Xavi Solutions: Updated financial targets and goodwill write-offs

Research Update

2023-01-19

07:20

Redeye provides a research update following Xavi Solutions’ updated financial targets. In connection with the announcement, the company also made goodwill write-offs that will affect its Q4 2022 result. Accordingly, we make forecast adjustments to reflect the new financial targets, leading to a revised fair value range.

Jacob Svensson

Fredrik Nilsson

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Goodwill write-offs affecting Q4 2022

Xavi Solutions announced a goodwill write-down of SEK28.9m in connection with the preparation of closing its books for 2022 and the associated review of impairment needs. The write-down is attributable to the Solve segment (Frontwalker Group SEK13.9m) and the Serve segment (Tavana IT SEK15m), which does not affect its cash flow. In addition, Xavi Solutions will do a write-off of approximately SEK2.0m within the Ventures segment. According to management, this is because of the market slowdown due to geopolitical uncertainties affecting the segment’s expected cash flow generation.

Updated financial targets

In accordance with the announcement, Xavi Solutions updated its financial targets to achieve net sales of approximately SEK154m by the end of 2025 with an EBITA of approximately SEK11m. This is lower than the previously communicated targets of net sales of SEK185m by the end of 2024 with earnings after tax of approximately SEK11m, while it is also a postponement by 12 months. Consequently, we make forecast adjustments to reflect its new financial targets, which indicate slower operational momentum than our previous estimates.

Forecast adjustments with a new fair value range

We decrease our sales forecast by 4% and 12% for 2023e and 2024e, while we expect sales of SEK150m by 2025e (SEK172m) compared to Xavi Solutions’ target of SEK154m. Furthermore, we expect an EBITA of SEK9m by 2025e (SEK14m), slightly below its target of SEK11m. Altogether, our DCF gives rise to a new Base Case of SEK0.60 (SEK0.75) per share, while our new Bear and Bull Cases are SEK0.20 (SEK0.25) and SEK1.25 (SEK1.30), respectively.

SEKm	2020	2021	2022e	2023e	2024e
Revenues	8.7	118.5	115.6	122.1	135.5
Revenue Growth	nm.	1263%	-2.5%	5.6%	11.0%
EBITDA	-1.8	4.5	3.4	4.0	7.0
EBIT	-4.3	0.36	-31.0	0.33	2.8
EBIT Margin	-49.7%	0.3%	-26.8%	0.3%	2.1%
Net Income	-5.7	-1.7	-32.1	-0.07	1.9
EV/Revenue	1.7	0.2	0.3	0.2	0.2
EV/EBIT	-3.4	69.2	-1.2	72.0	7.7

Case

A Swedish IT consulting group ready to scale up

As a Swedish IT consulting group providing specialised know-how in the structurally growing IT space, Xavi Solutions and its team of experts add value to clients by making them more competitive with digital solutions. With the recent strategic shift to a complete IT consultancy following divestments and operational streamlining, and with group functions that we believe can handle larger volumes at limited cost increases, we see Xavi Solutions poised for growth with improved profitability. As such, solid quarterly reports and M&A will act as future catalysts.

Evidence

The transformation is starting to materialise

Given its solid customer base and recently sharply increased sales through acquisitions, we note that Xavi Solution has validated its business model with a competitive strategy while the company now has the scale to execute its strategic transition to a complete IT consulting group. Moreover, we believe its current EBIT levels around breakeven and its headroom to scale up at limited incremental cost increases suggest solid profitability as Xavi Solutions grows.

Challenge

In need of coveted employees

Attracting and retaining coveted employees, the most valuable asset for any IT consulting firm, is critical, which is a challenge for Xavi Solutions. However, Xavi Solutions works actively with the company culture, which signifies by its Great Place to Work certification. We argue that this certification, combined with the use of Talent Acquisition Specialists (TAS), ensures a good corporate culture with satisfied employees while it supports the company in attracting and retaining skilled and experienced employees.

Challenge

Will it succeed in transforming into a profitable IT consultancy?

While IT consulting companies are generally cash-flow-generating businesses, one challenge for Xavi Solutions is to succeed in transforming into a profitable one. Moreover, the competition for talented employees has driven up salaries in the industry over the years, which could harm margins. However, with its possibility of handling larger volumes with limited overhead, we believe that Xavi Solutions has set the foundation to become profitable, implying scalability and profitability improvements as the company grows.

