AdEPT Telecom BUY. 9 September 2014 UK EQUITY RESEARCH TELECOMMUNICATIONS. Price 120.5p Target Price. Initiation of coverage: Dialling up dividends

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1 9 September 2014 UK EQUITY RESEARCH TELECOMMUNICATIONS BUY Price 120.5p Target Price 170p Reuters/BBG ADT.L / ADT LN Index AIM All-Sh. Telecom Sector Telecommunications Market Cap 26.6m Shares in Issue 22.1m NAV 10.7m Gearing 0.6x Interest Cover 8x Performance All-Share Sector 1 month: -3.6% -4.9% 3 months: 0.8% -1.4% 12 months: -6.5% 5.7% High/Low Key Data: 150p/106p EPS CAGR 3-year 0% ROCE 13.0% Free Cashflow Yield 6.9% Last Results Next Results Next Event Sep-13 Oct-13 Source: Capital IQ Analyst Nov-13 Dec-13 Jan-14 July FY14 Results November- FY15 Interims Feb-14 Mar-14 Apr-14 Trading update May-14 Jun-14 Jul-14 Aug-14 Sep-14 Brendan D Souza +44 (0) brendan.dsouza@wh-ireland.co.uk Marketing Communication This document has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Please refer to important disclosures towards the end of this document. AdEPT Telecom Initiation of coverage: Dialling up dividends AdEPT Telecom is a UK focused independent provider of telecom services. The company currently has 20,000 customers, to which it provides a range of communications solutions. AdEPT has a solid track record, spanning over a decade, of growing earnings and dividends, through providing its customers with bespoke communications solutions, which we expect to continue. We initiate coverage on AdEPT with a Target Price of 170p and a Buy rating. Highly experienced management team with a well-defined business strategy. We believe AdEPT s success has been predicated on its ability to provide its customers with bespoke communication solutions combined with high levels of customer service and support. This has seen it grow its customer base to 20,000 and reap handsome profits for its shareholders. The company has an enviable track record of growing EBITDA for 11 consecutive years, which is all the more impressive given it has managed to withstand the impact of the financial crisis along with a steep decline in fixed line telephony, its largest operating segment (75% of FY14A revenues). Cash generation machine. AdEPT does not own any major telecoms infrastructure, but instead, has relationships in place with all the major UK network operators and communication, who serve as suppliers. This dynamic means the company has low levels of capex ( 63k in FY14A; 80k in FY15E). As a result, it tends to throw up a lot of cash, with cash conversion averaging over 180% over the past 3 years, and estimated to average 150% over the next three years. The company s record of growing dividend and managements progressive dividend policy, is well supported by this robust cash generation. We forecast dividends to grow at a 26% CAGR over the next three years. Public sector key to near to medium term growth. AdEPT continues to successfully gain traction in the public sector. AdEPT s solutions help its local government clients achieve a material cost savings. Public sector revenue has grown from being non-existent in FY12 to 11.9% in March We expect public sector revenues to be amongst the main drivers of organic growth over the next few years. DCF based TP at 170p/share, with peer group implied value of 206p. Our 170p Target Price for AdEPT is based on our calculated NPV of DCF (8.2% WACC; 1.5% perpetuity growth rate); equating to 1.9x FY15E EV/Sales, 9.3x EV/EBITDA and 12.1x P/E. Against a peer group of London listed Telecom companies, AdEPT trades at a 41% discount to the group average. An average peer group multiple would imply a share price of 206p, which is 71% above current levels and 21% above our Target Price of 170p/share. Year End 31 March ( 'm ) 2013A 2014A 2015E 2016E 2017E Revenue EBITDA Adj. PTP Adj. Diluted EPS (p) EV/EBITDA (x) P/E (x)* DPS (p) Yield % *based on adj. diluted EPS; Source: Company data and WH Ireland Limited WH Ireland Limited, 11 St James s Square, Manchester, M2 6WH WH Ireland is authorised and regulated by The Financial Conduct Authority and is a member of The London Stock Exchange. Important disclosures and certifications regarding companies that are the subject of this report can be found within the disclosures page at the end of this document.

2 Table of contents Section Page Company profile 3 Business model 3 Network partners 3 Customised solutions 4 Customers 4 Products and services 5 Growth opportunities 6 Public sector 6 New products 8 Acquisitions 9 Valuation 10 Discounted cash flow analysis 10 Implied earnings multiples 10 Peer group comparison 11 Risk factors 11 Earnings estimates 12 Financial Statements 14 Profit and Loss Statement 14 Balance Sheet 15 Cash Flow statement 15 Directors and Management 16 Shareholding Structure 18 Disclosures 19 WH Ireland contacts 20 WH Ireland 2

3 AdEPT has over 20,000 customers spanning residential users, commercial businesses and public sector institutions A well-defined business strategy has seen EBITDA grow for 11 consecutive years Company profile AdEPT Telecom is an independent provider of voice and data telecommunications services in the UK. The company currently has over 20,000 customers spanning residential users, commercial businesses of varying sizes, and public sector institutions. It has relationships in place with all the major UK network operators and communication suppliers, through which it provides a range of telecom solutions including: landline calls, line rental, broadband, mobile and data connectivity services. AdEPT Telecom was founded in 2003 and joined AIM in February AdEPT s operations are highly automated, with its back end systems directly integrated into the backend systems of its partner carrier. This affords it with a high level of operational efficiency and provides it the ability to scale up its business, without the need to hire additional staff. The company is headquartered in Tunbridge Wells, Kent, where all of its 47 staff are based. Robust business strategy has seen earnings grow at a CAGR of 15% AdEPT has a well-defined business strategy, which has seen the company grow its EBITDA for 11 consecutive years and earnings increase at an impressive CAGR of 15% over the past three years. AdEPT s strategy focuses on four key areas: (i) (ii) (iii) (iv) Expanding its range of products to meet the ever changing needs of its customers Providing high levels of customer service to ensure customer retention Increasing public sector presence by leveraging frameworks Acquisitions, usually of customer bases from telesales operations Three key elements to AdEPT s business model AdEPT s business model essentially has 3 pillars: (i) network partners; (ii) customised solutions; and (iii) Customers Fig. 1: Supply chain Source: Company data and WH Ireland research AdEPT has relationships with all the major UK communications suppliers Network partners Network partners include BT, Virgin Media, Vodafone, amongst others. AdEPT has relationships with all the major UK network operators and communication suppliers. It works with its carrier partners to develop products and solutions as per the ever changing WH Ireland 3

