Appen: Dominant position with structural tailwinds

Appen operates in an industry with robust long term structural tailwinds due to an insatiable need for training data for use in AI, digital advertising spend, autonomous vehicles and speech recognition to name a few end markets. 

Its FY19 results delivered a slight beat on guidance with EBITDA +42% $101m versus guidance $96m-$99m. The result clearly benefited from these tailwinds, as well as from Appen’s dominant position within this sector with a large and diverse global crowd, track record of product delivery and scalable operations and platform. 

Appen delivered a strong revenue growth rate +47% (or +37% in constant currency) with EBITDA +42% as margins fell from 19.6% to 18.8% due to a strategic loss-making acquisition in 2019 of Figure 8. Excluding Figure 8, economies of scale generated higher margins of 21.5%.

The Relevance division is the key growth driver for the business providing annotated data used in search technology for some of the largest technology companies globally. Revenue maintained its very strong trajectory +37% FY19 with operating leverage driving margins higher to 25.7% from 21.3%.

The Speech & Image division provides annotation of speech, natural language and image data used in speech-enabled consumer electronics. Revenue grew at a record rate + 32% but with project timing lumpiness EBITDA growth was 11%.

The strategic acquisition made in 2019 of Figure 8 is loss-making, this is in line with our expectations. Reassuringly growth rates recovered 2H19 after issues in the 2Q19 as management moved quickly to turnaround the operations and the path to profitability. We view this division as strategically important long term with a technology platform that widens the moat and increases the total addressable market so our expectation is it will be a key growth driver in the medium to long term.

Positive commentary about the future

The result commentary we viewed as positive around the future pipeline of customers and products. Importantly a multi-year agreement with a large customer was negotiated to hold price for 5 years which is positive in the context that there is a lack of pricing power. 

To grow its market position Appen is investing in sales and marketing where guidance is for softer 1H20 margins though we expect this to yield attractive returns and value creation for shareholders in the medium term. The balance sheet for Appen is in a strong position with net cash and no debt and unusually for a technology stock, pay a final dividend of 5cps taking the full-year dividend to 9cps.

The technology sector in the February 2020 reporting season has been impacted by the US-China trade war and the Coronavirus. For Appen, given the nascent stage of its Chinese business, the impact from the Coronavirus is expected to be immaterial though it remains a fluid situation for the foreseeable future.

Guidance for FY20 is for EBITDA expected to be a range of $125m-$130m which is broadly in line with consensus though we note that management has a track record of conservatism with guidance.

In summary

Appen’s result reflected the strength in the long-term structural tailwind combined with Appen’s market position and scale. 

Looking ahead, our view is that their drivers remain intact, though the challenge will be maintaining a level of re-investment to maintain its position and build out the technology platform balanced against market expectations.

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