There are a few punters who bought MSP at below 3c during the...

There are a few punters who bought MSP at below 3c during the takeover and who want to cash in on their arbitrage opportunity at 12c. These guys are creating a bit of an overhang in the market depth, which is making retail buyers cautious. Combine this with the uncertainty created by the takeover and lack of newsflow and management leadership and we get this 10.5c share price.

Because of the remaining loose ends with the MSP takeover, I think both companies are being intentionally quiet for the time being re company announcements, meeting continuous disclosure with the bare minimum. Until FFT own 100% of MSP, I'm not expecting much additional commentary with the soon to be released 4Cs, especially in relation to MSP. However, if FFT's forecast can be believed, and especially if the current growth trajectories can be maintained for a few years, then FFT has significant (perhaps multibagger) upside from current levels.

Consolidated revenue from both companies (MSP and FFT) was $19.5m in FY17 and should be in the region of $34m for FY18. So the consolidated business is clearly growing strongly on the top line. I’ve arrived at the $34m figure by assuming $19m in FFT revenue and extrapolating from the $3m Q1 revenue for MSP (i.e., assuming AVA growth continues, I see MSP generating around $15 in revenue for FY18).

While MSP’s last 4c suggests it is someway off being cashflow positive, I think the timing and speed (haste) of the takeover suggests that FFT management think that MSP will be cashflow positive this FY (my expectation is that MSP will start to be cashflow positive from the march quarter). So, for FY18, I think there is every chance that MSP will be both cashflow and EBITDA positive (perhaps to the tune of around $1m). With respect to FFT, we have the cashflow and EBITDA positive public forecast. While the Dec quarter could be cashflow negative for FFT (not enough large new contact wins announced during the quarter), with around $19m of forecast revenue, no debt, a newfound focus on cost control, and a gross profit margin of 60%, it is hard to see an FY18 EBITDA of less than $2m. On this basis, while the market is currently pricing FFT for further losses, I’m anticipating an FY18 EBITDA figure for the combined entity of around $3m.

With respect to FY19, assuming AVA continues its current growth trajectory, and assuming modest growth for FFT (Aura Ai orders are really only just beginning) and zero growth for BQT, combined revenue should be in the region of $45m (FFT25/MSP20). With rising profit margins for AVA to around 30% (which will occur with increased volume) and completed takeover cost savings/synergies, consolidated EBITDA for FY19 could well be north of $7m.

FFT+100% of MSP gives us a fully diluted market cap of around $25m at 10.5c. If the current growth trajectory (and FFT profit outlook) can be believed, fair value for the combined entity should be around $50m/22c at present. And if FY19 shapes up to be roughly what I've outlined above, then we are probably only 12-18 months away from a $95m+ market cap (=40c+/share). However, the fact that the share price is where it is on tiny volume tells me that (i), the poorly communicated/poorly explained takeover has caused a good deal of confusion and uncertainty about both companies and, (ii), despite the public forecasts, the market still doesn't believe that FFT will be profitable anytime soon.

In my opinion, the key strength of the existing FFT sensor detection business is its technological superiority relative to competitors (which are also relatively few in number). In my opinion, the key weakness of the existing FFT business is the minimal quantum of recurring or annuity-type revenue to smooth out lumpy contract wins. Getting control of AVA (which has sticky customers with predictable annual logistics spend) is a good start in improving recurring revenue streams (and was no doubt an important part of why the takeover was so important for FFT), but they also need to significantly increase recurring revenue in the perimeter sensor business.

FFT management are saying all the right things in this regard, but they actually need to do it, and do it soon and properly. I.e., they actually need to refocus the business towards regular software upgrades (as distinct from 10 year hardware replacement sales) as well as increasing their product range – I'm not just talking about BQT products. I think the company could build upon FFT CAMS (which integrates FFT sensors with multiple third party access control and video providers), build stronger/closer business relationships with third party providers, and start offering rigorous, well organized training and maintenance programs, not just in relation to FFT sensors, but also in relation to the third party products that are integrated into FFT CAMS. The new training programs I'm envisioning (which go far beyond the current training offered by the company) would be partly software based (a bit like airport/location-specific air traffic control simulation training – which can be sold along with other third party peripherals and require additional annual software upgrades etc), as well as real life simulation training (conducting in the field exercises etc). With the ever present spector of terrorism and rogue nation disruptions, this complex, high value, sensitive infrastructure (including digital/cable infrastructure), this kind of security simulation training will become essential.

US govt spending on security infrastructure has been largely put on ice since trump was elected. Around US$50b has been allocated in the fiscal 18 budget for domestic security infrastructure, but the vast majority of those funds have yet to be spent. The relevant agencies have until Sept to spend this money. When that money is spent, FFT should be in the running to get some decent sized contracts in the US – but not just the US. In general, governments and private enterprises around the world are increasing budgets for security infrastructure. (I don't think the recent Indian contract was a once off). And many investors may not be aware of the full range of potential infrastructure that requires intrusion detection of the kind provided by FFT – it's not just data networks, oil/gas pipelines, ports/airports, utilities, it's also high growth infrastructure projects like large scale solar farms, medicinal marijuana crops, and other high value medicinal crops. For all these reasons, I think FFT is more likely to surprise to the upside than the downside over the next 12-24 months.

For reasons described above, public CEO leadership is largely absent in both stocks at present. I see the FFT share price appreciating to around 22c this CY as the takeover is finally completed, newflow and management leadership begins, and the market starts to believe the profit outlook. It will probably require a couple more FFT contract win announcements/cashflow positive quarters and proper/well researched/well articulated commentary before the market believes that FFT will be profitable in FY18 and beyond. The share price is telling us that the market is currently assuming the worst with respect to both companies – but this can change suddenly with the right announcement. I don’t see a gradual share price rise. I think it will occur relatively suddenly following the right announcement.

Whether FFT (the consolidated entity) becomes a genuine multibagger will depend upon winning paradigm changing, long term large contracts (there are a few about, especially in the US) and/or significantly increasing annuity (predictable/reliable) revenue sufficient to allow investor confidence in bottom line growth.