4 needs of its large and diverse customers. The nature of AdEPT s business offering dictates that it carefully manages the supply risk associated with business critical communications. As a result, the company is highly selective in choosing its carrier partners, vetting them for both technical and financial stability. Customised solutions combined with high levels of customer service. Bespoke communication solutions tailored to its customers needs Over 700 multi-site customers 1,000 Premier customers, 5% of the customer base, accounted for half of FY2014 revenues AdEPT combines multi-product solutions from a number of carrier partners to provide bespoke solutions tailored to meet the specific requirements of its customers. It provides a single bill to customers and is obsessed with high levels of customer service and support. AdEPT provides dedicated account management for customers spending as little as 400 per month, which is a far lower threshold than its larger competitors. Customers AdEPT has over 20,000 customers, including over 15,000 business and dozens of public sector customers, including local governments and universities. AdEPT is a multisite and multi-product specialist, with over 700 multi-site customers taking a range of products. The company is increasingly focused on Premier customers (monthly spend of 400+), typically mid to large business and public sector institutions, who can benefit from AdEPT s ability to provide a full range of communication solutions. AdEPT currently has over 1,000 Premier customers. These represent 5% of its total customer base, but half of its FY2014 revenues. Client base includes over 15,000 business customers. AdEPT provides a wide range of communications solutions for all sizes of UK based clients, spread across a wide range of business sectors. AdEPT s sales team work with its customer base to develop competitively priced communications solutions required for their specific business needs. WH Ireland 4

5 Products and services include a wide range of voice and data solutions Customers receive a single bill for all services. All services are provided from a single head office in Kent AdEPT provides fixed line calls, line rental, mobile, data connectivity products and Voiceover-Internet Protocol (VoIP) services to thousands of business, public sector and residential customers across the UK. Customers receive a single bill for all the services they subscribe to. All of AdEPT s communication solutions are provided from a single head office location in Tunbridge Wells, Kent. AdEPT s segmental reporting classifies its communication solutions into two categories: 1. Fixed line services (75% of revenues in FY14A) AdEPT offers a comprehensive range of fixed line business telecom products catering to businesses of all sizes. The company has strategic relationships with all tier-1 suppliers, including BT, Vodafone and TalkTalk Business, to ensure customers get the best possible choice of network. AdEPT s fixed line services range from single analogue business and household landlines to complex digital multi-site solutions, offering customers the desired level of scalability. The company s obsession with customer service, value for money and industry-leading service level have led to its business customer base increase to over 15,000 customers of varying sizes from small business to mid-size and large enterprises. 2. Next generation services (25% of revenues in FY14A) Next generation services include data, mobile, inbound and VoIP services (in short: everything excluding fixed line services). I. Data connectivity II. III. IV. AdEPT provides fast high quality broadband, leased lines connections and MPLS networks. AdEPT partners with all the major networks across the UK, ensuring that its customers have the choice of the most appropriate and cost effective solution to meet their requirements. All of AdEPT s data solutions are scalable, as per its customer s needs. Data solutions are available from 2MB broadband to 100GB optical spectrum services at highly competitive rates. Mobile solutions AdEPT s Mobile solutions provides a wide variety of competitively priced mobile products and services, tailored to the specific requirements of each customer. As an independent provider, AdEPT provides mobile solutions from all the major UK mobile networks. The AdEPT Mobile team advises customers on mobile broadband packages for business and offers guidance on the wide range of the latest devices and networks. It offers the full range of the latest mobile handsets and devices, from the latest smartphone to tablet computers. Inbound solutions AdEPT s cloud/ network-based inbound call handling solutions offer a simple and scalable way to manage inbound calls. It provides customers with online access, enabling them to implement changes instantly. Customer can choose how they like their calls answered, handled and directed. Customers benefit from the low set up costs as no new hardware is required and from operating costs savings related to maintenance and technical support issues. From an operational stand point, call queuing at a network level removes strain from customer s telecoms infrastructure. VoIP solutions AdEPT s VoIP solution is backed by a secure and reliable network, providing a flexible and cost effective alternative to carrying inbound and outbound voice calls. Demand for VoIP solutions have been increasing as customers benefit from (i) better functionality versus conventional telephone lines, (ii) little/ no capital cost associated with a migration to VoIP. Given AdEPT s range of communication solutions which encompasses both traditional calls and line rental, it is well placed to handle this migration to VoIP telephony. WH Ireland 5

