Gamma Communications is an AIM market, London-listed communication technology provider to businesses in the UK and Western Europe. Its primary business is involved in unified cloud communication technology and SIP trunks, which are tools that businesses can use to simplify their telephone communication systems and reduce overall costs. Gamma has had a vintage year in 2020, with record growth in recent years of 20% driven by organic results and bolt-on acquisitions in European markets. Gamma is a market leader in the UK, where currently 88% of group revenues are derived. With an international expansion strategy focused on markets in Western Europe underway, is now a good time to buy the shares?
Before we look at Gamma’s business in more depth, it is probably worth explaining the products and services that Gamma provides, starting with SIP trunks. According to BTTcomms.com, most businesses across the UK used to use a legacy solution ISDN (Integrated Service Digital Network), which links business telephone communications through copper and fibre optics to the public telephone network. SIP trunks are a digital advancement, where all communications can be routed through virtual phone lines and broadband connections, rather than physical setups. SIP trunks allow for one telephone number to be used for anyone in a business regardless of premises or geographic location. They can also be easily flexed depending on the number of users, as it is a digital solution. Due to the nature of digital connectivity, call costs are significantly reduced.
The second product category for Gamma is UCaaS (Unified Communications as a Service). This segment represents a suite of varied technologies that enable the business to manage communications with abilities such as:
Digitally queuing inbound calls and directing them to specific locations;
Management reporting, with performance and call quality analytics;
Making calls directly from a desktop;
Integration with Microsoft Teams and Skype.
Whilst Gamma has a market-leading SIP trunk technology in Europe, it is currently aiming to leverage this position to grow its offering in Unified Communication.
Whilst there are some exciting secular changes in telecoms technology set to change the way the world communicates (5G and artificial intelligence), Gamma operates within a more grounded segment of business communications. Gamma provides modern connectivity tools for B2B and B2C communications, and its solutions provide a critical service for businesses to function on a daily basis. Whilst this segment has less overall disruption and is not at the forefront of technological change, there are a few market trends that are providing a tailwind for Gamma and similar business communications providers.
Firstly, the increased need for flexibility and adoption of cloud-based solutions. The pandemic has accelerated a trend that was already underway: the need for businesses to be flexible to working locations, their operations to be continuous (no matter the environmental challenges) and the increased need for scale in communications, which are far more costly to scale outside of the cloud than with the infinite scale a cloud-based solution can provide.
A second trend for businesses to manage that plays into Gamma’s solutions would be the increase in multichannel customer contact points. Businesses in pretty much every sector have to be very nimble in the channels they now use to interact with customers. Let's take the example of a large retail chain. On any given day, a retail chain will have customers contacting them through customer service telephone lines, website chat functions, customer service emails, third party websites and social media sites. Gamma has solutions that manage multiple channels so businesses can easily facilitate customer leads through the preferred inbound channel of each customer.
In terms of recent performance, 2020 was another solid year for Gamma. The mass shift of employees from offices across the UK and Europe to home working has underpinned the need for businesses to remain flexible with communications strategies, and Gamma has certainly benefited from this shift. Revenues in 2020 were up 9% on an organic basis and 20% including acquisitions. The core product line of SIP trunking in the UK saw revenues increase 17% and in the Unified Communications segment, Gamma made further developments to integrate solutions with Microsoft Teams: a rapidly growing application for business collaboration. Growth before 2020 has been very consistent too. Averaging 15% revenue growth per annum in the years 2016 to 2020, Gamma has earned its place as a reliable growth stock on the Aim market. 2020 also saw strategic progress from Gamma, with the disposal of a Manchester-based fibre network business ‘The Loop’ for a cash consideration of £19.5m and the acquisition of four small businesses in Germany, Spain, The Netherlands and the UK. The market for UCaaS solutions is much less penetrated in Europe than in the UK, and thus, recent acquisitions have been focused on building scale in this less-developed market.
Gamma Communications financial metrics, source: Annual reports 2016-2020
Gamma’s financial metrics help to provide insight into the financial health of the business. Gamma’s revenue growth has been steadily accelerating in recent years. However, the two largest years for growth can be attributed to acquisitions in 2018 and 2020. Whilst typically this is less encouraging than organic growth, I have explained at length below why Gamma’s acquisitions can be seen in a very positive light. Operating profit has grown in line with revenue over the years and the profit margin has increased as Gamma has grown scale, owing to the fact that Gamma is growing strategically, rather than reducing margins to boost revenue. Looking further to the balance sheet, the amount of capital Gamma employs on a yearly basis is low. Gamma has virtually no debt, and due to being capital-light, Gamma’s return on capital employed is impressive. Acquisitions have steadily increased capital employed over the years (typically, by adding intangibles to the books such as software) but profits have grown in tandem, showing Gamma is more than capable of turning capital investment into profit. Overall, I would rate Gamma’s metrics very favourably and I am encouraged by the mix of revenue growth and margin improvement — often a recipe for stock market gains!
Gamma Communications cash flow expenditure, source: Gamma Comms Cash Flow Statements 2016-2020
I wanted to talk a little about Gamma’s acquisitions, seeing as they not only seem frequent but are also core to Gamma’s growth strategy going forwards. I have compiled this chart by analysing Gamma’s cash flow statement for the years 2016 through to 2020. The green bars show Gamma’s net operating cash flow (the cash left over for the year after all costs from business activities are considered), the red bars show cash spent on investment activity (acquisition or internal investment) and the gold bars show dividend payments. It is worth noting that the years 2016 and 2017 saw no acquisitions and the years 2018 to 2020 have all had acquisitions of varying proportion. What I wanted to portray with this graph is the reassurance that acquisitions are of bolt-on size and are paid for out of cash profits generated by the business, not debt. These acquisitions can almost be seen as outsourced R&D, where the company is choosing to allocate capital by buying into the best opportunities to increase scale and product offering.
What I really like about the Gamma model is that instead of allocating large dividends to shareholders and therefore paying away most of its cash flow, it is reinvesting earned capital into small bolt-on businesses to grow in Europe. This method of capital allocation makes sense and also means the business is not taking on debt, which would increase the overall cost of capital. In my opinion, this allows me to consider the growth in 2020 of 20% as quasi-organic, as the growth has been funded by existing capital, rather than taking out a chunk of debt to fund growth.
Gamma currently trades at around 28x expected earnings in 2021. However, if further acquisitions were to be included, I could easily see expectations being beat. Gamma operates as a market leader in a critical niche for business communications, and I think, on a balance, its track record for growth, superior financial metrics, super clean balance sheet and astute capital allocation policies will serve shareholders for many years to come.
The Twenties Trader does not own a position in Gamma Communications