Research note - Gordon Capital

Managed to obtain this recent research note on Tesserent by Gordon Capital.  Positive, wait to see if share price follows.

GORDON CAPITAL PTY LTD

Lvl 9, 440 Collins St, Melbourne, Vic, 3000  Ph: (03) 9607 1371  www.gordoncapital.com.au Gordon Capital Pty Ltd, is Corporate Authorised Representative No. 338899 of InterPrac Financial Planning Pty Ltd (AFSL 246638)

TESSERENT LIMITED (TNT) UPDATE FY 2016 Review – framework for accelerated growth has been established

DIRECTORS Russell Yardley, Chairman Keith Glennan, Managing Director Steve Bertamini, Non-Executive Director Gregory Baxter, Non-Executive Director Paul Brandling, Non-Executive Director MARKET DATA ASX Code: TNT Current Price: $0.10 52 week Share Price Range: $0.10 - $0.2775 Market Capitalisation: $11.5 million Enterprise Value: $8.1 million CAPITAL STRUCTURE Shares on Issue: 115.3 million FINANCIAL SUMMARY $’000 FY 2016 (A) FY 2017 (F)* Revenue 4,714 ~7,500 EBITDA (-487) ~(1,500) Net Profit (-754) ~(2,000) *Gordon Capital estimates SHAREHOLDERS Grand Floridian Pty Ltd 27.4% RTSF Super Pty Ltd 12.6% Vendors of Blue Reef 11.2% T B C (Australia) Pty Ltd 6.6% SENIOR ANALYST Michael Gordon (03) 9607 1371 September 2016 KEY POINTS  FY 2016 revenue up 30.2%, to $4.7 million.  Assets and business of Blue Reef acquired and merged with existing education business.  The education sector is a global growth opportunity and a channel partner has been secured in the US.  Key sales and marketing appointments in the June quarter.  Sales professionals now located in Melbourne, Sydney, Brisbane and Singapore.  Infrastructure and resources now in place to build sales momentum.  Contracted annuity income in place equivalent to 25% - 30% of our forecast FY 2017 revenue. INVESTMENT PROPOSITION Tesserent is in the rapid ramp up phase of commercialising its cyber security platform on a global scale. The focus is now on driving customer acquisition and building scale in this large and fast growing industry. With the sales and marketing team now in place, sales momentum will build through FY 2017. Successful execution of its business plan and the achievement of key milestones will provide scope for considerable valuation gains over the next two years as critical mass and sustainable profitability is achieved. Gordon Capital Pty Ltd Page 2 of 7 EVENT The key data from Tesserent’s FY 2016 results are detailed in the table below. (A$000) Y/e 30 June 2015 2016 % chg Operating Revenue 3,750 4,884 +30.2 Cost of Sales -1,292 -1,948 Gross Profit 2,458 2,936 +19.4 Overheads -2,101 -3,112 Adjusted EBITDA 357 -176 IPO costs - -247 Share based payments - -236 Other - -75 EBITDA 357 -734 Depreciation & Amortisation -105 -199 Interest -129 -92 Pre-Tax Profit 123 -1,025 Tax -31 271 Net Profit After Tax 92 -754 Net Operating Cash Flow -105 -450 Total Assets 1,684 9,571 Net Cash -1,019 3,381 Shareholders’ Funds -1,406 6,385 ANALYSIS AND COMMENT Tesserent listed on the ASX in February 2016 having raised $7 million to fund its global development strategy. Accordingly, FY 2016 was a transformative year as it moved into the public arena and continued to build infrastructure critical to the execution of its strategy. Prior to listing, the company established a solid revenue base from a broad mix of clients with very limited management and sales and marketing resources. The primary focus was in building the physical infrastructure to support the company’s managed security services business model. Since listing, the focus has been on expanding the management team and putting in place a sales and marketing team, which is now largely completed. Gordon Capital Pty Ltd Page 3 of 7 The FY 2016 results reflects this transitioning. Sales were close to our forecast notwithstanding that the IPO process was highly disruptive and the sales and marketing team didn’t come together until near the end of the financial year. The increase in overheads was due to the expansion of resources to drive growth as well as from increased costs arising from the integration of the acquisition of the Blue Reef business. Notwithstanding the increase in the cost base, the loss was less than we expected, mostly due to key staff appointments joining the company a bit later than anticipated. The other key highlight of the year was the acquisition in May 2016 of the assets and business of Blue Reef, a provider of cyber security management and training services to schools. These initiatives set the framework for the development of the company over the next few years. We expect significant growth in FY 2017 as the company builds sales momentum with a much stronger impact anticipated in FY 2018 and beyond. The three legs to the company’s growth strategy are:  Corporate and Government Managed Security Services Client base in Australia and Asia Pacific.  Specialised Education Cyber Safety Offering Servicing schools in Australia and overseas.  