6 Three major growth opportunities in the near to medium term We believe AdEPT s well-defined business strategy, which saw the company grow its EBITDA for 11 consecutive years and earnings increase at an impressive CAGR of 15% over the past three years, will continue to reap great dividends for shareholders. We forecast earnings to grow at 16% over the next 3 years (FY14A-FY17E). AdEPT s solutions help its local government clients achieve highly material cost saving Public framework agreements are key to leveraging AdEPT s presence in the public sector We believe the three key tenets of growth will hinge on the following: 1. Public sector presence to continue growing AdEPT has continued to successfully gain traction in the public sector space. It currently provides communication solutions to 19 councils and a number of other public sector customers, including major universities, located across the UK. It offers various framework compliant solutions for public sector customers to meet their ongoing cost reduction initiatives, combined with full project management for the migration from the existing supplier. AdEPT s solutions help its local government clients achieve highly material cost savings to their voice and data communication needs. The majority of these savings are achieved with no hardware changes and no technology refresh costs to impact on capital budgets. This is highly significant given the tight budgetary and cost constraints the public sector has been under, during the past few years. Three major frameworks. In FY2014, AdEPT was awarded the approved supplier status to the Crown Commercial Service under the Telephony Service Framework, its third such public sector framework agreement. Prior to this it had been awarded the ja.net and ESPO Telecom Framework agreements. These public framework agreements are key to leveraging AdEPT s presence in the public sector and serve as a seal of approval, saving the customer the hassle of running a supply tender process. Fig. 2: Major frameworks awarded Source: Company data and WH Ireland research WH Ireland 6

7 Management s strategy of focusing on increasing its public sector presence, by helping customers achieve the budget reductions and cost initiatives they have been set, have begun to pay off. AdEPT has won a number of clients in the public sector space, including several county councils. Fig. 3: Public sector revenue growth % 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Public sector revenues ( '000) % of total Source: Company data and WH Ireland research 0.0% Public sector revenue has grown from being non-existent in FY12 to 4.5% of revenue in March 2013, thereon edging up to 11.9% in March Given the rate at which AdEPT continues to win public sector customers combined with cross selling and upselling to its existing customers base, we expect public sector revenues to increase robustly over the next few years and be amongst the main drivers of organic growth. WH Ireland 7

8 2. Robust demand for new products AdEPT was originally established as a fixed line telecom provider but has evolved its product offering to keep up with changes in technology and the ever evolving needs of its customers. Although revenues from fixed line services continue to be the biggest contributor to revenue, next generation services (broadband, mobile, etc.) have grown robustly. Between FY11 and FY14, revenues from fixed line services declined at a CAGR of 8%, whilst next generation services grew at a solid 13%. Next generation services share of the revenue mix increased from 15% in FY11 to 25% in FY14. Key drivers of this increase in next generation services revenues has been robust customer demand for faster data connectivity and the continued deployment on the 21st Century Network (roll out of a new IP based network by BT to replace legacy public telephone and data networks). Fig. 4: Revenue mix by operating segment, 2011A-2017E A 2012A 2013A 2014A 2015E 2016E 2017E Fixed line services Next generation services Source: Company data and WH Ireland research estimates We believe the key to AdEPT s success at countering declining fixed line revenues and, moreover growing earnings, has been the company s ability to constantly monitor product development and offerings, across data, broadband and VoIP services, to ensure customers are provided the latest communication solutions at the highest quality standards. It has added new products to its portfolio, such as 40 GB and 100 GB optical spectrum services (OSEA) and successfully sold these into its existing customer base. Communications technologies are currently seeing a number of big changes from which we believe AdEPT is well positioned to benefit. These include (i) an increased uptake of cloud or network-based services for business contact centres; (ii) increasing availability of superfast broadband services; combined with (iii) ever increasing applications being run over these networks (VoIP, Video Conferencing, etc.). We forecast next generation services to increase to 30% of total revenues in FY2020E. WH Ireland 8

9 AdEPT has completed 19 acquisitions since incorporation in More acquisitions in a highly fragmented market AdEPT is no stranger to acquisitions. It made its first acquisition within months of being incorporated in 2003, and has since successfully completed 19 acquisitions: 7 businesses and 12 customer base purchases. The UK market for residential and business telephony are vastly different. The residential market has c.10 competitors and is dominated by BT and to a lesser extent Virgin Media. The two companies cumulatively accounted for 65% of residential telecom revenues in 1Q14, according to data from Ofcom. BT alone accounted for as much as 52% of the annual revenue in this space. Fig. 5: UK Business telecom market is highly fragmented Residential Business competitors competitors 700+ Under 2m pa sales c25 Over 20m pa sales Source: Company data and WH Ireland research 5.1bn of annual sales in the UK business telephony market is divided amongst over 700 telcos Recent acquisition multiples range between 1.4x to 2.1x revenues The business end of the telecoms market is highly fragmented with over 700 companies vying for a piece of 5.1bn in annual sales. According to data from Ofcom, BT and Virgin Media accounted for c.45% of revenues this space, with the other 55% controlled by various other companies. This 2.8bn in sales attributable to the other 55% companies, is in turn divided amongst over 700 telcos; most of which have annual sales of under 2m. Just 25 companies in the business telephony space have annual sales over 20m. Not surprisingly, most of AdEPT s 19 acquisitions, over its 11 years of existence, have focused on business telephony. It acquires customer bases of smaller business customers from other telesales operations in the industry, rather than operate an in-house telesales operation. (AdEPT s in-house sales team tends to focus on acquiring larger premier clients, who account for c.50% of its revenue.) Management has explicitly stated that it is looking to acquire businesses and customer bases to complement its existing business telephony position and take advantage of the continued consolidation of the fragmented market. We expect future acquisitions to be in the range of AdEPT s 2013 and 2014 acquisitions: 1.4x to 2.1x Revenue and 4.2x to 5.6x EBITDA. WH Ireland 9