Valuation

Low EV/S does not reflect its potential

Our DCF model indicates a Base Case of SEK0.60 per share and Bear and Bull cases of SEK0.20 and SEK1.25, respectively. We argue that Xavi Solutions’ shift towards a complete IT consulting company has not been seen fully fundamentally yet, creating an interesting opportunity based on its current EV/S multiple. As this shift materialises to a greater extent, we argue that Xavi Solutions can shrink the valuation gap to its peers.

Updated financial targets and goodwill write-offs

In accordance with the recent announcement, Xavi Solutions updated its financing targets as follows:

Xavi Solutions will primarily have an organic growth strategy supplemented by smaller acquisitions

The company will be profit and dividend maximizing

Achieve net sales of approximately SEK154m by the end of 2025

Achieve an EBITA of approximately SEK11m, corresponding to a margin of ~7%

The company’s new financial targets are lower than the previously communicated targets of net sales of SEK185m by the end of 2024 with earnings after tax of approximately SEK11m, while the targets are postponed 12 months to the end of 2025. We believe the updated financial targets are a soft signal to investors, which witnesses a slower operational momentum than our previous estimates. However, given Xavi Solutions’ M&A aspirations, we appreciate seeing that the company has gone from an earnings after-tax target to an EBITA target, as a substantial part could be amortised on account of future acquisitions. Moreover, we argue that EBITA is more widespread among IT consulting companies, making Xavi Solutions more comparable to relevant peers.

Worth mentioning is that we did not believe that Xavi Solutions would reach its previous targets, with estimated net sales of SEK154m by the end of 2024 and SEK172m by 2025 in our Base Case. However, our previous estimates were still above the current adjusted financial targets. Accordingly, we make forecast adjustments to reflect its new financial targets, which will be discussed below.

Furthermore, Xavi Solutions announced a goodwill write-down of SEK28.9m in connection with the preparation of closing its books for 2022 and the associated review of impairment needs. The write-down is attributable to the Solve segment (Frontwalker Group SEK13.9m) and the Serve segment (Tavana IT SEK15m), which does not affect its cash flow. In addition, a write-down of approximately SEK2.0m is done within the Ventures segment. According to management, this is because the segments’ generation of cash flows will take longer than expected due to external factors such as a market slowdown due to geopolitical uncertainties, like the war in Ukraine. As such, we will keep track of other IT consultancy companies to investigate if the market slowdown is widespread in the industry.

Estimate changes

We take a stance on Xavi Solutions’ updated financial targets and make forecast adjustments. First, we decrease our sales estimates for 2023e and 2024e by 4% and 12%, respectively. In addition, we expect sales of SEK150m by 2025e (previously SEK172m), compared to Xavi Solutions’ sales target of SEK154m for the same year.

Consequently, this will lead to a lowered EBITA and to relate to the updated financial targets, we now expect Xavi Solutions to reach an EBITA of SEK9m by 2025e (previously SEK14m), slightly below its target of SEK11m for the year. See the table below for further estimate adjustments in our Base Case.

Valuation - New fair value range

Altogether, our DCF gives rise to a new fair value range thanks to our previously mentioned forecast adjustments. Our new Base Case is SEK0.60 (SEK0.75) per share, while our new Bear and Bull Cases are SEK0.20 (SEK0.25) and SEK1.25 (SEK1.30), respectively.

People: 3

Xavi Solutions receives an average rating within the People rating judging by the qualities of its management, board members and owners, as well as its actions and track record. The CEO, Nicklas Raask, has a solid background from large international companies and has experience within one of Xavi Solutions subsidiaries and thus knows its operations very well. The board has relevant and complementary expertise, including entrepreneurial skills and experience from publicly listed companies and within the IT industry, which we like. To achieve a higher score in the future, we want to see management executing its current strategic plan.

Business: 3

Xavi Solutions achieves an average score in the Business category due to several aspects. First, Xavi Solutions offers clear value creation for its customers by increasing their competitiveness and efficiency through digital solutions and applications adapted to their day-to-day operations. Second, IT consulting firms are generally stable cash flow-generating businesses that create value for their shareholders. And third, with its niche focus on digital/tech, structural trends are driving the market, while there is a pent-up need for the right skills in the market that means higher underlying demand than the market growth figures suggest. However, to improve this rating in the future, we want to see Xavi Solutions grow its business with stable profitability while taking a larger market share.

