DTL - Data#3 Limited

[craft]

IT companies I reckon will face the same pressure as mining service company.
Governments and Companies will focus on cost cutting.

With Federal and States has a pile of debt and growing, I cant see them splash too much cash on IT spending.

I don't have any of the IT service companies for some reason it isn't attractive to me unless
you are a software producer with high switching cost and patents like IRE

Cost cutting only goes so far – eventually even our politician will realise the only sustainable way forward is efficiency and productivity, the very essence of what technology offers. The actual software will evolve as will the methods of delivery but DTL has a competitive position and niche experience in cost effectively delivering productivity enhancing tools.

The next half results are shaping up as pivotal. A further delay in IT investment will see price smacked as DTL has effectively called the bottom with its second half forecast whilst the market seems to be doubting it. For me it’s a 50/50 call on IT investment cycle timing. I hope it’s delayed and DTL is offered at a real bargain – but with only a 50% probability of this happening I have been adding a few at these levels because the price stacks up on my assumptions for a long term investment.

Investment cycles are expected within my time frame and this one has not diminished my view on DTL in any way, neither has a change in delivery method to greater cloud utilisation.

 

[Ves]

Hi craft - sums it up pretty well for me. I've been buying a few as well. It's interesting to note that for anyone buying around $1.10ish in the last few years that the dividend stream has so far mitigated any (paper) capital loss. Those who benefit from franking credits are still in front - probably not the end of the world if you're riding out the investment cycle for long term results.

I remember you saying it in another thread about the GFC and your biggest fears were right near the bottom (ie "what does everyone know that I don't?"), it is starting to look like that with DTL based on long-term projections and a new investment cycle looming. Near term it probably looks like an absolute mess to a lot of others.

 

[VSntchr]

I remember you saying it in another thread about the GFC and your biggest fears were right near the bottom (ie "what does everyone know that I don't?"), it is starting to look like that with DTL based on long-term projections and a new investment cycle looming. Near term it probably looks like an absolute mess to a lot of others.

As a non-holder of DTL this statement is also very interesting to me and reflects how I have been feeling with DTL. As the price has slowly been dropping from $1.20 I have been getting more and more interested and spending more time researching. I would have began accumulation already if I had spare funds - I have just needed them elsewhere thus far.

DTL could prove to be a good example of not needing a GFC to get GFC like prices. As always, if it happens...it will seem glaringly obvious looking back.

SMX and the newly formed RXP are other IT's that I'm watching closely.

 

[Ves]

SMX and the newly formed RXP are other IT's that I'm watching closely.

I've had a brief look at both of those (that said, I probably know SMX a little better than RXP). RXP is often referred to as a mini-SMX.

SMX used a roll-up / acquisition strategy to reach it's current scale, and it looks like they will continue to do much of the same in the short-medium term. They've done it really well, in fact. I think they've made it look a hell of a lot easier than it really is in reality. Of course, it looks great on the way up, but often the skeletons in the closet and the inefficiencies aren't seen until an economic downturn / slowing investment cycle hits. It can still work and some IT consultancies they've bought no doubt perform better as part of a larger jigsaw puzzle. But each time they're making an acquisition they are betting in the long-term that they can run the operation more efficiently on the multiple paid than the previous owner could. There's also "key personnel" and "legacy" issues... but there are on the flip side the benefits of these practices being very capital light, people orientated business, which means they have quite a bit of operational leverage. Also watch out for revenue concentration / big contracts and the need to for consultancies to win those make or break contracts from big blue chip clients for which everyone else is also fighting.

I like DTL because it grows organically... in part this really helps it control as much of its own destiny as possible.

 

[VSntchr]

but there are on the flip side the benefits of these practices being very capital light, people orientated business, which means they have quite a bit of operational leverage.

I see the benefit of having a flexible cost structure, i.e. letting go contractors if work dries up ..but doesn't the above describe the opposite of operational leverage?

I like DTL because it grows organically... in part this really helps it control as much of its own destiny as possible.

Yep. I agree.
Not to be ignored however, is the advantage of the roll-up (as it's been discussed in other threads) that has to do with the quirk of the market that allows listed companies to buy unlisted companies at say 3-5x EBITDA and then have them instantly valued at 8+x EBITDA...assuming that the music doesn't stop and the acquisitions integrate well...it is real value-add for shareholders..

I would certainly prefer the DTL type business that grows organically. Far less risk, easier to sleep at night. But if certain conditions present themselves, allowing a roll-up to be purchased at a significant discount to my perceived valuation of the company - then I think as investors its in our best interests to assess the opportunity.

 

[Ves]

I see the benefit of having a flexible cost structure, i.e. letting go contractors if work dries up ..but doesn't the above describe the opposite of operational leverage?