10 Our TP of 170p/share implies an over 40% upside from current levels Valuation We initiate coverage on AdEPT Telecom with a Target Price of 170/share. Our Target Price is based on our calculated Net Present Value (NPV) of Discounted Cash Flow (DCF) and implies an upside of over 40% upside from current levels leading us to initiate with a Buy rating. Table 1: Adept Telecom Discounted Cash Flow (DCF) analysis ( '000) 2015E 2016E 2017E 2018E 2019E 2020E 2021E Perpetuity EBITDA 4,391 4,343 4,316 4,225 4,133 4,039 3,943 Taxes Capex, cap. & purch. of intangibles -2, Change in working capital (use) Free Cash Flows 895 3,221 3,451 3,364 3,278 3,192 3,106 46,984 Discount rate NPV of free cash flows 827 2,767 2,769 2,533 2,324 2,139 1,972 28,358 Total of NPV of free cash flows 43,688 Net Debt (cash) 2,962 Equity value 40,726 NPV/share (p) Current price (p) Upside/ (Downside) 42% Capital Weight Cost Company beta 0.80 (Post tax) X Risk Premium 6.75 Debt 35% 6.0% + Risk free rate 4.0 Equity 65% 9.4% =Cost of Equity 9.4 WACC 8.2% Perpetuity growth rate 1.5 Source: WH Ireland research estimates Our TP implies a P/E ratio of 12.1x in FY2015E Our calculated NPV for AdEPT using a DCF methodology yields 170p/share. Key assumptions in our calculation include a company beta of 0.80, a risk premium of 6.75% and a long term risk free rate of 4% on UK gilts, which equate to a 9.4% cost of equity. Further we assume a 8% pre-tax cost of debt and a 25% long term effective tax rate which equates to a 6.0% post tax cost of debt. We assume 35% of AdEPT s capital consists of debt (in-line with historical debt to equity structure) which in turn results in a WACC of 8.2%. We assume a 1.5% perpetuity growth rate to our estimated FCF from FY2021E onwards. Implied earnings multiples On an EV/sales basis our price target of 170p/share equates to 1.9x for both our FY2015E and FY2016E sales. Table 2: Implied earnings multiples based on Target Price of 170p Earnings multiple 2014A 2015E 2016E 2017E EV/Sales EV/EBITDA P/E* P/FCF *based on adj. diluted EPS; Source: WH Ireland research estimates Our valuation equates to a 9.3x EV/EBITDA in 2015E, declining to 9.4x in FY2016E. On an adjusted diluted EPS basis, our valuation for AdEPT equates to P/E ratio of 12.1x for FY2015E and 12.3x in FY2016E. We believe that calculating a P/E ratio on an adjusted diluted EPS number is more relevant, given it excludes amortisation charges, and thus is a better barometer of the company s robust cash generation. WH Ireland 10

11 Peer group comparison We benchmark AdEPT s valuation against a peer group of telecoms companies listed in London, across the Main Market and AIM, spanning a range of market capitalisations. We believe the peer group valuation comparison below provides a useful valuation crosscheck to our DCF based methodology. Table 3: AdEPT Telecom peer group valuation comparison as at 8 September 2014 Company Ticker Price M Cap EV EV/ Sales EV/EBITDA P/E (p) ( m) ( m) FY+1 FY+2 FY+1 FY+2 FY+1 FY+2 Maintel Holdings AIM:MAI x 1.3x 9.0x 8.7x 11.1x 10.7x Alternative Networks AIM:AN x 1.7x 13.7x 11.7x 18.8x 16.1x Manx Telecom AIM:MANX x 4.2x 12.5x 12.0x 14.7x 15.0x KCOM Group LSE:KCOM x 1.5x 7.7x 7.5x 13.1x 12.7x Daisy Group AIM:DAY x 1.6x 10.2x 10.0x 13.0x 12.6x Cable & Wireless LSE:CWC ,236 1, x 1.8x 5.6x 5.2x 19.6x 17.6x TalkTalk Telecom LSE:TALK ,772 3, x 1.8x 11.3x 9.2x 21.6x 15.9x BT Group LSE:BT.A ,534 38, x 2.1x 6.2x 6.1x 13.3x 12.3x Peer group average 2.1x 2.0x 9.5x 8.8x 15.7x 14.1x AdEPT Telecom AIM:ADT x 1.3x 7.0x 7.0x 9.2x 9.2x Prem/(Discount) -36.4% -34.8% -26.1% -20.0% -41.2% -34.9% Small cap telecom average 2.2x 2.1x 10.6x 10.0x 14.2x 13.4x Prem/(Discount) -38.4% -36.7% -33.7% -29.5% -35.0% -31.6% Mid/large cap telecoms average 2.0x 1.9x 7.7x 6.8x 18.2x 15.3x Prem/(Discount) -32.9% -31.3% -8.8% 3.1% -49.3% -39.8% Source: Capital IQ and WH Ireland research AdEPT s peer group valuation implies a share price of 206p/share, which is 71% above current levels and 21% above our 170p Target Price On a 1-year forward basis, the average EV/Sales across our selected peer group of 8 telecom companies that AdEPT is benchmarked against, is 2.2x; an EV/EBITDA multiple of 9.5x and a P/E multiple of 15.7x. AdEPT trades at a discount of 36% to the peer group EV/Sales multiple, a 26% discount to the EV/EBITDA multiple and a 41% discount to the group P/E multiple of 15.7x. We believe this discount is unwarranted and note that should AdEPT trade at the peer group average multiple of 15.7x 1-year forward P/E, it would imply a share price of 206p, which is 71% above currently levels and 21% above our Target Price of 170p/share. Valuing AdEPT at the average multiple of the small cap telcos implies a share price of 186p/share; +54% versus current levels We have also calculated two separate sub group averages for small cap companies in our group of 8 and mid to large companies (which includes BT, TalkTalk and Cable & Wireless). AdEPT trades at a 35% discount to the small cap average 1-year forward multiple of 14.2x. Assuming that AdEPT s share trade at this 14.2x small cap telecom companies average multiple, implied a share price of 186p, which is 54% above current levels and c. 10% above our DCF based valuation of 170p. Risk factors AdEPT operates in a highly competitive market with rapid technological changes, introductions of new services and products, and a competitive pricing landscape. The company could fall behind its competitors on launching new products and upgrading existing offerings, which could lead to a loss of market share, revenues and profitability. The company operates in a fragmented market where bolt on acquisitions are to be expected. Although management is highly prudent in selecting acquisition targets, there are no guarantees that future acquisitions will be accretive. Additionally, acquisition of customer bases could result in initial and/or gradual customer churn, which could impact the economics of the acquisition. The company operates a lean staffing of under 50 employees. Loss of one or more of its key employees could have a material impact to revenue and profitability. WH Ireland 11

