Kaz has survived the dot com crash but most investors don’t...

Kaz has survived the dot com crash but most investors don’t appear to have noticed, which is fine by us.
Over the past few months we've frequently remarked on the rarity of Buy recommendations. That hasn't been for want of trying, it is more a consequence of the breathtaking rises in many stocks since March this year. Finally, though, we think we've dug up a stock that we believe is worthy of a Buy recommendation, if conditioned somewhat by the word 'speculative'.

We've had our eye on Kaz Group, a dot com era survivor, for a while, but only now are we happy to recommend it. In this review we'll explain why. Our minds were made up after a typically tortuous train ride to attend this IT specialist's annual meeting in Sydney's western suburbs. CEO Peter Kazacos' desire to stage this gathering closer to company headquarters should be applauded, although cynics may point to recent boardroom turmoil as the motive to hold the event beyond the brokers' lunching circuit. Shareholders hoping for sparks were left disappointed but our trip wasn't wasted. We learnt that the well-publicised crunch in discretionary IT spending hit Kaz as hard as all the other IT companies. But Kaz's strong market position should see it recover more quickly than most when industry spending eventually returns. Management has also made some tough decisions, incurring restructuring costs of $3.5m in 2003. But while conditions remain difficult, there was an air of confidence to the meeting that suggested the worst may be over.

What really sparked our interest, though, is the 21% share price fall since our detailed review in issue 137/Oct 03 (Hold for the Upside—$0.305). That review explains in detail more about Kaz's operations—here we're going to look at what we believe Kaz is worth. The falling share price took Kaz's market capitalisation down to below $200m. Compare that to its 2003 sales of $358m and earnings before interest, tax and amortisation (EBITA) of $23m and it doesn't look expensive at all.

So, let's look at Kaz's constituent parts and assess what they might be worth if sold. The company's IT outsourcing division that houses Aspect Computing, purchased at the top of the market in 2002 for roughly $200m in cash and shares, contributed revenue of $258m and earnings before interest, tax, depreciation and amortisation (EBITDA) of $24.3m for the year. Even with this type of low margin, fixed cost business, management could probably fetch $120m, equal to six times the division's earnings before interest, tax and amortisation (EBITA) figure. At the other extreme, the company's rather nondescript Business Services division is anchored by the AAS superannuation administration operations.

With few competitors and strong margins, it's the sort of business we love and we're sure others would also be attracted to it. With an EBITDA contribution of $20.3m on revenues of $98.5m, we think it worth, at the very least, $120m. The Software Solutions division makes up the third string to the company's bow. Its earnings are notoriously difficult to forecast, as we saw with last year's drop in EBITDA from $7.2m to just $900,000. Kaz builds and owns the software but putting anything more than a token value on its future revenue stream is fraught with danger. But even if Software Solutions wasn't worth anything at all—which we strongly suspect is not the case as this can be a very profitable business—Aspect Computing and AAS are worth at least $240m—$40m more than Kaz's current market capitalisation. In other words, subscribers acting on this recommendation have a reasonable margin of safety if our calculations are somewhat awry.

We also draw confidence from a few other quarters. For instance, while the media tend to focus on reported profits, we're more interested in the cash the company has left once all the necessary bills, taxes, interest and capital expenditure items are paid for. In accounting jargon, it's called free cash flow and, in Kaz's case, it came in at a very healthy $21m.

Also, despite $250m in goodwill on the balance sheet, the company remains conservatively financed with cash in the bank completely offsetting debt of $48m. Another convincing sign is that founder Peter Kazacos owns about 20% of the stock while other directors hold 16% between them. The announcement of a share buyback also sends a reassuring message that the board's actions are in step with fellow shareholders. So, we feel that the recent share price fall provides a good opportunity to invest in a quality IT company at the bottom of the cycle. It's not without risks but when the IT sector finally turns around, which it eventually will, Kaz should come back into favour. With a forecast PER of 9.2 and a fully-franked yield of 4.2%, Kaz is a SPECULATIVE BUY.


If that the post your after,wait till kaz has a post