Cloud computing and its infrastructure continues to grow in importance as de-scaling and the emergence of smaller players in the digital space, as well as good scale economics even for larger players, means computing needs become further outsourced to providers. The problem is being tech, stocks with these exposures can be expensive. Below we give an outline of the investment case for two stocks that have pronounced value angles due to market inefficiencies. While there are some risks to them, they can work in the current environment to be able to carve out returns for value investors.
The first stock to consider for some cloud exposure is Asseco Poland. It reached highs some months ago, but has traded off them by about 20% due first to the rotation out of tech early in the year, and then by the Russian invasion due to its Baltic exposures and listing in Warsaw, Poland.
Why is this stock interesting? The main reason is its valuation. While quite hard to parse, minority interests and a complicated holding structure where the company exercises minority control over others results in a multiple that is very low for the businesses that it’s in.
It’s two segments which here are presented on a deconsolidated basis are as follows. Asseco’s core business is tech consulting, much like Deloitte’s tech consulting business or like Accenture’s (ACN). The other segment, Formula Systems (FORTY), is the segment that shows the deconsolidated income from Formula Systems which is a holding company itself listed in Israel, owing US and Israeli cloud businesses.
The big cloud exposure it has is in Magic Software (MGIC), which does cloud integration services for companies. While it has a consulting angle within it as well, it has meaningful revenue from its proprietary cloud computing software that clients use for integrated cloud setups. It has nice exposure to logistics and healthcare end-markets, which are booming and resilient respectively. With Asseco Having higher tech exposures, not limited to just Magic but also to ICT companies in Israel that work extensively with their border force and military in cybersec and other digital solutions, as well as with Sapiens (SPNS) which provides the insurance industry with tech solutions, its multiple seems very low with higher tech and secularly growing services as 12% of its EBIT. It is low especially when compared with IBM (IBM) which also has a mix of high tech services in Red Hat related to cloud, as well as a very prominent tech consulting business. Asseco has loads of growth while IBM fails to deliver profitable growth, but Asseco still has the lower multiple, which undervalues it.
The risk here is that buying Asseco exposes you to the Polish Zloty, which while a respectable currency, could lose out to the USD in a safe haven flight if the economy turns and when real rates are rising in US treasuries.
Avaya Holdings (NYSE: AVYA)
Avaya is a company that has been thrown in the forget bin due to years of PE and activist ownership followed by a bankruptcy some years ago. Since then the company has been instituting a transformation to change its economics meaningfully. The business’ fundamental exposures are companies that utilize call centers, and companies that have bought AVYA’s cloud based corporate communications suite. It is all now provided through the cloud, making it modular and sellable at scale to companies working in different configurations.
The reason why this is a nice opportunity is because they are changing their revenue model from a perpetual license where more revenue was booked upfront to a subscription model. Every quarter the share of this revenue is growing, and therefore new business is being underbilled on the subscription basis relative to how it would have been billed in the declining share of perpetual revenue. So while the revenue seems to be falling, it is actually holding strong. The company trades at 5x EBITDA despite the decent demand profile, which has been buoyed by the WFH push that has supported AVYA products. The risk here that we see isn’t the business model but the leverage, which is substantial accounting for 66% of EV at quite high rates> 4%. While the recurring subscription revenue makes this company attractive regardless, leverage is a thing that investors should take into account especially as rates are poised to rise. But the low multiple provides a margin of safety, and if they can handle the debt, and capital markets would be willing to treat them as such, in the worst-case scenario of needing to restructure the debt or raise equity, they have a model that will be able to provide LBO like returns. The operating profit is almost able to cover interest expenses now that impairment charges are in the rear view, and they have $ 500 million in cash to cover a couple of years of interest since they’re hedged for the next 9 months.
Cloud products, providers and infrastructure remains an interesting market that offers ample growth opportunities that can be handily bet on to continue as digitalisation remains a key force. These two companies give you that exposure while also a strong value angle, albeit with some idiosyncratic risk factors, if you aren’t comfortable investing in the sort of high beta stocks that often have cloud exposures given the situation in the markets that maybe have yet to fully absorb rate increases and other news on inflation. Asseco in particular also pays a nice dividend at around almost 4% despite being a tech company. Perhaps buying them together weighting 3: 1 towards Asseco as a cloud-value based weighting towards Asseco could be the way to go to reduce rate risk and create a cash flow from a quite ample dividend.