12 Earnings estimates Earnings estimates summary DPS to grow at a CAGR of 26% over the next three year period We forecast diluted EPS of 5.62p in FY2015E (+1 YoY), benefitting from (i) higher revenues (+5% YoY); and (ii) higher gross margins (+10 bps YoY); offset by a higher YoY effective tax rate at 34% (28% in FY14A). Our dividends per share (DPS) forecast for FY2015E at 4p is a third higher versus 3p in FY 2014A and equates to a 66% payout (versus 49% in FY 2014A). Our DPS estimates imply a CAGR of 26% over the period FY2014A to FY2017E. Revenues Our FY2015E revenue forecast of 21.9m is 5% higher versus the prior year, largely down to the acquisition of Bluecherry Telecom s customer base in FY2015E. We forecast no growth in revenues from FY2016E onwards, as growth in next generation services are offset by declines in fixed line services. Our revenue forecast are -1% and -2% versus current market estimates for FY2015E and FY2016E respectively. Fig. 6: Revenue and gross profit, 2011A-2017E ( m) Fig. 7: Revenue by operating segment, 2011A-2017E 100% 80% 60% 40% 20% A 2012A 2013A 2014A 2015E 2016E 2017E Revenues Gross profit 0% 2011A 2012A 2013A 2014A 2015E 2016E 2017E Fixed line services Next generation services Source: Company data and WH Ireland research estimates Source: Company data and WH Ireland research estimates Revenue from next generation services to increase from 24% of the product mix in FY15E to 27% in FY17E Fig. 8: Gross margins, 2011A-2017E 45% By operating segment, we forecast revenues from next generation services to benefit from the robust customer demand for faster data connectivity and the continued deployment on the 21st Century Network, leading to next generation services revenue increasing by 4% YoY to 5.3m in FY15E, accounting for 24% of the revenue mix. Fixed line revenues are forecasted to see a one-off growth, increasing by 6% in FY15E to 16.6m, resulting from the acquisition of Bluecherry s customer base. We forecast the Bluecherry acquisition to result in a one-off increase of fixed line revenue in the sales mix to 76% (75% in FY14A). From FY16 onwards, we expect next generation services to steadily grow as a percent of the group s revenue mix, reaching 27% in FY17E. Gross profit and gross margins Fig. 9: Gross profit by operating segment, 2011A-2017E 100% 40% 35% 30% 80% 60% 40% 20% 25% 2011A 2012A 2013A 2014A 2015E 2016E 2017E Gross margin Fixed line services Next generation services 0% 2011A 2012A 2013A 2014A 2015E 2016E 2017E Fixed line services Next generation services Source: Company data and WH Ireland research estimates Source: Company data and WH Ireland research estimates WH Ireland 12

13 Gross margins are forecast to increase by 10 bps YoY to 36.5% for FY15E, benefitting from gross margin growth across both operating segments. We estimate gross margins to grow a further 10 bps in FY16E, resulting from higher margins across both operating segments. Our EBITDA forecasts are +5% versus market estimates in FY2015E and +3% in FY2016E Low capex results in high cash generation. Cash conversion averaged 180% in the past 3 years; 151% over next 3 years Dividends supported by robust free cash flow generation Gross profits are forecast to increase 6% in FY2015E to 8m, benefiting mainly from higher revenues (+5% YoY) and marginally higher gross margins (+10 bps YoY). For FY2016E, we forecast gross profits to stay largely flat as a result of zero revenue growth. Our gross profit forecast stand +1% ahead of market estimates for FY2015E and in-line for FY2016E. EBITDA and EBITDA margins AdEPT has a highly automated back end system which is directly integrated into the back end systems of its partner carriers. This affords it with a high level of operational efficiency and provides it the ability to scale up its business, without the need to hire additional staff. We note that the acquisition of customer databases does normally require any significant additions to AdEPT s employee count, which stood at 47 people (including 3 Non Exec. Directors) at the end of March At a general and administrative expenses level, we forecast a 2% growth YoY, which is inline with the average rate over the past year. Our resultant EBITDA forecast is 9% higher YoY at 4.4m in FY15E, benefitting from higher revenues and gross margins. For FY16E, we forecast EBITDA to decline by 1% as higher G&A costs (+2% YoY) fail to be offset by flat revenues and modest gross margin growth. At an EBITDA level, our forecasts stand 5% and 3% above market estimates for FY2015E and FY2016E respectively. Our implied EBITDA margins are expected to increase by 60 bps YoY to 20% in FY2015E and thereon decline by 20 bps in FY2016E to 19.8%. Earnings per share (EPS) We forecast diluted EPS to increase 1% in FY2015E to 5.62p, benefitting from (i) higher revenues (+5% YoY) and (ii) higher gross margins (+10 bps YoY); marginally offset by a higher YoY effective tax rate at 34% (28% in FY14A). In FY16E, we forecast diluted EPS to tend up by 6%, largely down a lower effective tax rate (32% versus 34% in FY2015E). Cash conversion machine AdEPT does not own any major telecoms infrastructure, but instead, has relationships in place with all the major UK network operators and communication, who serve as suppliers. This dynamic means the company s capex is next to nothing ( 63k in FY14A; 80k in FY15E and 16E). As a result, AdEPT business model tends to throw up a lot of cash, with cash conversion (Operating cash flow/ operating income) averaging over 180% over the past 3 years. We estimate cash conversion to average 151% over the FY15E to FY17E period. Dividend per share (EPS) and Free Cash Flows per share (FCF/share) We believe the company s record of growing dividend and managements progressive dividend policy, is well supported by robust cash generation. Our dividends per share (DPS) forecasts for FY2015E at 4p (+33% YoY), equates to 99% of our FCF/share estimate; which includes a 2.1m acquisition of Bluecherry s customer base and a 0.2m cash payout related to a deferred consideration for the 2013 Bluebell acquisition. In FY2016E, we forecast dividends to tick up by a penny to 5p (+25% YoY), equating to a 34% of FCF/share at 14.6p/ share. Our DPS estimates for FY2015E and FY2016E are inline with market expectations. WH Ireland 13

