Should you buy UXC?

The investment community is united in praise for UXC’s (ASX: UXC) acquisition of cloud services reseller Keystone Management Solutions, which provides access to a rapidly growing customer base.

Keystone Management Solutions is Australia’s largest reseller and service provider for ServiceNow, a US-based IT cloud business. With a growth rate of 70%, it has one of the fastest growth rates (70%) for cloud-based organizations globally. The business generates higher margins than UXC’s existing business operations.

UXC is an Australian business solutions and information and communications technology (ICT) consultancy firm that services medium to large entities in the private and public sectors across Australia and New Zealand. It is the largest Australian-owned ICT company, partnering with the likes of Oracle, Microsoft, Cisco and SAP.

Its competitor include SMS Technology and Management (ASX: SMX)Technology One (ASX: TNE)Oakton (ASX: OKN) and CSG (ASX: CSV). Personally, I would rate Technology One as the second best in this genre as the cloud opportunity could develop into a material driver of earnings. The only “cloud “ on the horizon is the challenges posed by competing against large incumbents in the UK market.

Both Oakton and SMS Technology and Management have recently reduced dividends while Oakton also had a 6% fall in revenues. CSG has moved away from the IT consulting sector by selling off its major division to instead focus on print equipment sales and services. By contrast, UXC expects the acquisition to be value accretive from the outset and will underpin cloud-based software and enable the company to increase its annuity-style recurring income.

Why invest now?

Some are convinced that the sector is at the bottom of its cycle. An article in the Australian Financial Review (AFR) stated that “with the AGM season now over, IT service sector expectations have been reduced and it looks like we have hit bottom”. Over the past few years the information technology sector has been in a mild bear cycle, as many major companies cut or delay IT capital spending. Potential catalysts for a turnaround are an uptick in international economies and a need to implement efficiency controls.

However, UXC is one of a few stocks in the sector that will be reliant on the occurrence of a cyclical upswing. Additionally, it has the best leverage to growth in the enterprise software market and its strong balance sheet and cash flow lend credence to potential capital management initiatives, one of which could be to raise dividends from the current 5.1% fully franked level.

Foolish takeaway

In my opinion, it is an opportune time to invest in UXC for investors with a medium and long-term horizon. Opportune because the sector is currently on a low and even if a cyclical upturn were not to eventuate, the company is less reliant on this than its competitors.

The acquisition has been described as enabling UXC to benefit from a structural shift that will underpin cloud-based software and result in higher quality earnings as 50% of Keystone’s earnings are annuity style income.

The only note of caution is a potential slump in IT demand as a result of a severe economic downturn.

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Motley Fool contributor Mark Woodruff does not own shares in any of the companies mentioned in this article.

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