Could be the wrong word. Basically at the bottom of the investment cycle staff productivity and asset utilisation are at their lowest. This will pick up when the investment cycle picks up and the earnings will reflect that. Some times variable costs are hard to actually shed... because if you pull the trigger at the wrong time you miss the wrong cycle and start behind in the race against those who did not. DTL talk about "carry costs" a lot, that's most likely why they've doing this, they are waiting to pounce on the uptick of the market. DTL have been investing ahead of the curve for the last few years now.

 

[VSntchr]

Yeah, good points.
Just to add to your statement, the latest report reads:

"In our products segment, the cost ratio increased from
65.6% to 68.6% and in services from 83.0% to 83.9% as we
consciously accepted lower levels of utilisation in return for
maintaining capacity and capability."

 

[VSntchr]

Very informative BRR presentation by Data 3 today.

One thing that I thought was interesting was the concept of risk sharing that John was talking about.
He elaborated by saying that DTL was venturing into business performance.

Would this be in contrast to how some have described DTL in the past as different to the listed peers such as SMX, DWS etc as DTL has traditionally focused on IT infrastructure and solutions rather than the business analytics side of things?

 

[McLovin]

Could be the wrong word. Basically at the bottom of the investment cycle staff productivity and asset utilisation are at their lowest. This will pick up when the investment cycle picks up and the earnings will reflect that. Some times variable costs are hard to actually shed... because if you pull the trigger at the wrong time you miss the wrong cycle and start behind in the race against those who did not. DTL talk about "carry costs" a lot, that's most likely why they've doing this, they are waiting to pounce on the uptick of the market. DTL have been investing ahead of the curve for the last few years now.

This came up again in the prezzo today. Grant acknowledged they are carrying staff in anticipation of when things start to turn (he sounded cautiously optimistic that the worst may have passed). Personally, I think it's a very prudent strategy, especially as these IT companies are constantly talking about how hard it is to recruit the right people. A best of breed business should have assets (people and equipment) ready to go when business picks up.

I really like the transparency of the management at DTL. Straight shooters.

 

[Klogg]

Personally, I think it's a very prudent strategy, especially as these IT companies are constantly talking about how hard it is to recruit the right people. A best of breed business should have assets (people and equipment) ready to go when business picks up.

That's actually a great attitude to have, and is a definite positive for management... I'm interviewing applicants for three roles (testing and development) and it's a pain in the a$$ to find anyone who even knows the basics! (Unless you offer contract rates slightly above market)

Might have to go and steal them from the Data#3 offices, haha.

 

[craft]

This came up again in the prezzo today. Grant acknowledged they are carrying staff in anticipation of when things start to turn (he sounded cautiously optimistic that the worst may have passed). Personally, I think it's a very prudent strategy, especially as these IT companies are constantly talking about how hard it is to recruit the right people. A best of breed business should have assets (people and equipment) ready to go when business picks up.

I really like the transparency of the management at DTL. Straight shooters.

I really like companies with the balance sheet strength and management fortitude to suffer short term pain for long term gain. And the best bit is the majority of the market that are fixated on short term gratification hates it. The combination adds up to quality companies at reasonable prices.

MMS is another that showed this capacity by carrying all their staff through recent turmoil.

 

[Ves]

I really like companies with the balance sheet strength and management fortitude to suffer short term pain for long term gain. And the best bit is the majority of the market that are fixated on short term gratification hates it. The combination adds up to quality companies at reasonable prices.

Psychologically it would appear that most people find it harder to forecast growth in a company that has been going through a rough patch profitability wise, especially when it extends over multiple reporting periods.

The same can be seen in a bear market or a recession "what if it never ends?"

On the other hand, something that has already started to grow earnings at a rapid clip, seems to be the exact opposite and sensational share price rallies and very optimistic opinions are not uncommon.

 

[McLovin]

Psychologically it would appear that most people find it harder to forecast growth in a company that has been going through a rough patch profitability wise, especially when it extends over multiple reporting periods.

The same can be seen in a bear market or a recession "what if it never ends?"

On the other hand, something that has already started to grow earnings at a rapid clip, seems to be the exact opposite and sensational share price rallies and very optimistic opinions are not uncommon.

I actually think it is more likely to do with most people (and I'd include most fund managers in that) not understanding the business cycle. Guys like our old mate Roger cr@p on about value investing blah blah blah, but all they're really doing is riding earnings momentum and as soon as it shows signs of stopping they sell. Even his forumla assumes that as it is now so it will always be. Which logically means you undervalue at the bottom and overvalue at the top. I don't even think you need to be a whiz at forecasting growth (I sure as hell ain't), just don't let your emotions get the better of you and have some faith that every works in cycles. It probably doesn't hurt to be an optimist either!

 

[VSntchr]

I actually think it is more likely to do with most people (and I'd include most fund managers in that) not understanding the business cycle. Guys like our old mate Roger cr@p on about value investing blah blah blah, but all they're really doing is riding earnings momentum and as soon as it shows signs of stopping they sell. Even his forumla assumes that as it is now so it will always be. Which logically means you undervalue at the bottom and overvalue at the top. I don't even think you need to be a whiz at forecasting growth (I sure as hell ain't), just don't let your emotions get the better of you and have some faith that every works in cycles. It probably doesn't hurt to be an optimist either!

