The long and the short of IT

Wagging the big dog: Public Sector tech

The UK’s Public Sector is a big dog. It issues £4.8trillion in contract notices (source: Tussell) from 8,200 public bodies with 20,000+ frameworks and 266,000 buyer & supplier contracts. It is estimated to soak up £1 of every £5 of all UK IT spend. As the UK enters an election cycle, IT suppliers are making negative commentary about spend disruption. While there is a big clutch of big companies exposed to this big market, the latest news is from the smallest; TPXimpact (12/2) and Made Tech (26/2). Investors should read these as curtain raisers for Accenture, AWS, Bytes, Capita, Computacenter, Kainos, Microsoft, Sopra Steria, Vodafone, etc when they comment. The Public Sector always goes into purdah ahead of elections. The Election Effect is temporal but it usually depresses market values (natch – see below). We need to think about the news cycle and when to buy as “others are fearful”.

Situation Update

The world goes to the polls in 2024 with an estimated 4bn votes being woed by needy politicians. The UK election is anticipated any time from October to January 2025, with November seen as most likely (to clash with the US). Public Sector IT buyers go into purdah into an election. The effect is acerbated when there is (as now) a potential regime change, coupled with a longer recovery as newbie legislators remember their policy wish lists.

The current UK Chancellor Jeremy Hunt MP is preparing for another round of voter-grabbing tax cuts in next week’s budget (6/3). Running the numbers suggests public spending cuts as Mr Hunt pays for the give-aways. While public spending is forecast to rise 1% above inflation each year over the next parliament, much of the money will be taken by the few departments where spending is protected (health and defence). The unprotected departments (Justice, local government, Home Office etc) face cuts unless the next government raises taxes or borrows more.

For its part, the Labour party is planning to relieve some of the spending pressure with particular tax rise (non-dom regime) but shadow chancellor, Rachel Reeves MP, has ruled out raising income or wealth taxes to fund daily departmental spending, so far (there are few votes in tax raises).

The Resolution Foundation calculated that Mr Hunts move could mean taking a fifth out of budgets for certain departments across the parliament at a level “equivalent to those undertaken by David Cameron’s government from 2010 to 2015”. Mr Cameron inherited an okay background, not the case now as a fifth of local authorities complain that they are likely to go bust over the next year.

Similarly, the IFS argues that while day-to-day spending on public services would rise in real terms by £17bn. After accounting for “plausible settlements” for spending on the NHS, childcare, defence, schools and overseas aid, the IFS analysis concludes that other areas of government would face real-terms cuts of £18bn by 2028–29, an average cut of 3.4% a year for four years.

Public Sector grammer: Past Perfect, Present tense, Future Imperfect

Public Sector spend ballooned during the pandemic and now there is diminished capacity for driving new programmes (a mix of budget and fatigue). Any call for smaller government (popular sloganeering) will lead to a hiring moratorium resulting in the continuation of the knowledge and skills gap in Public Sector. This will ensure that the UK government remains an acquirer of third-party IT services. In addition Central government organisations have favoured collaborative ecosystems, consisting of ‘bodies’ from the private sector working alongside the client’s IT team and this multi-sourcing will continue. In addition the current AI ‘Discovery phase’ in Public Sector should lead to contract awards even in a tight budgetary environment as ‘spend to save’ initiatives (AI’s big promise) accelerates in a new parliament.

The expected stop/start motion is captured by Georgina O’Toole Chief Analyst and Partner of industry analysts TechMarketView who argues: “It will take time for the new government to assess the financial situation and prioritise its procurement plans, so we can expect a hiatus in spending outside of core contract extensions. Despite these challenges, it is clear improving public services will only be possible by enabling acceleration in the adoption of digital technology.”

Points to Ponder:

• Vast technical debt - their may be trouble ahead. An independent study by the Modernisation and Reform Group found the UK government spends £2.3bn of its £4.7bn annual tech budget on "keeping the lights on activities" on "outdated legacy systems."

• Strategic Suppliers win The majority of Public sector spend heads to large IT suppliers - 89% of the total spend going to the 150 ‘tech titans’ – despite the Government’s commitment to award a third of contracts to SMEs, according to industry analysts at Tussell.

• All for the love of framework contracts. Many of the contracts, worth a total of more than £2.5bn, were won through large frameworks, but these are being dis-aggregated. Rem: Frameworks will usually lock-in a day rate in return for visibility, however currently day rates are drifting lower, suggesting that there will be pressures to re-negotiate at break clauses.

SMEs will fare well

SMEs have been gaining share of Public Sector contracts since the ERG initiative headed by Sir Francis Maude in the Conservative/Liberal coalition government, 2010 – 2015. This will continue.

Memories of 2010 rekindled

We did a double-take on reading the Resolution Foundation reference to that Conservative/Liberal coalition government. Investors may recall its defining positive moves to encourage SME suppliers but also the ERG group (out of the Cabinet Office) strong armed the largest suppliers to sign new (i.e. lower value) MOUs, essentially terms of trade As we bake in the lessons of history and the lessons learned from the Horizon debacle our view that the outlook is more mixed for the larger suppliers.

The Strategic Suppliers

A third of UK government spending goes on the procurement of goods and services from third-party suppliers. The larger ones are Strategic Suppliers and there were 39 (as per December 2023). The Strategic Suppliers are private sector companies whose relationship with the government is centrally coordinated through the Cabinet Office, due to the strategic importance of the goods and services they provide. The government typically spends over £100m/year with these suppliers. They are managed by the Cabinet Office who appoints a 'Crown Representative' to act as a ‘single customer’ and ensure that the government has a consistent message.  

