The quarterly figures came in above Redeye’s estimates on top line, and even more so on EBIT. After a couple of reports that have disappointed the market, we think this report may have turned the sentiment around for the share price. Most importantly, Network Solutions showed good sales despite not announcing an exceptionally high number of orders. We think this indicated a stronger underlying foundation of recurring revenues than we and the market expected.

Network Solutions accounted for 87% of sales in the quarter. Sales grew by 12% y/y. Currency-adjusted organic growth for the quarter was +3%. This was 14% above our estimates - indicating a higher share of recurring revenues than we had thought. This indicates a high degree of seasonality also in recurring revenue.

Due to the seasonal pattern in Network Solutions, with Q2 typically being bigger than Q1, Q3 bigger than Q2, and Q4 bigger than Q3, we provide a quarterly comparison diagram below.

The sequential growth in Network Solutions originated from Licenses and Professional Services . As previously stated, the revenue mix of Network Solutions is much less steady than that of the steady flow of royalty fees in Operating Systems.

The revenue mix of the ingoing parts of Network Solutions can be seen below:

Regarding the revenue dynamic, License revenues are often booked at the start of a new project, whereas revenues from Professional Services are booked in the implementation that follows. As a result, Professional Services is generally strong in the quarter after a strong quarter in Licenses. Considering that Q3 was not strong for Licenses, we were surprised by the high figure for Professional Services. We think this is related to one of the announced deals for AdaptiveMobile Security.

Sales from Operating Systems continued to decline, but less than we thought. Sales came in at SEK34m, corresponding to a y/y drop of 17%, or -20% currency adjusted. This is a continuous drop that is expected as customers, especially key accounts (Nokia and Ericsson), introduce open-source software for new products.

In the conference call, management said that Nokia and Ericsson together declined sales by 27% y/y and accounted for about 50% of total sales in Q4. This means that sales from the remaining customers were more or less flat compared to last year. In January, Enea announced a three-year extension deal in Operating Systems that indicated a somewhat slower decline than we had estimated. We commented on this deal here. As we believe this deal must be related to either Ericsson or Nokia, the decline could become less aggressive going forward.

Gross margin landed on 76% (excluding “other operating income”), compared to 75% for full-year 2022 and 77% in the last quarter.

The somewhat lower gross margin is partly due to a higher share of Professional Services in Network Solutions, originating from AdaptiveMobile Security. However, currency effects from the revaluation of working capital affected gross profit negatively by SEK8.1m. The underlying gross margin was thus 79.2%.

The seasonal pattern of license revenues being stronger the farther into the financial year we get implies that Q1 will have a much higher share of service revenue (with a lower gross margin) than all other quarters, but especially compared to Q4. However, we think the already mentioned deal for AdaptiveMobile Security and the currency effect affected this dynamic in the quarter. To illustrate the seasonality, see the below diagram for the same figures:

Reported OPEX, incl. D&A, was SEK151m, and “clean” OPEX (excl. D&A) was SEK105m. “Other operating income” consists of revaluation of incentive program and FX-related revaluations of accounts receivable, meaning that we consider this as a one-off. These one-offs amounted to SEK2m, implying that the underlying OPEX is SEK103m.

While Enea says it is scaling up its sales and marketing efforts, this cost base has already been upscaled. Hence, investors shouldn't expect any significant cost increase from this going forward.

In the report, Enea changed its financial targets. From previously having been "above 20% EBIT margin and positive growth", it has now changed this to "double-digit growth in Network Solutions, EBITDA margin above 35%, and strong cash flows."

Regarding the 'double-digit growth', this is a positive step towards showing that the company itself believes in its future. Enea did not say it specifically, but sounded very much like this target is 'organic growth' and that M&A should come on top of this.

Regarding the 35% EBITDA margin, this may sound much better than the 20% EBIT margin. To assess the underlying profitability, we look at the implied free cash flow (FCF), excluding changes in working capital. In other words, we look at EBITDA less CAPEX. During 2022, Enea had a quarterly average CAPEX of SEK34m, which is the same as it was in Q4. This should be compared to quarterly depreciation and amortization of SEK45m in the quarter. Free cash flow is thus higher than EBIT, e.g., 25% FCF margin vs 21% EBIT margin in Q4. Assuming quarterly CAPEX of SEK36m in 2023E, a 35% EBITDA margin corresponds to a FCF margin of 22%.

Net debt to EBITDA is currently at 1.1. However, in the quarter Enea had a negative effect on working capital of SEK-72m due to late invoicing. As such, the underlying net debt is lower than it appears. As such, the underlying net debt/EBITDA is rather around 0.8.

Assuming a conservative ceiling of Net Debt/EBITDA of 2.0, we think Enea can make acquisitions worth cSEK300m.

Considering the current negative market sentiment, with valuations coming down also on the private market, we deem it possible to acquire a company at a multiple of 2.5x sales, which would add something like SEK100-150m to Enea’s revenue base, or around 15% to total sales.

In November, Enea was awarded a one-year agreement with a North American mobile network provider. The contract was for Enea’s WiFi offering that was acquired through Aptilo. The contract includes USD1.2m license revenues booked in Q4 2022 and USD0.4m of professional services throughout 2023. The deal was signed with an existing customer who had previously used other services from Enea. This is a good example of a successful cross-selling between acquired subsidiaries.

In December, Enea was awarded a three-year agreement with a European telecom operator. The contract was for Enea’s cybersecurity offering acquired through AdaptiveMobile Security. The contract includes EUR1.0m of license revenues booked in Q4 2022 and EUR1.2m of professional services throughout 2023-2025. The deal was signed with an existing customer who had previously used other services from Enea. As such, this is another example of successful cross-selling between acquired subsidiaries.

In January, Enea announced an extension agreement with an existing customer in Operating Systems. Rather than receiving SEK25m annually with yearly renewal, Enea has now signed a three-year agreement corresponding to an annual value of SEK20m in revenues. The SEK20m per year should be compared to our estimated revenues for Operating Systems in 2022e of SEK121m.

This agreement implies an annual revenue decline of c.11% if using the second year as a reference. This is slightly better than our estimated annual decline for Operating Systems of c.15%.

While this extension order is slightly ahead of our current estimates, it only accounts for c.17% of total annual revenues for this segment. Hence, we maintain our estimates and reiterate our valuation range.

Growth assumptions to 2027

Note: no acquisitions included in estimates.

Margins

General

Growth assumptions to 2027

Note: no acquisitions included in estimates.

Margins

General

Growth assumptions to 2027

Note: no acquisitions included in estimates.

Margins

General