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Digia: Meeting with management - Danske Bank

Conclusion
We today hosted a meeting with Digia's CFO Kristiina Simola and Harri Vepsäläinen, SVP Digia Digital.
Overall, we got a positive impresssion, although no big news compared to comments given after the Q2 report three weeks ago. Digia reported stronger than expected Q2, with sales holding up well despite COVID-19 (up 8% y/y; helped by the more stable Services which grew by 13% y/y, compensating for -2% in Projects) and EBITA margin jumping to 11.7% from 8.8% year-ago, boosted by COVID-related savings from travel etc. The company reached target 10% EBITA margin in H1 20, but acknowledges that this was exceptionally good. Digia guides for 2020 EBITA to increase, but does not give guidance for H2. We however got a fairly positive impression, with the Services sales being stable and outlook for Projects probably not much worse than in Q2. Projects have been delayed rather than cancelled. Digia also has a sizable exposure to the public sector (up to 30% we believe), which adds to stability - even though Digia commented that pricing in public sector projects has declined to unattractive levels in some cases.

We asked whether the 10% EBITA margin target level (sustainably) is now easier to reach, following good H1 20. Perhaps, but depends on the impacts of COVID-19; if it leads to a longer period of lower demand, it could impact pricing negatively. Digia also highlights that it is investing in long term growth, with many growth initiatives having a negative impact on margins, and the target would be easy to reach if it just cut all development. In our estimates, we have assumed lower H2 20 EBITA margin than in H1. Digia constantly looks for M&A targets and balance sheet had plenty of headroom at 0.9x ND/EBITDA (2020E), however valuations have increased recently.

We also met with Digia's competitors Gofore and Vincit last week. In general both had a similar, positive message about demand for digitalisation consulting in Finland: there is structurally growing need for services that help companies and public sector to digitalise their operations, and COVID-19 has not really changed this. However, the impacts of COVID-19 seemed quite different, with Gofore quite unaffected (up to 70% of sales to the public sector) but Vincit having seen more project postponemenets and cancellations, leading to temporary layoffs (probably due to smaller customers). Both expect M&A to continue in the industry, partly due to difficulties in recruiting.

Our view on the stock: We see Digia as a growth case that is well positioned to grow in the growing Finnish IT services market. The company has a high share (>60%) of recurring maintenance revenues - which is its main diffrerentiator among the smaller IT companies. Digia has reached a significant turnaround in performance since the QT spin-off in 2016 and we expect growth to continue in 2021-22. We have argued that Digia should be valued at high-end of its peer group and in line with HiQ, which historically traded at ca. 12.5x NTM EV/EBITA. For Digia, we estimate 11.8x 2021E and 10.3x 2022E EV/EBITA and 8-9% FCF yieds, which looks attractive.

Last week, Triton made a bid for HiQ which implies ca. 20x 2020E EBITA and 17x 2021E on FactSet consensus numbers. However, we do not see Digia as the most potential takeover target among Finnish IT services companies due to its business mix: it combines own ERP products, consulting, and maintenance/monitoring business. We think a consulting company like Gofore with no own products could be a more likely target for a larger player seeking presence in Finland.

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