Some good comments there, and from you too Ves.
It's funny that the market is pushing new recent highs, yet a few of the stocks I follow closely are near recent lows. Your comments around cycles have been (pardon the pun) cycling in my head the last few days and have really helped when spending time analysing these companies.

I've fired my first round of ammunition at DTL as of today..with another 3 or 4 bullets left in the gun for the next couple of weeks/months.

Now I've just got to go home and get back to praying that it isnt different this time

 

[Klogg]

I've been pondering the cycle talk that has been going on and am trying to figure out at what point I should be comfortable that this particular cycle is near the 'bottom'...

I noted that Ves made reference to asset utilisation and number of staff, as did John Grant when he mentioned additional staff with varying skill-sets in some offices. So, on that note I compiled some very basic data on NPAT and Equity for DTL, DWS and SMX, with the ultimate aim to show Return on Equity (closest thing to Asset Utilisation I could think of) as shown in the table below:



A few things worth noting before I continue:

• I couldn't find data older than 2005 for most. If you know where to get this, please do tell!
• SMX is a slightly different story, as they grew via acquisition rather than organically (as is reflected by the intangibles on the balance sheet)
• DWS have also made acquisitions, but it was the most relevant comparison I could find
• As listed in the notes, there is an adjustment in 2006 for DWS for an Equity payment made. I took 'normalised' NPAT
• 2014 Half Year results can't really be used for this purpose - I only listed them for the sake of completeness

*Edit: I'm not comparing ROE between companies, simply the trend over the years for each. I chose three in-case there were any outlier results for one single company that threw out my analysis.

Now, to see if there was a trend at all, I decided to graph it:



Unfortunately, this has shown me one of three things...

1. I'm failing to see a cycle in this time-frame
2. There is no cycle in this time-frame
3. OR, I'm looking in the wrong spot for the answer I'm after (because my link between ROE and Asset Utilisation was based on a flawed assumption)

In conclusion, this exercise hasn't really helped me... Could anyone tell me if I'm in fact looking at the correct data (in terms of time-frame or data type) for the answer on the cycle 'bottoming'?

Apologies for the long post, but I thought I'd give it a crack instead of being spoon-fed the answer...
And thanks in advance.

 

[Klogg]

Another edit - should've used ROC, but in this case the companies have no material debt so ROE will suffice.

 

[craft]

Hi Klogg
To me cycles are a concept of how volatility in Revenue, Asset Utilisation and Margin play out on operational/financial leverage. It’s not something that necessarily shows up as a sound wave pattern in the historical financials.

DTLs early ROE’s should be taken in context of a much smaller and less mature company.

 

[Klogg]

Hi Klogg
To me cycles are a concept of how volatility in Revenue, Asset Utilisation and Margin play out on operational/financial leverage. It’s not something that necessarily shows up as a sound wave pattern in the historical financials.

Perfect, this gives me something to build an understanding from! As usual, you come through with the goods - Thanks craft!

...and I really should slap myself for what I just did. I searched everywhere EXCEPT the damn ASX website for previous annual reports.

Anyway, I'll go off and do a little more research. Thanks again.

 

[Ves]

Hi Klogg,

I also use Asset Turnover ratios to measure asset utilisation. In this case you are measuring how many dollars of revenue the company can generate per dollar of assets. It's just revenue / total assets.

You can also look at internal cost ratios, these will indicate that there is a cost management issue, margin pressure or they are carrying costs (ie. they are not utilising their staff at peak efficiency and waiting for an uptick). Sometimes it could be a mixture of these factors.

Employee expense ratios etc are also good for people based businesses.

I also use EBIT and EBITDA margins over time. And these are clearly falling for all of these IT companies since the GFC. But remember that SMX / OKN / DWS etc are slightly different in nature, they are more managed services companies, and DTL is more of a product & operational efficiency type business. So the cycles may peak at slightly different times.

Internal financial leverage is also handy, we discussed how to calculate this in the Present Value of Future Cash Flows thread (I remember making myself look silly by doing it long hand!).

I agree with craft. I think how these all fit together in the big picture is gives you a good indication - but business cycles aren't an exact science they're not going to fit perfectly on a graph or chart, especially not with a single ratio I don't think. But generally when most of the companies in the industry start declining in profitability you know it's on the way down.

Just remember for DTL the 2011 result was way above trend, so it's a bit of an outlier and may or may not distort the picture.

 

[VSntchr]

Interesting to see the updates to Gartners hype charts which were referenced in the 2010 AGM letter (thanks craft for highlighting this letter earlier in the thread).

2012

2013
(sorry couldn't find a chart for this one.


These charts should have been shown to anyone purchasing any tech stock without earnings (so any tech stock) back in 1999