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Product Review Img Vertical

Date : 24/11/2022

Integrated Research

ASX :

IRI

Market Cap : $58.80 Million

Buy

52 Week Range : $0.315 - $1.36

Share Price : $0.365

IRI has been oversold. However, the company is exhibiting positive signs. We recommend a 'Buy'.

Company Analysis

Integrated Research (ASX: IRI) is an enterprise software company that troubleshoots critical IT infrastructure, payments, and communications systems and provides proactive performance management solutions.

Founded in 1988 by Steve Killelea in his apartment above a chicken shop in Sydney, IRI’s platform offers real-time analytics, fast troubleshooting, dynamic alerts, comprehensive reporting, and customisable dashboards to deliver a seamless user experience to its 600+ customers and 470,000+ SaaS users. The company’s suite of Prognosis products can quickly identify the root cause of problems, resulting in significant cost savings and avoiding downtime and outages.

Thus, Prognosis is an integrated suite of monitoring and management software designed to give an organisation’s management and technical personnel operational insight into and optimise their operation.

IRI operates through 3 segments – Collaborate, Transact, and Infrastructure. In the Collaborate segment, the biggest revenue generator (over 50%), IRI’s product integrates with software such as Zoom, Microsoft Teams, Skype, Cisco, and other communication services. It optimises for peak performance to ensure successful usage, productivity, and user experience.

In the Transact segment, they monitor and analyse payment transactions. The payments industry is evolving at a rapid rate. Organisations are hustling to find a way to manage booming transaction volumes effectively. The shift to cashless payments, new payment schemes and technologies, and higher customer expectations to remain successful in a competitive market are other tailwinds boosting the adoption of IRI’s software.

The Infrastructure segment provides IT infrastructure solutions that are an absolute necessity. The most prominent client here is Hewlett-Packard.


Source: IRI

It does not just stop here. IRI also constantly invests in Research & Development (R&D) to keep its innovation lines open across all business segments. IRI has spent over $20 million on innovation in the past couple of years, and in the past year, they introduced 5 new products.

Integrated Research Boasts a Gold Standard Clientele

Good innovation attracts the best clients. IRI’s product brings efficiency and cost benefits to its users, and therefore, the company has been able to boast a lengthy list of high-profile customers. Over 20% of IRI’s customers are Fortune 500 companies, such as banks, technology giants, stock exchanges, telecommunication carriers, etc. Noteworthy mentions are – BHP, Bloomberg, Airbus, Dell, and JP Morgan.


Source: IRI

These customers come from more than 60 countries through direct sales offices in the USA, UK, Germany, Singapore, and Australia via a global, channel-driven distribution network. The customer set includes:

  • 7 out of the Top 10 US Banks
  • 8 out of the Top 10 Telcos
  • 10 out of the Top 25 Fortune 500 Companies
  • 6 out of the Top 20 Aussie Companies

IRI generates revenue from licence fees, recurring maintenance, testing solutions and professional services. Revenue from the sale of licences is recognised at the delivery date. Revenue from maintenance contracts is recognised over the service agreement. Revenue from professional services and testing solution services is recognised over the period the services are delivered. This makes IRI’s revenues cyclical. However, with the business model changing, the revenues will become consistent and recurring.

Company Updates

Why we think the Share Price has Bottomed

Despite having a highly innovative product and gold-standard clientele, the IRI share price chart in the past year has not been pretty, much like most technology companies. After shares hit a high of around $4.8 a share in August 2021, IRI has been on a downward trajectory. The reason? There have been both microeconomic and macroeconomic headwinds affecting the business.


Source: Tradingview.com

Two Microeconomic Headwinds

  1. IRI uses a sales team to distribute and market its products to new clients. With the pandemic wreaking havoc, face-to-face meetings were impossible, and IRI saw growth hard to come by.
  2. Since most of the IRI’s customers are located abroad, it generates most of its revenues in USD. In 2021, the Australian Dollar was extremely strong due to heightened commodity prices and export levels. This weighed on earnings as IRI had to convert its USD earnings to AUD.