The Strategic Suppliers close proximity to government offers them liaising opportunities with key procurement stakeholders. The Strategic Supplier programme's use of MOUs means, as the Cabinet Office describe, "strategic suppliers will agree to provide the government with the information it needs to monitor and manage risks", with the aim of increasing "accountability".  Between FY21/22 and FY22/23, the Strategic Suppliers' public sector revenue collectively declined by 17%, resulting in a drop of total market share from 11% to 9% with 2/3rds of Strategic Suppliers experiencing a revenue fall.

Company commentary

Made Tech: Interim Results (26/2)

Summary view: Improving trends

The commentary and subsequent analyst call was peppered with caution about the potential impact of the election, potential slowdown in new contract acquisitions. Yet interim results showed improving dashboard KPIs as a more mature Made Tech benefits from a lower cost base (FTEs 388, 484 Y/Y) feeding improved profitability and a healthy contracted backlog. In the period Made Tech inked new contracts, hired experienced staff (CFO, CRO) and continued to gain from Public Sector multi-sourcing, the disaggregation of large IT contracts, and the ‘lean’ in favour of SME suppliers. Fortunes should continue to improve.

The numbers: Mixed

Interim results featured a 7% fall in revenue to £19.1m, but Gross Profit Margin rose to 37.1%, 32.9% Y/Y with Adj EBITDA +180% to 7.3% margin. However, Sales Bookings (total value of sales contracts awarded in the Period, to be delivered in FY24-FY27) were down 61% to £12.6m. Although this followed three wins: Department of Business and Trade (£1.9m, 1 year contract), Government Digital Service (£5.0m, 2 year contract) and Ministry of Justice (£3.8m, 1.5 year contract). The Contracted Backlog (contracted revenue yet to be recognised) was +28% to £61.3m which underpins (c90%) FY25 revenue projections. Net Cash was £7.9m vs £9.0m Y/Y.

Current Trading & Outlook: Reiterates guidance

The Group guided that it was on track to meet FY24 profit expectations, with revenue slightly down Y/Y, largely due to a “challenging market and uncertainty created by the forthcoming general election”. Profit is to improve due to ongoing productivity and cost control initiatives.

CEO Rory MacDonald commentary:

• Operational plan: “Made Tech is focused on ensuring that it is fit and ready to capitalise on the structural growth opportunities that we see in the UK public services market, with an efficient, right-sized cost base, experienced senior management, and an achievable strategic growth plan in place, whilst also maintaining our reputation for excellence amongst clients.”

• Election Effect: “The upcoming general election undoubtedly introduces a measure of uncertainty, with potential slowdowns in new contract acquisitions likely, as clients navigate the changing political landscape.”

Enhances the (T&M) business model with SaaS

The official launch of the first suite of in-house developed, software products, Housing Repairs, Housing Voids, and Evidence. This expands the company portfolio beyond services with a recurring SaaS revenue model. The aim is to offer a suite of comprehensive solutions designed for “the specific needs of our clients”. While Made Tech has signed a flagship client in the period it guides that investors should anticipate commercialisation “over the next 12-18 months”.

Note: We updated our IT Professional Services dashbord in the wake of the print (see below).

TPXimpact Q3 trading Update (12/2)

Summary view.

There is an organisation change to come into effect from 1 April will see TPXimpact divide into three businesses; Digital Transformation, Digital Experience and KITS. As prior efforts to consolidate the company were not successful, this people and cultural change needs careful management and communication with investors. Otherwise positively CEO Bjorn Conway reiterated FY guidance and commented that the outlook remained positive “irrespective of the short-term uncertainty that may occur due to a general election.

• Overall, Q3 trading was in line with achieving the Company's financial targets for FY2024 with Q3 revenue +32% Y/Y to £20.2m and YTD revenue +25% to £61.8 million. Previously announced FY targets are FY24 revenue range £80-85m (implying revenue growth of 15-20%) and Adj EBITDA range of £4-5m (margin of 5-6%). In addition, targeted net debt (excluding lease liabilities) c£11m (31/3/2024) or a net debt to Adjusted EBITDA ratio of <2.5x.

• Following the forthcoming re-organisation (1/4/24), TPXimpact will comprise three businesses Digital Transformation (being the Consulting, Data & Insights and RedCortex teams), Digital Experience and KITS (managed services) .

• FY25 outlook was reiterated with an existing like-for-like revenue growth target of 10-15% and further margin improvement of 2-3% on top of that expected to be achieved in FY24

• Bjorn Conway, CEO commented that the outlook remained positive “irrespective of the short-term uncertainty that may occur due to a general election”.

The data

Valuation heatmap: Value appears in T&M IT Services

Source: Yahoo Finance, Analyst after hours 26/2

The strategic Suppliers Public Sector revenue (from Tussell)

Source Tussell

Updated Professional Services updated dashboard

Source Company data, Analyst

End notes & Disclaimer: Please read

All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. This is not investment advice. Opinions contained in this report represent those of the author at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. The author is not liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained herein. The information should not be construed in any manner whatsoever as, personalized advice nor construed by any subscriber or prospective subscriber as a solicitation to effect, or attempt to effect, any transaction in a security. Any logo used in this report is the property of the company to which it relates, is used here strictly for informational and identification purposes only and is not used to imply any ownership or license rights between any such company and Technology Investment Services Ltd. Email addresses and any other personally identifiable information collected in the provision of the newsletter are only used to provide and improve the newsletter.

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My name is George O’Connor. I am a tech investment and IT industry analyst. I explore shareholder value, its drivers, the best exponents, the duffers. The target readers are investors, companies, advisors, stakeholders and YOU. If you like this please subscribe and pass it on to colleagues and friends. That said, if you hate it - do the same. Thanks for dropping by dear investor.