The importance of cloud computing and its infrastructure continues to grow in terms of de-scaling and the emergence of smaller players in the digital space, as well as economies of scale good even for larger players, which means increased outsourcing of computing needs for service providers. The problem is that being technical, stocks with these exposures can be expensive. Below we present an investment case diagram of two stocks that have shown the angles of value due to market inefficiency. While there are some risks for them, they can operate in the current environment to be able to generate returns for value investors.
The first stock to consider for some cloud exposure is Asseco Poland. It reached its highest levels a few months ago, but traded around 20% due to the rotation of technology early in the year, then the Russian invasion due to its exposure to the Baltic Sea and its listing in Warsaw, Poland.
Why is this arrow so interesting? The main reason is its evaluation. While it is difficult to analyze, minority interests and a complex ownership structure where a firm exercises minority control over others results in a very low multiplier for the firms in which it operates.
The two parts which are here given on a non-consolidated basis are as follows. Asseco’s primary business is technology consulting, such as the technology consulting business for Deloitte or such as Accenture (ACN). The other part, formula systems (forty), is the portion showing the unconsolidated income from Formula Systems which is a holding company listed in Israel, owed to US and Israeli cloud companies.
Big cloud exposure It’s in Magic Software (MGIC), which provides cloud integration services for businesses. Although it has a consulting angle within it as well, it enjoys meaningful revenue from its own cloud computing software that clients use for integrated cloud setups. It has good exposure to the end markets of logistics and healthcare, which are respectively thriving and resilient. With Asseco having high tech exposures, not only Magic but also ICT companies in Israel that work extensively with its border forces and military in cybersecurity and other digital solutions, as well as with Sapiens (Spence) which provides the insurance industry with tech solutions, its plurality appears to be very low with higher technology and services secularly growing at 12% of its EBIT. It is low especially when compared to IBM (IBM) which also has a mix of high-tech services at Red Hat related to the cloud, as well as a very prominent technology consulting firm. Asseco has a lot of growth while IBM has failed to achieve profitable growth, but Asseco still has the lower multiplier, which reduces its value.
The risk here is that buying Asseco exposes you to the Polish zloty, which although a respectable currency, could lose the US dollar to the safe haven flight if the economy turns around and when real rates in US Treasuries rise.
Avaya Holdings (New York Stock Exchange:AVYA)
Avaya is a company that was thrown into the trash due to years of private ownership and activists followed by bankruptcy a few years ago. Since then the company has begun to transform into Purposefully changing their economies. Primary business exposures are companies using call centers and companies that have purchased AVYA’s cloud-based corporate communications suite. They are all now provided through the cloud, making them widely salable to businesses operating in various configurations.
The reason this is a good opportunity is that they are changing their revenue model from a perpetual license where more revenue has been reserved up front to a subscription model. Every quarter, the share of this revenue is increasing and therefore new business is billed on a subscription basis with respect to how it will be billed in the decreasing share of permanent revenue. So while revenue appears to be declining, it is actually flat. The company is trading at 5x EBITDA despite a decent demand profile, which was supported by a WFH push that backed AVYA products. The risk we see here is not the business model but the leverage, which accounts for massively 66% of EV at very high rates >4%. While the recurring subscription revenue makes this company attractive regardless, leverage is something investors should take into consideration especially as prices set to rise. But a low multiplier provides a margin of safety, and if they can handle debt, and capital markets will be willing to treat them as such, in the worst case scenario of needing to restructure debt or raise equity, they have a model that will be able to provide LBO-like returns. Operating profit is almost able to cover their interest expense now that impairment charges are in the back view, and they have $500 million in cash to cover two years of interest since then. Hedge for the next 9 months.
Cloud products, service providers, and infrastructure remains an interesting market that offers significant growth opportunities that can easily be bet on to continue as digitalization remains a major force. These two companies give you that exposure while also giving you a strong value angle, albeit with some special risk factors, if you are not comfortable investing in the kind of high experimental stocks that often have cloud exposure given the situation in the markets it may well be absorbing increases In full prices and other inflation news. Asseco in particular also pays a decent dividend of around 4% despite being a tech company. Buying them together with a 3:1 weight against Asseco as a cloud based weight against Asseco is probably the way to go to reduce price risk and create cash flow from a very large return.