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SMS acquisition demonstrates company strength

SMS Management and Technology (ASX: SMX) is an IT software and service provider servicing a broad range of industries in Australia. SMS is the largest listed company in the IT space and has 85% of the ASX 20 as past or present customers.

SMS offers a mix of role-based (IT services [the cloud], systems integration, consulting, customer relationship management) and outcome-based (business performance improvement, application development and operational change) services to companies in the financial, communication and technology, and transport sectors.The company also has some exposure to government contracts.

Exposure to a wide range of industries has softened the impact on revenue experienced as a result of the cyclical downturn in demand for IT solutions. The industry is seeing weak demand as a result of low consumer and business confidence leading into the federal election later this year, with all major players affected.

Brokers have noted that large companies and the government cannot continue to defer IT spending indefinitely, as it will result in inferior online offerings that will eventually affect revenue and market share. The risk to SMS and other Australian IT companies is that the future contracts will go to cheaper overseas suppliers. SMS is somewhat sheltered from this by offering tailored solutions to many niche markets and benefits from low-cost labour from offices in Singapore, Hong Kong, and Vietnam.

SMS is well positioned to benefit from a turnaround in consumer and business confidence with a solid balance sheet comprising  no debt and an excess of $29 million in cash before Monday’s acquisition. On Monday, SMS announced that it had signed an agreement to purchase the group of entities known as Indicium and Access Networks.

The deal is worth $22 million over a two-year period with an upfront payment and two deferred payments based on performance. The purchase is set to add earnings of $20 million, be accretive to earnings per share, and add around $1.5 million in net profit in FY 2013-14. Indicium provides “vendor independent IT Infrastructure and Managed Services from consulting, design, onboarding, management and service desk”.

The key part of the addition for SMS is the exposure to the 60% of Indicium’s earnings, which are of annuity nature. Brokers have estimated that it will have the effect of doubling SMS’s exposure to annuity revenue from 7% to 15%, improving consistency of earnings.

The company’s strong balance sheet and acquisition will allow it to maintain or grow dividends in coming years. Analysis expect the company to pay a dividend of $0.27 in 2013-14, representing a yield of 5.8% (100% franked) based on recent price.

Foolish takeaway

While SMS is suffering due to a downturn in demand for IT services, recent acquisitions and a strong balance sheet will ensure the company emerges unscathed from a lower-revenue period. SMS has a healthy balance sheet to support dividends and acquisitions in the future, and currently has a fully franked yield of 5.8%. SMS is a quality company in a poorly performing sector. Foolish investors will acknowledge that the strength of the company should benefit the share price in the medium term.

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Motley Fool contributor Andrew Mudie does not own shares of any companies mentioned in this article.

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