Alithya Group (NASDAQ:ALYA) recently reported a mixed set of FQ3 ‘21 results. On the one hand, the sequential sales growth was a positive surprise considering the seasonally weak December quarter (although the pent-up demand likely helped somewhat). However, many of the same challenges remain – in addition to its large Canadian customers transitioning away from legacy staffing services, its Oracle customers in the US are also in the midst of an ongoing transition to the cloud. As a result, margins have been a drag, and FQ3 ’21 showed little sign of this changing anytime soon. Yet, shares appear to have baked in a relatively optimistic scenario based on the valuation, and with the current EV/EBITDA multiple at a premium to peers, I am neutral.
Canada Leads the Top-Line Recovery in FQ3 ‘21
For its latest quarter, Alithya’s revenue improved c. 3% Q/Q and c. 7% Y/Y on the back of large contract renewals and the benefit from prior acquisitions, along with the release of some pent-up demand from prior Covid-19-led slowdowns. Notably, bookings stood at an impressive c. $126 million (implying a c. 1.9x book-to-bill ratio), although I would note that the headline number benefited from a two-year renewal from Desjardins, which likely added c. $40-50 million in bookings for the quarter. In the US, however, challenges remain, with utilization still below the c. 75-80% target in FQ3 ’21 on headwinds across both its Oracle practice and on legacy projects.
Source: Alithya Group FQ3 ’21 Presentation Slides
Nonetheless, top-line trends in the Canada business continued to improve, rising c. 9% Y/Y and 3% Q/Q, as the stabilization at several “core” longer-term Canadian customers (including the multi-year renewal with Desjardins) boosted results. Another recent notable win is AGA Benefit Solutions, which is utilizing Alithya’s Digital Solutions Center for the consolidation of back-end client and administrative data, along with the development of a modernized member portal. The surprisingly strong Canadian business performance stands in stark contrast with sluggish organic growth in recent years, and with management pointing to stabilization and continued growth ahead, I am upbeat.
Source: Alithya Group FQ3 ’21 Presentation Slides
Margin Dilution Remains the Key Concern
Despite the positive revenue performance, Alithya’s gross and adj EBITDA margins were down c. 150bps and c. 207bps Y/Y, respectively. Key cost drivers include a below-par baseline utilization, cost increases on key strategic projects, and a step up in hiring across sales and project implementation (up c. 175 people in FQ3 ’21). Interestingly, c. $1.5 million in costs were incurred on a key strategic project related to the co-development of new IP with a customer and therefore, includes revenue royalty participation, which could pay off down the line.
Source: Alithya Group FQ3 ’21 Presentation Slides
As a result, adj. EBITDA of $2.3 million was disappointing, with additional expenses like redundant office space and ERP implementation costs (c. $0.7 million for the quarter) further weighing on headline profitability. Nonetheless, considering the elevated fixed cost base, post-Covid-19 improvements in utilization should eventually drive additional EBITDA generation, while the partnered approach to IP development could also help margins over time. In the near-term, however, further margin dilution appears to be the base case.
Synergy Realization from Prior M&A is Tracking Positively
Thinking longer-term, I continue to view Alithya as an emerging IT services provider utilizing an active M&A-led growth strategy to build out scale. Since end-2019, the company has completed three acquisitions for a total consideration of c. $47 million. Relative to the c. $7 million in EBITDA generation, this implies an average acquisition multiple of 6-7x, which seems reasonable. The last acquisition, for instance, saw Alithya paying c. 7x EBITDA for Askida, roughly in-line with its other prior acquisitions, including Travercent (cash only) and IoT/AI company Matricis Informatique (cash and stock).
Importantly, management has noted that its recent acquisitions (Askida, Travercent, and Matricis) are all delivering organic growth alongside the targeted synergies. With plenty of opportunities from an expanded scope and cross-border capabilities from the acquisitions, I view the positive commentary as a positive and important guidepost for the growth-by-acquisition strategy going forward.
Constrained by a Levered Balance Sheet
One key hurdle to future M&A, however, is Alithya’s balance sheet – the company reported c. $17.1 million in net bank borrowings against c. $12.7 million in cash and equivalents (including restricted cash). However, I would note that there are other obligations as well, for instance, the c. $15 million in M&A-related purchase payables and c. $10 million in government loans. This implies that excluding vendor financing, the overall net debt position stands at a concerning c. $27 million (equating to c. 3x net debt/EBITDA). While the c. $7 million in PPP relief (likely in FQ4 ‘21 or FQ1 ’22) should help, I remain concerned that the debt-laden balance sheet will constrain M&A appetite in the upcoming quarters.
Source: Alithya Group FQ3 ’21 MD&A
Final Take
While Alithya delivered surprisingly positive top-line results for the quarter, margin dilution remains a concern, especially with shares currently trading at a relative premium to IT service provider peers like Enghouse (OTCPK:EGHSF), Hackett Group (HCKT), Huron Consulting (HURN), and Perficient (PRFT). With the levered balance sheet also likely to delay future M&A, I remain relatively cautious pending visibility into a sustained organic growth recovery and margin expansion.
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