Wholesale Opportunities - Tesserent Proprietary Platform Addressing global markets, including Asia, UK, US and UAE. Near the end of the fiscal year, the company appointed Heads of Global Sales and Marketing, both highly experienced in cyber security, and added sales professionals in Sydney, Brisbane and Singapore. To this point, the company has had a strong presence in Melbourne and its international presence largely reflected the reach of its client base. Accordingly, it was under-represented in other important domestic markets, which has now been addressed. The new Head of Global Sales is responsible for the international expansion of the company through direct relationships, channel partners and distributors. We expect sales momentum to build through the year, especially in the second half once the activity pipeline fills. The Blue Reef business is uniquely focused on the education market where its value offering extends beyond the technical aspects of cyber security to encompass programs to teach students to behave responsibly on the internet. The platform also includes many features that allow teachers and school management to maintain oversight of student online activity. The assets and clients of this business were acquired and merged with Tesserent’s existing education business in a new division, Tesserent Education. The acquisition of Blue Reef will provide a considerable lift in the revenue base of Tesserent, however, due to the peculiarities of the acquisition the impact will progressively emerge over FY 2017 as annual invoices are issued. In acquiring the client base of Blue Reef, Tesserent took on the obligations and costs of supporting those clients (there was a cost impact of about $200K in FY 2016) but is only entitled to the revenue when the annual payments on multi-year contracts are due or when contracts are renewed. Further, accounts are generally billed annually, and revenue is accrued and recognised on a monthly basis. Tesserent will receive the cash flow benefit of the Blue Reef client base through FY 2017, which based on about 150 clients will have billings estimated at Gordon Capital Pty Ltd Page 4 of 7 between $2.0 million and $2.5 million. However, assuming the renewals occur evenly through the year (in fact there is a marked concentration in the December quarter), only half of these billings will flow to revenue in FY 2017 with the full impact in FY 2018. This is only a starting point and is based on Blue Reef’s client base at the date of the acquisition and ignores new client business that is likely to be secured in the normal course of operations over the next year. Tesserent has recently signed a US channel partner who we understand has been trialling the Tesserent Education platform with a number of schools and is now well positioned to generate early sales. The US has enormous potential and this could be the forerunner of larger push into this and other international education markets. The power in the Tesserent business model lies in the annuity streams that flow from multi-year (typically three) contracts. Accounts are typically paid annually in advance (although sometimes quarterly) and amortised to revenue monthly in arrears. Whilst there is a delayed impact on reported revenue and profit, (and a significant contingent unearned income liability on the balance sheet) the cash flow implications are positive. As at 30 June 2016, annuity income for FY 2017 of $2.0 million was in place, about 25% - 30% of our forecast FY 2017 revenue. The Tesserent balance share is typical of an early stage services based technology company; limited physical assets and significant intangibles. The company was debt fee as at 30 June with cash reserves of $3.4 million. With the infrastructure and resources now in place FY 2017 will be about driving growth and building sales momentum. We are forecasting revenue of around $7.5 million, about 60%, growth, with a much higher annual run-rate in the June quarter. With the full year impact of the Blue Reef acquisition and recent staff appointments, overheads will again markedly increase. Accordingly, we are forecasting an EBITDA loss of around $1.5 million and a net loss of around $2.0 million in FY 2016. Nonetheless, cash flow from operations could be close to breakeven. In FY 2018, we think that revenue could exceed $12 million and a maiden profit as a listed company may be achievable. BUSINESS OVERVIEW Tesserent has developed a cloud-based platform for the delivery of comprehensive cyber security services in commercial and institutional environments. It is an innovative platform that centralises the security management of critical IT infrastructure by leveraging established industry technologies. Tesserent directly provides Security-as-a-Service to customers in Australia and internationally, and has also licensed the technology to channel partners in Hong Kong, South Korea, UK, and the UAE, who in turn provide the service to their own customer bases. Security services for a customer’s computer infrastructure, include firewall, authentication, anti-virus, anti-malware/spyware, intrusion detection, security event management, content inspection, and bring-your-own-device support amongst other services. A key feature of the platform is its ability to coordinate a wide range of threat intelligence data from many of the world’s leading cyber-security data providers and distil this data into actionable information that is immediately disseminated to each customer’s network. New threat intelligence created from the analysis of this information is then fed back to all of Tesserent’s customers globally thereby ensuring that each customer’s network benefits from the new knowledge. Tesserent is employing