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Date : 04/08/2021

Appen

ASX :

APX

Market Cap : $1.53 Billion

Dividend Per Share : $0.05

Dividend Yield : 0.79 %

Buy

52 Week Range : $10.65 - $43.66

Share Price : $12.57

Appen is trading at a heavily discounted valuation and can be a prime acquisition target in the hot M&A market

Company Analysis

The Appen (ASX: APX) share price has lagged since the February sell-off. Therefore, it is a terrific play amongst the WAAAX stocks as it is the cheapest opportunity in this hot sector. We are reiterating our view, and now we believe it is even more relevant as Appen is trading at an incredibly low earnings multiple of less than 14 times compared to the WAAAX median P/E of 93.6 times.

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Source: Tradingview.com

Appen is a very important player in the artificial intelligence industry. They offer data sets that can be bought and used to train systems for machine learning (ML) and improved artificial intelligence (AI). To build successful and accurate ML and AI models that deliver results in the same way as when humans are operating the systems, very large volumes of data are required to train the model before seeing accurate results. Appen supplies this much-needed training data. The data is classified by humans and is of high quality that is ready to be applied by customers to build AI systems. According to a recent note from Citi, Appen is attracting the eyes of US tech giants Facebook and Google which are increasing their investments in this space. An acceleration in advertising revenue growth from these giants could act as a substantial driver for Appen’s AI and ML data services. Hence, last week, Google’s parent company Alphabet revealed an impressive 84% year-on-year growth of its $9.45 billion YouTube advertising revenue for the second quarter. Same for Facebook which also registered terrific ads revenue which skyrocketed by 56% year-on-year to $38.6 billion for the second quarter of FY21.

How big is AI in the advertising market, and what is the growth driving force for this industry? Well, the AI market is expanding at an astonishing rate as the amount of data companies are collecting increases. Businesses are on the look to exploit this data in meaningful ways. In the digital advertising space, the primary growth driver of AI is attributed to programmatic advertising. If we just take a glance at the U.S. market, it is estimated that businesses are spending more than $81 billion on this technology and it is growing at a fast pace beyond a CAGR of 26% in the last five years.

M&A activities at multi-year high: Appen in the spotlight

Activity in the Mergers and Acquisitions space is at a multi-year high. Hence, Australia’s record M&A boom can only intensify given the near-term ultra-low-interest rates coupled with investors’ confidence that the economy will rebound from the pandemic are likely to drive more deals. This week we have already seen the market getting a boost on Monday following the announcement that Square Inc (NYSE: SQ) is intended to purchase AfterPay (ASX: APT) for US$29 billion, the biggest buyout ever seen of an Aussie company. What’s next? Well, with the recent rise in M&A and given Appen’s position as a leading player in the AI training data field, we won’t be surprised to see that APX will be the next potential acquisition target. As we have mentioned, Appen is trading at a relatively cheap price-to-earnings compared to its peers particularly since the beginning of this year when we saw APX’s share price at a 43% discount following the broad market stocks’ rotation from growth to value. Nonetheless, Appen shares had gained over 11% since the beginning of the week, and we even think that APX might find some levels of support ahead of its earnings report scheduled for the 25th of August. We also think that a big stock-market rotation is underway, and the tech is preparing its return. The return in appeal for growth stocks is as a result of dwindling bond yields. The US 10-year treasury note plunged to its lowest level since February as bond prices have rallied. In our view, low yields support a positive outlook for the tech sector and growth stocks. We assume investors prefer to put their money into bets that could keep delivering solid results during a sluggish broader economy, and in fact, tech has been doing pretty well over the last decade.

Overall, Appen is on the sweet spot for investors. Appen shares came down to an EV/EBITDA of about 13 times. The interesting part here is Appen’s main competitor Lionbridge which was acquired by Telus International for an EV/EBITDA of 16 to 20 times. Furthermore, we consider a possible return of the growth stocks which will consequently set Appen share price back to its uptrend.

WAAAX relative valuation FY21

When we look at Appen’s valuation, we can see that the company is ticking all the boxes of a “stock at a discount”. Hence, the price-earnings ratio is just at about 13 times while the WAAAX median earnings multiple sits high above at more than 93 times. It goes the same for Appen’s EV/Revenue and EV/EBITDA multiples which are approximately 80% lower than WAAX’s corresponding multiples.

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Appen back on track with a strong performance to support earnings growth

If you remember from our previous report on Appen, we had mentioned a difficult FY20 for the firm which reflected on APX’s share price. The first shock experienced was due to investors expecting a growth of over 25% during the first half of FY20. Thus, the revenues from Speech & Image turned out to be underperforming, hence, the stock came under massive selling pressure as investors sold off.

