APX Multiples -- Are they 'Fair'?

APX Multiples -- Are They 'Fair'?

@chad987 posed an excellent question recently: "T.E.P., do you think the market is treating Appen as a halfway growth-cyclical stock rather than a full growth stock? Management did say speech/image are cyclical, and mega-cap tech reprioritisation has shown earnings are unpredictable, could this explain the insane valuation difference between it and other growth stocks?"

Let's start by understanding exactly how Appen is being valued right now versus how it has been treated historically.

Computed below are the key multiples for understanding Appen's valuation over Jun 2017 to April 2021, reported quarterly.

These are: TEV/LTM total revenue, TEV/NTM total revenue, TEV/LTM EBITDA, TEV/NTM EBITDA, TEV/LTM EBIT, TEV/NTM EBIT, P/LTM EPS, P/NTM EPS, P/LTM Normalised EPS, P/BV, P/Tangible BV, P/BV, P/Tangible BV, P/NTM CFPS, TEV/LTM Unlevered FCF and Market Cap/LTM Levered FCF.



Across 2017 to 2021, Appen has traded across a range of:

• TEV/LTM Total Revenue: 2.67x to 8.44x (3.3x currently)
• TEV/LTM EBITDA: 17.33x to 48.82x (25.61x currently)
• P/BV: 4.15x to 19.35x (4.15x currently)

What does this tell us?
Firstly, Appen currently trades at the bottom end of these historical valuation-multiple ranges. In other words, sentiment towards the stock is very low relative to historical levels.

Secondly, anything that affects the (perceived) timing, likelihood or duration of future cash flows will affect these valuation multiples. Thus, I don't think the situation we find ourselves in is as simple as classifying Appen as a cyclical v growth v high-growth stock.

Ultimately, there are a large set of factors such as competitive dynamics, pricing power, the nature of revenue (% recurring revenue), management, etc. that are all influencing broker estimates of future growth rates, margins and subsequently cash flow. This is reflected in the valuation multiples.

But, what valuation multiple is 'fair'?
I consider Altium & Wisetech the closest comparators to Appen on the ASX, albeit they are very different businesses. (The best comparator to Appen globally is Lionbridge AI).

These two businesses trade at enormously higher valuation multiples. Currently, they trade 340% (ALU) to 540% (WTC) higher on a revenue multiple basis and 55% (ALU) to 194% (WTC) higher on an EBITDA multiple basis.



There a few factors that dictate why Altium and Wisetech are being rewarded with higher multiples. The multiple premium afforded to Altium and Wisetech is significantly higher than that of Appen's primarily because of two main factors. 1) Earnings quality and 2) earnings reliability.

1) Earnings quality is reflected below in the operating statistics of ALU v WTC v APX, across gross margin (%) and EBITDA margin.

ALU has a gross margin approximately 1.9x higher than APX. WTC's gross margin is 3.3x higher than APX's. The EBITDA margin premium over Appen is between 2.2x (WTC) and 2.9x% (ALU).


2) On the other hand, earnings reliability can be reflected in the percentage of revenue that is recurring:

• 65% of Altium's revenue is recurring
• 91% of Wisetech's revenue is recurring

What could cause a re-rate in Appen's valuation multiples?
As discussed previously, analyst growth rate expectations are currently rock bottom and well below Appen's guidance. Confirmation from Appen that their long term earnings growth trajectory is sound (probably towards the end of this year with CY2022 earnings guidance) will lead to a normalisation of future growth rate expectations by analysts -- this will lead to broker upgrades and a rising share price. This alone should lead to a 50%-100% increase in share price if the valuation multiples return to APX's average historical levels across 2017 to 2021.

Long term, could Appen reach valuations as lofty as Altium's or Wisetech's?
Possibly. They might not be able to reach 15-20x revenue (which is extreme), but they are making important steps towards transitioning to a higher quality SaaS-based business model. There is one key chart to watch. The percentage of Appen's revenue that is recurring.

In 2H20, Appen reported a 343% increase in committed revenue versus 2H2019. This $92M of committed revenue in 2H20 is 31% of the total, up from $36M in 1H20 (12% of the total). In my opinion, this has been underestimated by the investment community.




Appen's acquisition of Figure8 was a game-changer for the company strategically. Figure Eight materially increases the quality of Appen's revenues and the breadth of its customer base via high growth, high-gross margin recurring revenue from annual platform subscription fees (SaaS model) earned from its ~200 customers.

The acquisition combined the scale, quality and language expertise of Appen's leading global crowd, supported by its efficient crowd management platform, with Figure Eight's innovative data annotation platform, to create a unique end to end solution.

We are only beginning to see the fruits of this acquisition. Accounting for differences in gross margin, EBITDA margin and recurring revenue, it is my view that Appen deserves to trade on at least half of Altium's revenue multiple -- which would be a revenue multiple of ~7x (versus ALU at 14.6x). On 2020 revenue of $600m that suggests Appen currently deserves a valuation of circa $3.5 billion AUD -- for a share price of $28.

If Appen could reach ALU's 65% recurring revenue threshold, continue growth at a materially higher pace compared to ALU and increase EBITDA margin to close the gap towards ALU's 34% margin, it would be reasonable to expect that Appen too could trade on 10x+ revenue for a market capitalisation north of $6 billion AUD ($50+ share price).

Appen remains the largest holding in my portfolio -- I am grateful that Mr Market has provided me with a chance to enter at this level.

Time will tell if I am right.

T.E.P.