Sepura looks to manage down debt and capitalise on new markets

Sepura’s cash flow problems have caught the headlines this year, but with four years of double digit organic growth, solid EBITDA and new market opportunities in North America appearing, underlying performance remains strong, Steve Barber, VP Group Strategy, tells James Atkinson

Sepura looks to manage down debt and capitalise on new markets

Sepura has been on something of a financial rollercoaster of late after revealing the scale of its current debt in April this year. The UK-based professional mobile radio products and solutions provider’s debt rocketed from €1.1m in 2015 to €119.4m as of 1 April 2016 – the end of its financial year.

This, coupled with the news that its revenues would not meet market expectations after two major projects did not close in time to be included in the 2016 results, sent its share price plummeting in April to 39.50p - down from a 52-week high of £198.40. As of 15 July, it was trading at 48.50p.

The debt has accrued mainly as a result of Sepura’s acquisition of Spanish PMR manufacturer Teltronic in 2015, together with slower customer payments and the need for more working capital. This resulted in short term cash constraints.

In its 2015-16 results, published on 28 June 2016, Sepura noted that its financial performance was also affected by: a softening in important markets; uncertainty over the transition to the Emergency Services Network in the UK; oil and gas markets in Russia and Australia remaining subdued; and weakness in the Brazilian economy impacting ongoing projects.

The figures announced in the April profit warning were confirmed in July. Total revenue for the year was €189.7 (2015: €131.2m), while the Group posted a pre-tax loss of €19m (2015: profit €16.7m). However, the adjusted EBITDA figure showed a profit of €16.5m (2015: €15.0m). Teltronic made a revenue contribution of €44.7m.

Speaking to Wireless at Critical Communications World in Amsterdam at the beginning of June, and ahead of the final 2016 results, Steve Barber, VP Group Strategy, Sepura (pictured below), argued that the Group’s underlying performance was strong.

‘Our 2016 revenues show a 45% increase year-on-year and are really strong. There were a number of orders, two in particular, due to come in Q4 2016, but they slipped into the 2017 financial year and that affected our numbers. But our EBITDA is estimated to be about the same as the previous year (in fact it was slightly higher – see above) so it is still strong, but the market was expecting more,’ concedes Barber.

Despite the overall financial performance in 2016 not meeting expectations, Sepura said it still reported a fourth consecutive year of double-digit growth in organic revenues. As of 1 April 2016, Sepura said it has an order backlog of €75m and its ‘strong pipeline of opportunities now totals >€400m’.

Barber says: ‘To put the share price movement and debt into context, we have exceeded our expected growth numbers for the last four years, which means the stock has became very healthy and strong. Teltronic, which we bought in May 2015, is a fantastic acquisition, but it perhaps brought bigger demands on our equity than we were expecting.’

He explains that this is partly because a higher percentage of Sepura’s sales are now systems project business. ‘We have been growing sales of systems since our acquisition of 3T (the Vienna-based TETRA infrastructure company Sepura bought in 2012). Following the acquisition of Teltronic, systems represent a greater proportion of our overall business.

‘We are doing more end to end projects, which are more resource and cash intensive, but also more strategic. In addition, there is a lot more of value add in our applications, following our acquisition of Portalify (bought in 2013), as well as developing our own apps on our own systems,’ says Barber.

Sepura said in its FY16 results that it will narrow its focus to concentrate on those regions and verticals where it is a market leader and where there are more immediate cash generating opportunities, particularly in North America and in the Transportation market.

£65m capital raising
Prior to the FY16 results, Sepura also announced that it would be undertaking a capital raising exercise to help manage the cash flow issue. On Friday 15 July 2016, Sepura announced at a general meeting that all resolutions to approve the placing of an open offer to raise £65m of gross proceeds were duly passed. The board said admission of the new shares was expected to occur on or before 0800 BST on 18 July.

The company has also revised its banking arrangements, while new CFO Richard Smith is leading a programme to drive operational improvements and strengthen cash management.

CEO Gordon Watling stated in the FY16 results: ‘We have revised our business model and our financial focus is firmly now on cash conversion, improving operating margins and increasing our revenue visibility with contracted and recurring business.’

Speaking of the fund raising at CCW back in June, Barber said: ‘We see this (liquidity) as a short term issue, which the new equity we will help us manage. We know that the demand for the Teltronic equity raising was very strong; in fact it was three times oversubscribed.

‘So, we expect most of our investors to fully support us again this time. Most are buying for the long term. The discussions I have had with our CEO and CFO about their talks with our shareholder base indicate they are supportive.

‘We have probably been punished harder than we should have been (in terms of share price). A lot of investors in the markets took into account that we were honest about the fact that we needed to raise equity.’

Sepura’s recovery strategy seems to have resonated in the City of London, where broker Liberum Capital, for example, published a broker’s note on Monday 18 July reinstating its BUY recommendation of Sepura shares following the approval of the £65m fund raising on Friday 15 July.

DMR pullout
However, one other major consequence of the company’s current financial state is its decision, announced at the FY16 results, to withdraw from the DMR market. Neither the DMR nor the Applications business have grown as rapidly as expected, the Group stated.

Explaining the decision to pull out of the DMR sector, Sepura said: ‘It (the Sepura Board) now believes that it will not be possible to achieve further market penetration without significant additional investment. It has therefore decided to withdraw from the DMR market, instead allocating the Group’s resources to opportunities which are more immediately revenue and cash generative within the TETRA market, such as those within the North American region and the transportation sector.’