a two pronged go-to-market strategy encompassing direct client relationships and distribution partners. Tesserent and its channel partners provide Security-as-a-Service to well over 200 Gordon Capital Pty Ltd Page 5 of 7 organisations and have customers in 11 countries and territories. In addition, recently acquired Blue Reef has about 150 clients in the education sector in Australia, New Zealand, SE Asia and China. As the company ramps up its sales and marketing efforts, we think it likely that the number of clients supported directly and through partners will pass 500 during FY 2017 and with continued market growth, Tesserent’s customer base could exceed 1,000 in FY 2018 or FY 2019. The Tesserent platform has been developed over the past five years and the commercial roll-out and business model validation process has been focused on securing direct client relationships. Despite limited financial and marketing resources, the company has built a solid client base across a wide industry spectrum including education, local government, retailing and distribution and manufacturing. This success has been driven by a relatively simple business model, a known cost structure with in-built growth capability, protection against redundancy and obsolescence and a high level of 24/7 support. Revenue is generated in the typical managed services model by the number of seats or terminals serviced but this will often bear little or no relationship to the client’s internet traffic which the network is designed to support. Tesserent’s model is ambivalent regarding the number of seats supported but is rather based on the size of the client’s “pipe” to the internet which is a proxy for the traffic volume to be managed. Fees are charged on a monthly basis with reference to the size of the internet connection. The average RPU is around $36K per annum but this varies from less than $10K to in excess of $100K per annum. BUSINESS DRIVERS AND GROWTH PROFILE Cyber security is an enormous, rapidly growing market which is increasingly delivered by consultants, integrators and IT security specialists through managed services business models. Reflecting the enormous cost to the global economy from IT security breaches, which is estimated at over US$400 billion annually, the cyber security managed services market has grown by about 66% over the past three years to be an US$18 billion industry and is expected to grow by another 50% over the next three years to US$27 billion. Whilst there are a relatively small number of key software and hardware technology providers who specialise in various components of the supply chain, there are numerous providers who package these components into business solutions. Tesserent’s solution stands in marked contrast to the standard distributed model where every network will have its own set of hardware and software which is individually managed and supported. Tesserent has built a single platform and centralised solution that incorporates key technology protocols from a range of leading suppliers which provides all the security services expected from a comprehensive, complex solution. Client access to the internet can be routed through Tesserent’s severs or those of its channel partners thereby providing high end cyber security services at markedly lower cost. With well over 200 clients managed directly or through channel partners, Tesserent has validated the technology and demonstrated a capability of being able to operate profitability. The strategy is now to rapidly scale up the business globally and to this end the company has developed a three-pronged go-to-market strategy around direct clients, channel partners and wholesale. Gordon Capital Pty Ltd Page 6 of 7 Tesserent’s platform is an attractive solution for systems integrators, IT security specialists and consultants who are now able to offer a simple, managed security solution to their own clients, usually as part of a broader service and support relationship. Channel partner relationships have been developed to accelerate the global roll-out of the platform with partners currently in place in the US, UK, South Korea, UAE and Hong Kong and the focus of business development is to rapidly expand this network. Tesserent has built a strong direct client base, including a significant number of well-recognised companies, through its initial commercialisation and business model validation strategy and will continue to develop its own client relationships in Australia and in selected offshore markets to leverage its infrastructure costs and for reference purposes. Nonetheless, we expect the growth in revenue from partners, in the medium to long term, to exceed that from the direct clients. Acquisitions will also be a key element in the company’s growth strategy as an effective means of achieving quantum leaps in the client base, gaining access to new verticals and adding to its technology platform and internal management capabilities. To this end, the May 2016 acquisition of the business of Blue Reef ticked all of these boxes. With over $3 million in cash, we believe the company has adequate resources to cover anticipated operating cash flow deficits over the next 12 to 18 months. However, additional capital may be required to fund any further acquisitions that may be undertaken through this period.