This was a double whammy as growth stalled and earnings were compressed due to forex pressures. Ultimately, a strong cash flow generating company was led to pause dividends. The result? Investors shied away from IRI.

Two Macroeconomic Headwinds

  1. Technology stocks have been smashed over the past year. Even Big tech companies are not immune to the current macroeconomic slowdown.
  2. With interest rate hikes and inflation having their say on valuations, it essentially had a multiplier effect on the already stressed IRI share price.

This is why we think IRI shares will Rebound

While the macroeconomic headwinds persist, the microeconomic headwinds have, in fact, turned. The pandemic is no longer affecting face-to-face sales meetings, and IRI should be able to now push for growth once again. This, coupled with the fact that the company is moving to a SaaS-based business model, means that revenue growth will be much more predictable and sustainable. The cyclical nature of earnings recognition will also be mitigated.

The forex headwinds have completely reversed. With global recession risks rising, one of the safest investments for traders and investors has been the King Dollar (USD). With IRI generating high-flying USD revenues and then converting them into AUD to recognise it in Australia, they have a favourable exchange rate – thereby boosting earnings capacity.

However, the stock has continued to trend downwards as the markets seem to be missing the reversal. We believe this a solid opportunity as we expect IRI to beat estimates in the upcoming earnings seasons. The estimates are also set very low due to the current valuation. Any positive surprise should act as a massive catalyst for the IRI share price and set it in a positive direction again.

Another point worth noting is that despite the massive slowdown, IRI had enough cash flow to sustain itself during the growth downturn. In fact, it retained 95% of its customers. A high retention rate coupled with the biggest companies in the world as clients is not something most tech companies can boast about.

IRI’s Transformational Strategy is Underway

Just like how Altium transformed its business model in 2021, IRI is doing the same. Given how the operating environment has changed significantly in a post-pandemic world, we believe this is a good time to change strategy.

There is pain in the short term, just as we saw with Altium. However, once the transformation is complete, IRI’s product will be back in the growth phase, along with all the benefits that a subscription model brings. It’s a bold move by the company and one that we see working very quickly.

The company has recently expanded its product offering to include software as a Service (SaaS) with the introduction of cloud-based solutions. As we have seen from Altium, it is a case of taking a step back to grow more efficiently with a much stronger SaaS-based revenue model.

IRI’s clientele is extremely strong and sticky. With a SaaS-based model, they will be able to leverage benefits such as – recurring revenue and low churn and maximise the lifetime value of their customers.

As we mentioned, IRI focuses on three core product lines: Collaborate, Transact, and Infrastructure. Consistent and core to these pillars, the strategy is to leverage the structural market changes of remote working and cashless payments as they support customers transitioning their businesses.

IRI is leveraging its existing customer base and market position to move into adjacent, higher-value segments. They continue building long-term recurring revenues as they transition the business model away from upfront revenue recognition. Finally, IRI is driving this change through the self-funded development of new SaaS products.

Three Phased Strategy will Ultimately Deliver

IRI’s strategy comprises three phases: Innovate, Execute, and Scale.

As part of the Innovate phase, the company brought to market its new SaaS platform as the foundation for developing a range of new products. This innovation remains ongoing, and the launch of new and enhanced products will continue – to meet current and emerging customer use cases.

The execution phase is taking longer than the company anticipated as they move to sell to a much higher percentage of new business. We remain confident that the go-to-market model is right and that the demand-generation efforts will pay off. IRI is also iterating its first-generation products following feedback from customers and partners to ensure that next-generation products better meet the needs of its customers.

In the Collaborate solution suite, IRI launched the new Collaboration Space Management product for conferencing rooms in partnership with Utelogy. In addition, new solutions were launched for Session Border Controllers (SBCs) and Direct Routing for Microsoft Teams. This new capability enables monitoring audio calls for organisations that connect external phone lines and use Microsoft Teams as an office phone system. We know how Work-from-Home and collaborative communication software has grown in importance in the past couple of years. We believe IRI’s product offering is essential to the industry.

