past 5 years) and generate meaningful free cash flow in the long term.

Source: Totus Capital, Company Accounts

While we have focused on eMite in this wire, PRO’s second business, Snare, has a strong blue-chip client base of over 4,000 customers who rely on their product for cybersecurity protection and compliance. This active customer base looks to be under monetised, generating $8-9m of revenue per year, predominantly under the legacy perpetual licence model.

Overall, the business has $13.7m of ARR, with the majority being generated by eMite currently.

At a share price of $1.12, this equates to a market capitalisation of $83m and an enterprise value of $71m. The overall business is trading on 5x ARR and growing its revenue at > 40% profitability.

This compares very favourably to ASX-listed software peers trading on an average 12.6x EV/Sales.

Source: Totus Capital, Company Accounts, Bloomberg

In our experience, quality companies that break through the $100m market cap barrier often experience a valuation re-rating as they become more investible to a larger group of funds.

Assuming PRO’s ARR growth slows to 20% per annum (which feels conservative based on the recent acceleration in contract wins) and the discount to ASX software peers halves to 9.0x. PRO could be worth c$190m, equivalent to $2.58 per share – over 100% upside over the next couple of years. Even if the multiple doesn’t re-rate we still see greater than 40% upside from current levels as revenue grows.

Disclosure: Totus owns PRO in the Totus Alpha Strategy vehicles. This is an independent and non-paid wire.

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