The Lockdown Series

Datalex ($DLE.ID): A leading airline software provider. A flight path to €1 and higher is achievable. 100%+ upside.

It is difficult to consider an Irish corporate that has had to deal with more challenges and headwinds in recent years than Datalex. One would have to consider the Irish banks in 2008 or, maybe even, Elan pharmaceuticals in 2002. There has been a restatement of accounts, a complete change of management, a boardroom reshuffle, a stock market delisting and the collapse of the airline industry globally due to COVID.

Despite this, Datalex has endured thanks to shareholder support via a loan facility and large airline customer support and is well positioned to participate in a multi-year recovery in the airline industry. Such progress will be well received by shareholders that have been through an eventful and stressful few years.

As a company, Datalex remains a leader in software solutions to support global airlines with their airfares and ancillary (non-airfare) revenue on an omni channel basis. It’s software revenue model means that as travel activity recovers so will its revenue and profits – making it a leveraged travel recovery play.

In the last week it has managed to surprise the market positively with a better profit outlook. It raised guidance for FY 2020 from $750k to $1.5mn to a range of $3.75mn to $4.5mn. The top end of the range would place the stock on an EV/EBITDA of 15x i.e $66mn / $4.5mn. While today’s multiple is elevated, it does not factor in the potential operating leverage in the business on a much leaner cost base looking out through 2021 and 2022. We believe that in 2 – 3 years Datalex can return to $45mn of revenue and 20% EBITDA margin. If so, the shares will be worth 1.3 euro versus 55 cents today. With 100%+ upside, we would use any weakness to buy and add the share to our “Lockdown Series”.

What is happening with air travel?

In a lockdown era, it is easy to lose global perspective. The airline industry is recovering in Asia, improving modestly in the US but remains in the doldrums in Europe. Despite the industry fallout, Datalex has seen its main airline customers remain supportive through a turbulent 2 years.

Despite its European presence, Datalex is really an Americas and Asia driven business. In 2019 the US was 45% of its revenue and Asia was 25%. Europe was only 15% with other regions making up the tail. This means that it will experience the domestic recovery in Asia and US air travel quicker than other European airline and travel shares.

What sort of recovery could we see? This month the CEO of Delta spoke about “the light at the end of the tunnel”. By 2022 analysts are expecting that JetBlue (domestic US) total revenues will be 85% of 2019. This is one of Datalex most significant customers. If we take an Asia quoted bell weather, like Cathay Pacific, analysts are currently penciling in revenue for 2022 at 90% of 2019. A 2 year recovery is definitely in keeping with the Lockdown Series mindset.

What does this mean for Datalex revenue?

How Datalex makes it money is broken down into 2 main areas: Service revenue and Platform revenue (i.e transaction based) – this means in its client contracts there are both fixed and variable components. This has allowed the company to maintain revenue ($13mn in H1 2020) despite air travel collapsing. Platform revenue was down to $7.7mn from $13.6mn in H1 2019. Service and consulting made up the balance of $5.6mn in H1 2020.

Looking out 2 years – what can revenue recover to? In 2019 and 2018, Datalex did $45mn of revenue. 2016 and 2017 were the Lufthansa years, with revenue increasing to $55mn and $63mn. However, the contract while a major win initially created significant complexities and costs of delivery for the company and contributed to the challenges experienced in the last 2 years.

The simple question is can Datalex get back to $45mn of revenue again? And how quickly? Its important to note that 80% of its revenue comes from 8 airlines and one significant win can move the needle for the company – so it is not just about the overall travel recovery.

So far, its larger airline clients have remained loyal and vocal in the public domain about their support for Datalex. We imagine the last headache a larger airline needs now is to replace a software system – but there will always be the risk of some churn in a software business and they reference 2 losses in 2021 in their latest H1 2020 update [noting they will be able to mitigate such at a profit and cost saving level]

More importantly, we believe the structural growth in ancillary (non-airfare) revenue will continue and some commentators are saying COVID will only accelerate this trend. Datalex is well positioned to capitalise on such as a provider of software to support such including omni-channel initiatives like Datalex Merchandiser.

In short, airfares will fall but all the other items we spend money on – seats, bags, cars, retail, hotels will rise. You can read more on the dynamic here:

In terms of the revenue outlook one should expect more airlines to engage Datalex to allow them to participate in this structural trend as the COVID doldrums subside.

Cash is king – a leaner ‘2015’ mindset.

Datalex use to be a much much leaner organisation that really saw its cost base inflate in recent years. Between 2015 and 2017 its headcount went from 190 staff to 270. In the last 2 years it has been through heavy restructuring with the headcount falling 25% , meaning that a recovery in platform revenue (activity based) will increasingly flow to the bottom line.

To give you a sense, in 2015 the company delivered $46mn of revenue and the total of COGS and Opex was $37mn. In 2019, the revenue number was $48mn and the COGS and opex were at $47mn. The foundation is set for improved operating leverage as there has been significant restructuring with the headcount back to 2015 levels of approximately 200 staff.

Operating cash flow is important. This was one of the warning flags in Datalex in 2017, as while EBITDA was improving in 2016 and 2017 the free cash flow generation was deteriorating. One factor was a ramp in capitalised R&D which was helping EBITDA but hurting cash flow as the acquisition of intangible assets (R&D) ramped in 2016 and 2017. However, no one expected the subsequent years to play out as dramatically as they did. Fortunately, this practice in recent reported results looks to be marginal. We would note that at the half year stage accounts receivables look elevated relative to revenue and warrants monitoring in future results – these may be temporary factors – noting it kept its credit related loss forecasts flat on H1 2019.

In software businesses, revenue recognition under complex accounting standards can create distortions in accounting revenue and profits versus cash flow. A key metric to watch with Datalex going forward will be its cash flow conversion from EBITDA. How is it doing in this regard? The operating cash flow in H1 2020 was $2.7mn despite a horrific trading environment in the first half of the year and an EBITDA loss. This looks to be very positive and means its operating cash flow margin was around 20% and inline with pre 2017 EBITDA and FCF margins.

This point is re-iterated in its recent guidance update. Full year 2020 guidance revisions are due to the improved revenues in the second half of the year, enhanced revenue recognition, non-recurring employee cost savings in 2020 and the release of certain balance sheet bad debt provisions.

As you can see, a lot of moving parts, but its important to not lose sight of the bigger picture and the potential of the business. 3 key factors: $45mn revenue + 20% EBITDA margin + good cash flow conversion. Simple. If the company can achieve this, shareholder returns will be healthy.

What EBITDA margin is achievable? What’s it worth?

Between 2012 and 2015, Datalex delivered an EBITDA margin of 20% and decent cashflow conversion. We believe that is possible again and that on $45mn of revenue the company can get back to $9mn of clean EBITDA.

What’s the right multiple? There are not perfect comps. Sabre is a large cap trading at 21x EV/EBITDA and Amadeus (GDS booking system) trades at 16x EV/EBITDA. For simplicity, we will use 15x EBITDA which is the current multiple at the high end of year end guidance.

What does that mean for valuation? $9mn 2022e of EBITDA x 15 multiple is an optimistic scenario. An enterprise value of $135mn needs to be adjusted for $13mn of loan support (due in November 2021) provided by its largest shareholder, Dermot Desmond, who owns 29% of the shares. Adjusting for this loan, the target EV points to a €103mn of potential equity value and €1.3 per share on the current share count. That compares to €0.55 today. A compelling opportunity as we emerge from the travel slump!

Collective Finance Research

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