Two new products for High Value and Real-time payments were launched in the Transact solutions suite. The team completed a feasibility plan for private cloud deployments to address data-governance concerns for large payment providers.

As IRI transitions to the Scale phase of its strategy, the business will move from contracting upfront revenues to a better-quality SaaS subscription model with higher annual recurring revenues.

Investment Thesis

FY22 was a challenging year for IR, with the macro environment leading to sales delays and cancellations. New SaaS product adoption has also been slower than anticipated, but positive signs of gaining traction have emerged. There have been recent leadership changes in the Americas and Europe, and business re-alignment is underway to address execution issues. The macro trends across Collaborate and Transact environments support the strategic outlook, and the three-phase strategy of Innovate, Execute, and Scale should propel the company towards its growth plan. Finally, IRI’s balance sheet is positioned for self-funded innovation and growth.

There are 2 Opportunities That will Drive Growth

  1. The Collaborate Segment is benefitting from a shift to Cloud

The pandemic has changed how we work. With more employees working from outside the office than ever before, companies have to respond very quickly to adapt all their technologies and processes to the cloud so they can be accessed from anywhere. This is where the opportunity lies for IRI. As we mentioned earlier in this report, IRI’s product already supports Microsoft Teams, Zoom, etc.

Cloud-based applications and solutions create more flexibility for businesses to operate across multiple environments. Remote working creates multiple workplaces for IRI’s customers, leading to increased user licenses. Complexity is also increasing with additional multi-vendor communications products, applications and devices creating an increasing likelihood of systems issues and failures. This presents an opportunity for IRI to upsell and cross-sell multiple solutions to address expanding customer communications footprint. It is also very evident that there are higher expectations for seamless communications experiences from users, which drives demand for better outcomes – thereby increasing the demand for IRI’s Prognosis.

For Collaborate, IRI’s target market is the 600 million unified communications users. Nearly 180 million are sophisticated conferencing users. Today, the company has 5.8 million users, or around a 3% share. The addressable market is growing at over 7.3% CAGR.


Source: IRI

  1. The Transact Segment is being completely Evolved

There is a structural change that is taking place within the transact segment. There is entrenched behavioural change by consumers and businesses to non-cash payment methods. We are seeing increasing use of debit and credit cards due to more form factors and channels, real-time ‘push’ payments displacing legacy batch payments. These real-time ‘requested’ payments will drive further demand.

The evolution is taking place rapidly, and effectively managing the booming transaction volumes is now critical for financial institutions. A greater shift to cashless payments, new payment schemes and technologies is increasing the need for what Prognosis brings to the table. Similar to the Collaborative segment, we see higher customer expectations to remain successful in a competitive market.

Merchants do not want complicated solutions – their data is already complex. They want simple, quick, easy to use and interpret, which is what they get with IRI.

Today, Integrated Research monitors over 600 million transactions daily. Globally there are 1,267 billion non-cash transactions occurring, and the total addressable market here is growing by a whopping 18.6% CAGR. Again, plenty of room to grow for IRI.

The Market has set a very low bar, and IRI should beat Estimates

In FY22, the company reported a net profit of $1.5 million after tax. Statutory revenue for the year was $62.9 million, down 20% over the prior year. Proforma Revenue for the year was $79.8 million. The proforma revenue declined by 4%.

The downfall in financial performance from the highs of FY20 has been staggering, and we have already pointed out why earlier in this report. We also went over how IRI will return to the growth trajectory. Now, the important analysis to consider is how much is already priced into the share price. For this, we shall look at market consensus.

Estimates suggest that IRI will grow its revenues by $8 million in FY23, and its Net Profits will be zero. From there, consensus goes on to suggest that the expectation is for IRI to grow its revenues by just $6 million in each of the following two years. This is an average growth of just 10% over the next 3 years.

Net Profit expectations have also cratered. FY20 Net Profit Margin was 21.6%, and now market expectations sit at just 5% in FY24 and 8% in FY25 – a far cry away from the highs seen before the pandemic.