Financials: 1

Xavi Solutions receives a lower rating for Financials than for the other two categories, and the main reason is that this category takes into account several years of history. We argue that Xavi Solutions is undergoing a strategic shift to a pure IT consulting business that has affected its historical continuity. Therefore, it takes time to affect the historical figures measured in this category because of its lagging characteristics. However, we believe that Xavi Solutions will continue to grow its business and achieve stable profitability, which may mean a higher rating in this category in the future.

Income Statement

Income statement
SEKm	2020	2021	2022e	2023e	2024e
Revenues	8.7	118.5	115.6	122.1	135.5
Cost of Revenue	1.4	20.2	20.9	22.7	24.2
Operating Expenses	9.1	93.8	91.3	95.4	104.3
EBITDA	-1.8	4.5	3.4	4.0	7.0
Depreciation	0.01	0.12	0.10	0.12	0.20
Amortizations	0.00	0.03	30.9	0.06	0.07
EBIT	-4.3	0.36	-31.0	0.33	2.8
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	1.3	2.2	1.3	0.40	0.40
Net Financial Items	-1.3	-2.2	-1.2	-0.40	-0.40
EBT	-5.7	-1.8	-32.1	-0.07	2.4
Income Tax Expenses	0.04	-0.15	0.00	0.00	0.55
Net Income	-5.7	-1.7	-32.1	-0.07	1.9

Balance Sheet

Balance sheet
Assets
Non-current assets
SEKm	2020	2021	2022e	2023e	2024e
Property, Plant and Equipment (Net)	0.29	0.25	0.16	0.41	0.61
Goodwill	55.4	58.9	30.0	30.0	30.0
Intangible Assets	0.15	0.00	-2.0	-1.7	-1.4
Right-of-Use Assets	6.8	3.1	3.1	3.1	3.1
Other Non-Current Assets	0.09	3.0	0.98	0.98	0.98
Total Non-Current Assets	62.7	65.2	32.2	32.8	33.3
Current assets
SEKm	2020	2021	2022e	2023e	2024e
Inventories	1.0	0.00	0.01	0.01	0.01
Accounts Receivable	22.0	22.1	17.3	18.3	20.3
Other Current Assets	5.1	5.7	5.8	6.1	6.8
Cash Equivalents	11.7	5.9	29.1	28.7	30.6
Total Current Assets	39.9	33.7	52.2	53.1	57.7
Total Assets	102.6	98.9	84.4	85.9	91.0
Equity and Liabilities
Equity
SEKm	2020	2021	2022e	2023e	2024e
Non Controlling Interest	3.2	3.1	1.1	1.1	1.1
Shareholder's Equity	26.9	22.1	15.0	14.9	16.8
Non-current liabilities
SEKm	2020	2021	2022e	2023e	2024e
Long Term Debt	2.9	0.00	0.00	0.00	0.00
Long Term Lease Liabilities	2.3	0.00	0.00	0.00	0.00
Other Long Term Liabilities	27.5	38.1	38.1	38.1	38.1
Total Non-Current Liabilities	32.7	38.1	38.1	38.1	38.1
Current liabilities
SEKm	2020	2021	2022e	2023e	2024e
Short Term Debt	2.5	0.00	0.00	0.00	0.00
Short Term Lease Liabilities	3.7	2.5	2.5	2.5	2.5
Accounts Payable	7.9	9.4	9.2	9.8	10.8
Other Current Liabilities	25.6	23.7	18.5	19.5	21.7
Total Current Liabilities	39.8	35.6	30.3	31.8	35.0
Total Liabilities and Equity	102.6	98.9	84.4	85.9	91.0

Cash Flow

Cash flow
SEKm	2020	2021	2022e	2023e	2024e
Operating Cash Flow	2.2	0.13	1.6	3.9	6.6
Investing Cash Flow	11.8	-0.91	-0.01	-0.73	-0.81
Financing Cash Flow	-6.7	-5.0	21.6	-3.5	-3.9

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