14 Financial Statements Profit and Loss Statement Year End 31 March ( 000) 2011A 2012A 2013A 2014A 2015E 2016E 2017E Revenues 23,734 21,913 21,023 20,852 21,945 21,945 21,945 Cost of sales 16,665 14,851 13,762 13,268 13,942 13,918 13,871 Gross profit 7,069 7,062 7,261 7,584 8,003 8,027 8,074 Gross margin 29.8% 32.2% 34.5% 36.4% 36.5% 36.6% 36.8% Selling, general and admin expenses 3,445 3,411 3,529 3,541 3,612 3,684 3,758 Share based compensation EBITDA 3,624 3,651 3,732 4,043 4,391 4,343 4,316 EBITDA margin 15.3% 16.7% 17.8% 19.4% 20.0% 19.8% 19.7% Depreciation, amortisation, etc. 1,673 1,832 1,936 1,934 2,066 1,944 1,742 Operating profit 1,951 1,819 1,796 2,109 2,326 2,399 2,575 Operating margin 8.2% 8.3% 8.5% 10.1% 10.6% 10.9% 11.7% Net financial expense (income) Other (gain) loss Pre-tax profit 752 1,190 1,637 1,845 2,023 2,096 2,272 Taxes Tax rate 65.0% 50.7% 39.9% 27.9% 33.7% 32.4% 30.4% Net profit ,330 1,342 1,416 1,582 Net profit attributable to shareholders ,330 1,342 1,416 1,582 Net Margin 1.1% 2.7% 4.7% 6.4% 6.1% 6.5% 7.2% Basic shares outstanding ('000) 21,067 21,067 21,067 21,552 22,070 22,070 22,070 Basic EPS (p) Adjusted Basic EPS (p) Diluted shares outstanding ('000) 24,097 24,286 24,339 23,932 23,867 23,867 23,867 Diluted EPS (p) Adjusted Diluted EPS (p) Dividends ,103 1,324 Dividend payout % 32.1% 48.6% 65.8% 77.9% 83.7% Dividend per share (p) Source: Company data and WH Ireland research estimates WH Ireland 14

15 Balance Sheet Year End 31 March ( 000) 2011A 2012A 2013A 2014A 2015E 2016E 2017E ASSETS Cash & cash equivalents 1,361 1,869 1,639 3,777 3,600 5,524 7,458 Accounts receivable 2,758 2,864 2,138 2,332 2,787 2,787 2,787 Other Current Assets 4,119 4,745 3,781 6,113 6,391 8,315 10,250 Intangibles 17,054 15,347 14,615 15,018 15,335 13,785 12,198 Net fixed assets Other long-term assets Long-term assets 17,458 15,514 14,789 15,212 15,576 14,062 12,501 Total Assets 21,577 20,259 18,570 21,325 21,967 22,378 22,750 LIABILITIES Accounts payable 3,957 3,473 3,238 3,854 3,923 3,911 3,915 Short-term debt 1,456 1,206 3,106 1,206 1,206 1,206 1,206 Taxes and others Current Liabilities 5,638 5,040 7,020 5,089 5,158 5,146 5,150 Long-term debt 7,270 6,001 1,803 5,533 5,533 5,533 5,533 Reserves and other Long-term liabilities 7,376 6,138 1,803 5,533 5,533 5,533 5,533 Issued share capital 2,107 2,107 2,107 2,194 2,194 2,194 2,194 Share premium 7, Other reserves Retained earnings -1,509 6,974 7,640 8,320 8,893 9,316 9,684 Total Equity 8,563 9,081 9,747 10,703 11,276 11,699 12,067 Total liabilities & equity 21,577 20,259 18,570 21,325 21,967 22,378 22,750 Source: Company data and WH Ireland research estimates Cash Flow Statement Year End 31 March ( 000) 2011A 2012A 2013A 2014A 2015E 2016E 2017E Operating profit 1,928 1,798 1,791 2,102 2,326 2,399 2,575 Depreciation Amortisation of Intangibles 1,620 1,804 1,907 1,900 2,033 1,899 1,687 Taxes Share based compensation Others Cash flow from operations (CFO) 2,968 2,662 3,732 4,043 3,710 3,664 3,627 Capex Acquisitions & divestitures ,176-2, Cap. and purchase of intangibles Others Net investments ,253-2, Change in working capital (use) Free cash flow (FCF) 2,926 2,547 2,987 1, ,221 3,451 Free cash flow per share (p) Net interest received (paid) Dividends paid ,214 Capital increase (decrease) Debt issued (redeemed) -1,572-1,543-2,350 1, Others , Cash flow from financing -2,450-2,039-3, ,072-1,296-1,517 Net increase(decrease) in cash , ,925 1,934 Source: Company data and WH Ireland research estimates WH Ireland 15