Operating Costs have fallen recently: IRI is concentrating on reducing overhead costs, which shows in its results. Sales & marketing spending pulled back in recent periods due to travel and trade show restrictions. G&A costs have been managed within a 6% to 8% range of revenue, and cost-saving initiatives have been re-invested to facilitate the business transition.

The low market expectations can also be seen in the valuation multiples. IRI shares are trading at an FY25 forward P/E of just 8.4x and an EV/Revenue of less than 1x for the next 3 years. This shows that the market does not expect growth and has set a very low bar that IRI can easily surpass.

New Management is here to turn it around

IRI appointed Rodney Foreman, an experienced Senior Vice President, to drive the business. In Europe, as a consequence of regional insecurity and other negative business sentiments, the second half of the year produced a softer result than the strong first half. Recent leadership changes in Europe are expected to yield a more positive outlook in the coming year.

Management Top Up Holdings

Management has also been topping up its holdings, taking advantage of the share price volatility. Directors James Scott & Catherine Aston added 50,000 and 37,500 each in October. This shows management’s confidence in the ongoing transformation and the ability to make a turn-around. For retail investors, it is reassuring that the Board is aligned with the company’s strategy

Balance Sheet Strengthened by paying off Debt

Despite the declining revenues and earnings, IRI’s cash generation has remained fairly strong. It is also reinvesting significantly in R&D – up to $23 million in FY22, around a third of its market capitalisation.

Cash collections remained strong during the year, with cash receipts from customers of $75.5 million, representing 95% of pro-forma revenue. The company’s net cash position as of 30 June 2022 was $12.3 million compared to $5.5 million in the prior year. IRI repaid bank loans of $5.3 million throughout the period, making the company debt-free.

New Management’s Key Priorities

IRI has established a firm foundation to enable growth, including clear priorities for FY23.

  • A recovery in the Americas and Europe is critical to returning to the growth phase. The company’s go-to-market strategy, supported by the new leadership teams, should deliver improved retention, up-sell, and win new customers.
  • Getting the new SaaS products into the hands of customers and prospects is a critical focus. IRI has invested in sales engineering functions to improve its demonstration capability. We believe this will give the company the technical edge to capture new wins.
  • Focus on customer renewals where there may be risk and customer plans for their unified communications and payment platforms. IRI has optimised its go-to-market strategy to maximise our retention opportunity.
  • The phased growth strategy kicked off with the launching of a new SaaS platform and products in the market. IRI will continue to review customer feedback to bring enhanced second-generation products to market.
  • Re-aligned the company to be more efficient and effective, whilst retaining a strong balance sheet, to support the sell-funding model of innovation and growth. IRI seeks to maintain a strong balance sheet through a measured investment approach.

FY23 is off to a Solid Start

In addition to the low bar that the market has set and the new priorities that the management has laid out on the table, IRI’s update at its AGM on the 23rd of November has been positive. Several tailwinds are boosting the outlook for IRI and increasing the likelihood of outperforming the consensus estimates. Supporting the outlook is the fact that the majority of first-half contracts are executed in December in line with prior year trends

In the first 4 months of FY23 (July to Oct):

  • The average contract life increased to 3.2 years
  • Annual Recurring Revenue (ARR) is trending in line with the same time last year
  • 10 new customers signed by IRI
  • Customer IT budgets appear to remain intact – signalling stronger than expected renewals
  • Solid pipeline leading into December with >75% comprising renewals

These are positive early indications that the new executive leadership’s strategies are working well, and we are confident in IRI returning to its growth phase.

Recommendation

Most of Integrated Research’s customers are blue chip companies, and over 20% are Fortune 500 companies. These customers are extremely sticky and high cash flow generative – indicating that IRI’s critical service will not be cut-off despite inflationary cost pressures.

Similar to Altium earlier this year, IRI is undergoing a business transformation that will see it go from a contract-based business model to a subscription-based one. This should bring several benefits, such as predictable and recurring revenues. New management is also in place, and FY23 is off to a good start. The markets have oversold IRI, and the company is now in line to outperform the consensus estimates. Management topping up holdings recently is a positive sign, and we recommend a ‘Buy‘.

 

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