Stockwatch: Director buying and fat yield imply upside

Is Fidessa poised for another growth phase? This mid-250 share used to be a storming growth play, providing software to financial trading firms. In recent years, however, its chart has shown a volatile-sideways trend and the table doesn't exactly show glistening growth. But various factors appear to combine to favour upside.

Fidessa is heralding good prospects, its markets being in "a new phase of recovery as the impact from regulatory and structural changes strengthens...creating a large number of opportunities as well as some additional challenges...a high level of new business activity."

The message is a bit convoluted, including a caution about increased competition among customers with some of them closing (selected operations) as the industry consolidates – "this may result in a higher level of headwind into 2016," says the firm.

There's also investment required to meet new opportunities which will have a small effect on the group's operating margin. But the overall story seems to be improving and a latest update for the July to October period re-affirmed so. If you believe chart patterns then a bullish "bowl" is now apparent.

Technology investors are likely identifying a product replacement cycle underway, often a trigger for software stocks.

Strong cash flow means useful dividends  

On a price/earnings (PE) basis, Fidessa has looked expensive for years; e.g. despite earnings per share bumping along in a flat trend, Company REFS cites annual average historic PE multiples from 19 (2012) to over 30 times (2014).  Last summer the stock de-rated like many tech-plays, amid risk-aversion generally and possibly fearing that a bear market would hit financial trading firms' confidence to invest in IT etc. 

August's interim results didn't exactly help - reporting flat profits and earnings - although management cited a "strengthening pipeline across the business" as market conditions improved. Recurring revenue also rose to 86% of the total, lending an image of quality. Last year's revenue was derived 42% from Europe, 40% from the Americas and 18% from Asia, so currency translation will always be a factor.

Since the stock fell from about 2,500p to below 1,800p over the summer, at 1,935p currently the shares trade on a forward PE multiple in the mid-twenties. Notice from the table how cash flow per share is much stronger than EPS, and despite a strong element of capital expenditure (mainly continued product development) the board enhances pay-outs by way of special dividends.

Ongoing investment likely explains why the board persists with dual dividends, but considering Fidessa's cash flow profile the annual pay-out looks established at around 85p and rising, hence the market visualises a circa 4.5% yield as underpinning the stock. The latest update cites "strong reserves, no debt, substantial levels of recurring revenue and strong cash generation". Investment in a fixed income support product should also not compromise future special dividends.

Directors persistently buying shares

Fidessa's announcements include many headed "Director Shareholding" and, while most tend to be small-scale buying related to a company incentive plan, there has been a firm trend in cash purchases recently: e.g. in September two directors bought £27,000 and £17,800 worth respectively at around 1,880p a share; similarly £18,000 and £36,050 worth at around 1,800p, the latter trades by the chairman John Hamer, who owns 86,808 shares.

There was a similar string of purchases during August, as if the directors were underlining their remarks at interims on the 3rd: "Fidessa believes that it is entering a period where significant opportunity is returning to the markets - with potential across all asset classes and increasingly few vendors able to meet customer needs also regulatory requirements." A total four directors have added to their holdings.

Fidessa's products comprise software solutions for buy-side and sell-side trading firms, also global connectivity and market data. Helping sales on the buy-side, firms need to show greater transparency in their performance, with regulation forcing "best execution" in equities and other assets (on behalf of clients). Such changes impact the sell-side by way of requiring firms to demonstrate the value they bring, hence technologies to differentiate their services. Fidessa has therefore been investing to extend the range of asset classes it supports, in areas such as compliance, trade optimisation and measurement. A new partnership programme is aimed at selected third parties to leverage Fidessa's infrastructure and enhance the applications for clients.

Global equities-related business is doing well with new deals across all regions but especially Asia given it's a more dynamic market and as brokers look to provide services across the region than on specific markets. There is a sense of transition with more emphasis on service differentiation and execution quality. Fidessa's new tools enable monitoring and best execution in real-time, rather than a post-trade activity, thereby offering competitive advantage. Also a new Direct Market Access platform gives brokers a high-performance solution for equities and derivatives.

A new investment management system was well-received earlier this year with the majority of clients looking to upgrade. Not surprisingly perhaps, Fidessa's main institutional shareholders appear rock-solid with their holdings - as if satisfied clients also - and the largest holder with 13.9% is Lindsell Train, a well-regarded fund manager whose website proclaims: "We aim to invest only in exceptional companies that have rare ability to grow the real value of their profits and cashflows over very long periods of time."

Jefferies - admittedly one of Fidessa's brokers - targets 2,580p a share i.e. a return to end-2014 levels. To some extent this stock may correlate with general sentiment in financial markets, but clearly there are various factors suggesting Fidessa is on a medium-term upwards trend.

 For more information see Fidessa's website.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.