16 Roger Wilson served as the first MD of Telewest s residential consumer business John Swaite has served as FD since He worked for AdEPT s auditor on its 2006 AIM floatation Directors and Management AdEPT s Board currently has seven Directors, three of who serve in a Non-Executive capacity. The Board is highly experienced in the telecoms business with skill sets spanning senior executive roles, strategy, operations, finance and sales. Ian Fishwick, who serves as CEO is a telecoms industry veteran, with two decades of experience in senior executive roles, prior to founding AdEPT in Table 4: AdEPT Telecom Senior Management and Board of Directors Name Position Held Roger Wilson Non-Executive Chairman Christopher Fishwick Non-Executive Deputy Chairman Ian Fishwick Chief Executive Officer John Swaite Finance Director Amanda Woodruffe Chief Operating Officer Joe Murphy Sales Director Dusan Lukic Non-Executive Director Source: Company data and WH Ireland research Roger Wilson, Non-Executive Chairman Roger Wilson is a telecom industry veteran with over two decades of experience. He served as the first Managing Director for Telewest Communications residential consumer business in the UK from 1997 to He spent 3 years between 1998 and 2001 in Poland establishing a telecom business. He served as Managing Director of the European Competitive Telecommunications Association (ECTA) until January Christopher Fishwick, Non-Executive Deputy Chairman Chris Fishwick spent 25 years in the City, starting his career as a Member of the London Stock Exchange, and latterly as Chief Executive of Aberdeen Asset Managers Limited. In addition to his rich City experience, Mr Fishwick has extensive experience as a Director of quoted companies. He has served on the boards of more than 15 quoted companies covering a range of sectors including Technology, Asset Management, Insurance and Property. He has spent the last five years as a venture capitalist investing in smaller quoted and unquoted companies. Ian Fishwick, Chief Executive Officer Ian Fishwick founded AdEPT in 2003, and has served as CEO since. Prior to founding AdEPT Mr. Fishwick spent 15 years as a senior executive in the telecoms industry. From 1983 to 1995 he worked at Marconi Secure Systems, where he held a number of senior positions including Financial Controller and subsequently Managing Director. From 1996 to 2000 he served as a Managing Director at Telewest Communications, managing Telewest North West, Telewest London and South East, and Cable London. He went on to serve as Managing Director of World Access (UK) Limited from 2000 to John Swaite, Finance Director John Swaite joined AdEPT in 2008 as Financial Controller and was promoted to the position of Finance Director the same year. Prior to AdEPT Mr Swaite spent the good part of a decade with Horwath Clark Whitehill, AdEPT s auditor, successfully rising to senior manager level. Whilst working for AdEPT s auditor, he worked on the company s 2006 flotation on AIM in February. Amanda Woodruffe, Chief Operating Officer Amanda Woodruffe serves as Chief Operating Officer of AdEPT. Mrs. Woodruffe is highly experienced in operational roles, having had a successfully career in a number of major companies. She worked at BT as a customer service trouble-shooter. She subsequently worked for Telewest where she worked with Amanda with Ian Fishwick on the cable mergers of Kent, Essex, and London, prior to being promoted to a national role. She was a key member of the team that set up the discount airlines Go and Hapag-Lloyd Express. She went on to work as an operations consultant, working on a number of international assignments for companies such as Sonera (mobile) and BoStream (broadband in WH Ireland 16

17 Sweden). She also worked as a consultant at EdExcel following the highly-published A- level fiasco in EdExcel went on to become 'best examination board' in Joe Murphy started his career at BT Wholesale and has been at AdEPT for almost a decade Joe Murphy, Sales Director Joe Murphy joined AdEPT in 2005 after beginning his career as a graduate at BT Wholesale. He worked within the Service Provider channel at BT, selling into the emerging ISP and Switchless Reseller markets before joining BT s specialist VoIP venture Eescape. Mr Murphy successfully led the AdEPT indirect Sales function until May 2009, creating one of the industry s leading Reseller Channels. He was promoted to the position of Sales Director in May 2009 and was appointed to the plc Board a year later. Dusan Lukic, Non-Executive Director Dusan (Dusko) Lukic is a veteran stockbroker, having spent 20 years covering UK and Continental European equity markets. During his career in stock broking he worked at Wood Mackenzie, Salomon Brothers, Schroder Securities and, latterly, Cazenove. At Cazenove, Mr Lukic served as the director responsible for Pan European equity sales to German institutions. He subsequently worked in private equity and asset management. WH Ireland 17

18 Shareholding structure Free float is estimated at 51.8% Christopher Fishwick is the largest shareholder with a 29.1% holding AdEPT currently has 22.1m basic shares outstanding. The company s 3 largest shareholders own a combined 54.4% of shares outstanding. Insider ownership is estimated at 43% and free float at 51.8% (Source: Capital IQ). Christopher Fishwick, who serves as AdEPT s Non-Exec. Deputy Chairman, is the largest shareholder with a 29.1% stake. Other large insider holdings in the company include that of AdEPT s CEO, Ian Fishwick, with a 5.4% stake in the company and Chairman, Roger Wilson who has a 3.6% interest. Table 5: AdEPT Telecom major shareholders Name Shares held (m) % Outstanding Christopher Fishwick % Greenwood Investments Limited % Fiske & Co clients account % Ian Fishwick % Allan Gauld % Octopus Investments % Roger Wilson % Brewin Dolphin Securities % Hargreave Hale % Patricia Wilson* % Others % Total shares outstanding % *Spouse of Roger Wilson; Source: Company data and WH Ireland research There are five institutional shareholders exceeding the 3% holdings threshold; who have an aggregate holding of 36%. Greenwood Investments is the largest institutional holder with 3.4m shares, equating to a 15.2% interest. Fiske & Co with a 10% interest and Octopus Investments with a 3.9% holding, round up the top three. WH Ireland 18