Furthermore, Appen confirmed that their Q3 revenues were below expectations due to the consequences of the pandemic. Following on, shares once again slumped in February 2021 as analysts and investors were expecting a more robust Q4 performance and a bullish outlook. We believe this belongs to the past as we have recognised two major catalysts that could bring Appen’s share back to a bull-run.

First, we are quite confident about the rebound of the economy post-pandemic which will set the company back on its pre-COVID earnings growth. We also think that growth stocks such as the tech names could lead the broad market. Despite a challenging FY20, we think that Appen did relatively well given its 12% increase in its revenue to $599.9 million. We also witnessed an underlying EBITDA of $108.6 million which is also improving year on year by 8%. In terms of operation, Appen is also adding up a few developments during the period with an increasing number of projects by 34% with its top five customers. As we see China coming back faster to normal post-COVID than the rest of the world, revenues deriving from China grew tremendously at 60% quarter on quarter. We could expect a comparable rate of revenue growth onward FY21 with the economic recovery post-COVID in the rest of the developed nations. On top of revenue that remains strong despite the impact of lower digital ad income, Appen also exhibits a robust balance sheet with an ample cash position of $78 million and virtually no debt.

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Appen fundamentals are rock-solid in our opinion as we have seen key performance drivers on the rise. Hence, APX reported an almost fourfold increase in its annual contract value year-on-year which was underpinned by the expansion of the company’s enterprise-wide platform agreement with its existing major customers. This lays the foundation for further growth in our opinion. The Relevance business segment of the company represents 72% of Appen’s revenue which registered a 15% increase year-on-year to $538.2 million as the company continued to deliver high-quality data during the pandemic and due to the resilience and strength of the remote work crowd model. Relevance is growing at an impressive CAGR of 60% over the last five years. On the other hand, the Speech & Image segment did not perform optimally during the period. It has been reflected by a year-on-year decline of 10% in revenue to $61.2 million. The decline was offset by the Relevance segment as the Speech & Image segment represents the third of Appen’s total revenue. Nonetheless, this business segment remains on track, and we expect it to continue its growth trajectory of 14% CAGR.

Appen’s growth rate has been affected by the pandemic and in our estimates, we are accounting for the fact that revenue growth in FY21 will be positive however moderate at circa 5% given that economies are progressively returning to normal with uncertainties that remain. Therefore, we have taken a conservative approach for this financial year. Following on, however, Appen should start growing consistently as all their clients recover from the pandemic. We do not expect EBITDA and EBITDA margins to aggressively rebound either given that efficient operations will be challenging in the short term. Following recovery from the pandemic, however, we expect Appen to breach the 19% EBITDA margins mark once again as economies of scale kick in, underpinned by an expansion of recurring revenues from institutional clients.

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There is nothing negative to say about the long-term prospect of Appen. We believe the company has a solid foundation for further growth. However, in the meantime, the company might be susceptible to short-term challenges which are more related to external factors such as the macro environment that we have mentioned earlier in this report. On the valuation front, Appen appears to be attractive to investors, particularly since the beginning of this year which we have seen the APX shares become quite cheap compared to its WAAAX peers, but not only. If we look back at Appen’s multiple during FY20, the company’s P/E was a tad above 45 times while the current P/E is estimated at just above 13 times. The same goes for EV/EBITDA. Given that the growth outlook is robust for the industry and the role Appen plays in the overall development of the machine learning and artificial intelligence industry, the company’s current valuation multiples do seem to be relatively undervalued and provides an opportunity for investors.

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Recommendation

Activity in the Merger and Acquisition space is at a multi-year high. Hence, Australia’s record M&A boom can only intensify given the near-term ultra-low-interest rates coupled with investors’ confidence that the economy will rebound from the pandemic – driving more deals in the near future. With the recent rise in M&A and given Appen’s position as a leading player in the AI training data field, we won’t be surprised to see that APX will be the next potential acquisition target. As we have mentioned, Appen is trading at a relatively cheap price-to-earnings compared to its peers particularly since the beginning of this year when we saw APX’s share price at a 43% discount following the broad market stocks’ rotation from growth to value. We also think that a big stock-market rotation is on the brink with the return of tech-driven by the appeal for growth stocks resulting from dwindling bond yields. We find Appen’s valuations severely undervalued given its leadership in the AI market. Overall, Appen is on the sweet spot for investors and could be the next candidate for M&A. We thus recommend Appen as a “Buy”.

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