Tech firms are often faced with trade-offs. Take Amazon, who for years prioritised growth ahead of profitability in order to build dominant positions in online retail, cloud services and voice-search (re Alexa/Echo). Likewise, we think ClearStar is adopting a similar long term strategy to create shareholder value. Sure if it decided to switch off the ‘expansion button’ today, then earnings would immediately flow through. However, what we’re talking about here is a much bigger opportunity – disrupting an addressable market worth c. $4bn pa.
Indeed, after a period of heavy IT/software investment (average 13.9% of 2015-18 sales), CLSU now not only enjoys 1 st mover advantage, but has also constructed a formidable ‘tech-moat’ around its leading employment & medical (MIS) screening solutions (see below). Going forward, the key will be to maintain this momentum – 2018 sales were up 13.1% LFL to $20.1m ($17.8m LY) – and reap the rewards of favourable operating leverage and 35%+ EBITDA drop through rates.
Don’t get me wrong, there is still plenty to do. Albeit the company is well on track, as evidenced by this morning’s upbeat results, raft of contract wins and mushrooming pipeline. In fact, CLSU was invited to tender for twice the number of RFPs in Q1’19, than for the whole of 2018. Implying to us that customers like what they see, inherent demand is strong and the new marketing/branding initiatives are working.
So, where does all this end up? Well, ultimately we reckon ClearStar can achieve 25% EBITDA margins and sustainable LFLs of 12%-15% pa. Justifying an EV/sales multiple of (at least) 3x (see below) by 2023 - equivalent to a theoretical stock price of c. 250p/share, and representing a compound 33% RoI, or 4.2x money return. Plus, with approx 95% of revenues in dollars, there’s a natural hedge for UK investors against £ weakness in the event of a ‘no deal’ Brexit.