19 Disclosures WH Ireland Recommendation Definitions Buy Expected to outperform the FTSE All Share by 15% or more over the next 12 months. Outperform Expected to outperform the FTSE All Share by 5/15% over the next 12 months. Market Perform Expected to perform in line with the FTSE All Share over the next 12 months. Underperform Expected to underperform the FTSE All Share by 5/15% or more over the next 12 months. Sell Expected to underperform the FTSE All Share by 15% or more over the next 12 months. Speculative Buy The stock has considerable level of upside but there is a higher than average degree of risk. Share Price Target The share price target is the level the stock should currently trade at if the market were to accept the analyst s view of the stock and if the necessary catalysts were in place to effect this change in perception within the performance horizon. Stock Rating Distribution As at the quarter ending 30 Jun 2014 the distribution of all our published recommendations is as follows: Recommendation Total Stocks Percentage % Corporate Buy Speculative Buy Outperform Market Perform Underperform Sell Total This table demonstrates the distribution of WH Ireland recommendations. The first column illustrates the distribution in absolute terms with the second showing the percentages. Conflicts of Interest Policy This research is classified as being non-independent as defined by the FCA s Conduct of Business Rule Please refer to for a summary of our conflict of interest policy. WH Ireland has acted as manager in the underwriting or placement of securities of this company within the last 12 months. Marketing Communication This document has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Please refer to important disclosures towards the end of this document. Disclaimer This research recommendation is intended only for distribution to Professional Clients and Eligible Counterparties as defined under the rules of the Financial Conduct Authority and is not directed at Retail Clients. This note contains investment advice of both a general and specific nature. It has been prepared with all reasonable care and is not knowingly misleading in whole or in part. The information herein is obtained from sources which we consider to be reliable but its accuracy and completeness cannot be guaranteed. The opinions and conclusions given herein are those of WH Ireland Ltd and are subject to change without notice. The report is not an offer or solicitation to buy or sell any security. Clients are advised that WH Ireland Ltd and/or its directors and employees may have already acted upon the recommendations contained herein or made use of all information on which they are based. WH Ireland is or may be providing, or has or may have provided within the previous 12 months, significant advice or investment services in relation to some of the investments concerned or related investments. Traders and salespeople may express opinions on the company that do not align with the opinions stated in this report. Recommendations may or may not be suitable for individuals clients and some securities carry a greater risk than others. Clients are advised to contact their investment advisor as to the suitability of each recommendation for their own circumstances before taking any action. No responsibility is taken for any losses, including, without limitation, any consequential loss, which may be incurred by clients acting upon such recommendations. The value of the securities and the income from them may fluctuate. It should be remembered that past performance is not necessarily a guide to future performance. For our mutual protection, telephone calls may be recorded and such recordings may be used in the event of a dispute. No part of this document is to be copied or distributed without prior consent. By accepting this document, you agree to be bound by the disclaimers stated above. Please refer to for a summary of our conflicts of interest policy and procedures. Analyst Certification The research analyst or analysts attest that the views expressed in this research report accurately reflect his or her personal views about the subject security and issuer. Companies Mentioned Company Name Recommendation Price (p) Price Date/Time Alternative Networks N/C September/ Day close BT Group N/C September/ Day close Cable & Wireless N/C 50 8 September/ Day close Daisy Group N/C September/ Day close KCOM Group N/C 98 8 September/ Day close Maintel Holdings N/C September/ Day close Manx Telecom N/C September/ Day close TalkTalk Telecom N/C September/ Day close Vodafone N/C September/ Day close Share Price Date/Time Company Name Recommendation Price (p) Price Date/Time AdEPT Telecom BUY September/ Day close Summary of Company Notes Headline Initiation of coverage: Dialling up dividends 9 September 2014 Summary of Security Recommendations Recommendation From To Analyst BUY 9 September CA Current Analyst (CA), Previous Analyst (PA) Date WH Ireland 19

20 Error! Unknown document property name. Contacts Research John Cummins Consumer/Support Services Eric Burns Technology Matthew Davis Technology Brendan D Souza TMT/Oil & Gas brendan.dsouza@wh-ireland.co.uk Oliver de Giorgio-Miller Life Sciences oliver.degiorgio-miller@wh-ireland.co.uk Ian Berry Industrials/Media ian.berry@wh-ireland.co.uk Alex Pye Healthcare alex.pye@wh-ireland.co.uk Paul Smith Mining paul.smith@wh-ireland.co.uk Nick Spoliar Support Services nick.spoliar@wh-ireland.co.uk Miles Nolan Head of Communications miles.nolan@wh-ireland.co.uk Sales & Trading Jasper Berry Head of Sales jasper.berry@wh-ireland.co.uk David Kilbourn david.kilbourn@wh-ireland.co.uk John Clements jonathan.clements@wh-ireland.co.uk Harry Ansell harry.ansell@wh-ireland.co.uk Glenn Poulter glenn.poulter@wh-ireland.co.uk Richard Merry richard.merry@wh-ireland.co.uk Investor Relations Jessica Metcalf Head of Investor Relations jessica.metcalf@wh-ireland.co.uk Margaret Featherby margaret.featherby@wh-ireland.co.uk Francesca Dellanzo francesca.dellanzo@wh-ireland.co.uk WH Ireland is a member of The London Stock Exchange and is authorised and regulated by The Financial Conduct Authority.