Sepura entered the lower cost DMR market in November 2013, partnering with Chinese PMR vendor Kirisun, which manufactures DMR radios and infrastructure to Sepura’s designs. Sepura said it is continuing to ship and install key DMR contracts and will continue to support its existing customers.

TETRA focus
Sepura is now re-focusing all of its attention on its TETRA roots, but there are question marks over the long term future of the technology as its primary market, public safety, is expected to migrate to broadband technology over the next 20 years or so.

However, that is not going to happen overnight. Research analyst IHS predicts the installed base of TETRA will increase at a CAGR of 6.2% from 3.6 million active radios at the end of 2015 to nearly 5 million at the end of 2020.

Europe represents the largest installed base with 53% share in 2015, which is expected to drop to 48% (as a mature market, future sales will largely be for replacement terminals) in 2020 as other regions grow. Asia is predicted to be the second-largest region and MEA the third by 2020.

Liberum’s latest broker’s note cited IHS research to the effect that the estimate for the public safety installed base was around 2.3 million radios, which is expected to rise to 2.8 million by the end of 2020, meaning public safety represents 56% of the installed base.

Sepura shipped 250,000 TETRA devices in the year, an increase of 15% on 2015’s figure of 217,000. Emerging markets such as Saudi Arabia received 63,000 devices in the period. Sepura now has an installed TETRA base of approximately 1.6 million devices in 120 countries.

The Americas
TETRA is a newish technology for the North American market, only being approved by the FCC in 2012, but as such it is an opportunity. Liberum notes that the PMR market in the USA is worth c.$3 billion and 1.5 million commercial analogue users are expected to convert to digital in the next three years – so there is plenty to go for in the region – hence Sepura’s avowed intent to focus on it.

The broker also notes that Sepura and Teltronic have won 13 of the first 16 TETRA network contracts in North America so far. On Friday 15 July, Teltronic’s US arm PowerTrunk was confirmed as the supplier for a $34 million TETRA radio system for New York City Transit Authority.

The acquisition of Teltronic has considerably boosted Sepura’s presence in both Latin America (revenues up 604% in FY16 to €33.8m from €4.8m) and North America (up 227% to €7.2m from €2.2m). Teltronic’s Transportation portfolio now makes it the Group’s largest commercial vertical providing 10% of total revenues in 2016, up from 7% in 2015.

The company said that the PMR market continues to grow, with an estimated total spend by PMR users expected to reach US$16.5 billion by 2017. Digital PMR now accounts for about 38% of the current 45 million PMR users today, with a further 11 million forecast to migrate from analogue to digital by 2019.

Barber says: ‘From a strategic position Sepura remains fully committed to the markets and strategy we have in place. You’ll have seen a lot of PR around our new North American successes recently, which are very significant contracts. North America is around 35% of the worldwide PMR market, hence it is important to our growth, in addition to continued growth in other geographies.

‘The fit between Teltronic and Sepura complemented us technically and geographically. Teltronic is strong in Latin America and North America, whilst Sepura is strong in Europe and Asia Pacific.’

Barber continues: ‘We are focusing on key markets this year, North America in particular, which we are excited about as it is a great opportunity. If you look at the trends there; New Jersey Transit; LAX Airport; San Francisco Airport; there is a lot more demand from end customers for TETRA now, as they are lot more confident in the technology.’

LTE broadband
Returning to the future of TETRA, Sepura does have an ace up its sleeve in that Teltronic’s eNebula range of TETRA infrastructure also supports LTE broadband technology. This means users can keep mission critical voice and some data applications on TETRA, but also have access to high speed broadband data via LTE.

So, if public safety agencies do migrate to LTE they can support both technologies simultaneously for as long as they want and then move fully onto LTE when they are ready. Other sectors such as transportation are also keen to implement similar arrangements.

Barber says: ‘We have shipped two LTE systems for Bilbao Metro and the Canary Islands police, which are complementary overlays to our TETRA installed base. Customers are using it for applications like fixed and mobile cameras for video. We have some more contracts in negotiation for LTE too.

‘Most customers are buying TETRA for mission critical voice and data and then LTE for broadband video,’ continues Barber. ‘The LTE standard is still not in a state where it is fully mission critical. In fact, mission critical video and data may even slip out of 3GPP Release 14 (due in 2017) to Release 15.’

As a major TETRA handset supplier to UK emergency services, Sepura is naturally keeping a close eye on how the UK’s new 4G Emergency Services Network is progressing. ‘It will be interesting to see how the mission critical LTE market develops, especially in the UK, but there are still some doubts about device availability at the moment for ESN, especially within the publicised timescales,’ observes Barber.

He points out that while the UK may be a home base for Sepura, the company is by no means reliant on it anymore. ‘Around 90% to 95% of our business in now outside of the UK. So, whereas when we started in 2002, 90% of our business was in the UK, it is now the other way round. That shows how far the company has come, expanding geographically and into different verticals beyond public safety.’

It will clearly take Sepura some time to restore its finances to an even keel, but its strategy seems to be meeting approval in the financial markets so far. It remains to be seen how fast it can reduce its debt burden and improve its financial management. Its recent flurry of TETRA wins in the Americas bodes well, but of course these need resources to implement, so it will need to maintain a firm grip on running costs.

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