Austerity measures present challenges and opportunities for Allocate Software

Chancellor George Osborne last week unveiled some of the deepest cuts to public expenditure ever witnessed as he began to grapple with a massive budget deficit and attempted to restore the nation’s reputation for fiscal probity.

For companies that rely heavily for their bread and butter on central and local government, the Comprehensive Spending Review signalled the end of the good times of the spendthrift New Labour regime.

The obvious casualties of the austerity cuts were construction firms and civil engineers involved in building schools and updating Britain‘s failing infrastructure along with defence specialists and IT contractors.

And with an estimated 45 per cent of its revenues coming from the public purse, you might expect Allocate Software (LON:ALL) to be slightly perturbed by the austerity measures.

However according to the City research boutique Edison, Allocate is one of a handful of businesses that has built its reputation on being nimble and adapting well to changes.

In fact analyst Dan Ridsdale reckons the company may eventually benefit from the drive to greater efficiency both in the health service and the defence sector, where the group is also active.

That’s because the Allocate business model is all about helping the public sector save money rather than acting as a drain on budgets. 

A case in point is the company’s Healthroster software, which helps NHS trusts roster staff more efficiently.

“A small  NHS Trust will save multiple ten’s of thousands of pounds per annum and a large NHS  Trust will save several million pounds ,” Allocate chief executive Ian Bowles told Proactive Investors.

“Typically you get a complete return on the investment in the first year from using our software.

“We are in the very fortunate position of having a lot of clients we can reference that are prepared to talk to colleagues in other  NHS Trusts to tell them just how much time and money is being saved.”

That “demonstrable return on investment” should enable the public sector to save jobs, Bowles adds. 

Edison reckons the recently purchased Dynamic Change business, a specialist in the emerging area of Software as a Service, may be affected by the coalition’s planned transfer of budgetary control from Primary Care Trusts to GP consortia.

“However, these changes are not due to be implemented until 2013 and opportunities to cross-sell Dynamic Change applications  into Allocate’s customer base should help offset potential spending weakness in the meantime,” analyst Ridsdale said.

The last update from Allocate on September 22 showed the company is thriving. In the first quarter of its new financial year the group landed 14 new contracts, half of them from the NHS.

However it has a substantial pipeline of business from the private sector where it works for the likes of Cunard and Maersk.

And Allocate is making headway with its overseas expansion plans. It landed its first significant contract in the US and signed a third deal in Malaysia. 

“Additionally, the company has commenced the roll-out of its multi-million pound Australian contract,” broker Numis said in a research note shortly after the update.

“Despite the challenges within the NHS, the performance remains strong and management, whilst cognizant of the risks, are upbeat on the pipeline.”

At the same time Bowles’ shrewdly judged build and buy strategy is winning plaudits in the City.

In December it bought Swedish firm Time Care for £8 million, followed in May by the purchase of Dynamic Change, a specialist in the growing healthcare arena, for maximum consideration over three years of £8.9 million.

Both are bedding in well, though their integration isn’t preventing the company from looking at other opportunities.

Bowles is on record as saying  Allocate had a long list of up to  15 potential takeover targets. 

However he made the point that the company would not be looking to conclude that many transactions while he also played down the prospects of an imminent deal.

“I don’t think anything will happen in the next two or three months,” he said. 

“But the company will continue to make acquisitions over the next 12, 18 and 24 months.”

Last year the company generated £4.9 million of cash and at the time of the annual results had £2.9 million sitting on its balance sheet.

One obvious use for those funds would be to pay a dividend. However, Bowles rejected this call. “We want to utilise the cash to strengthen the company and scale the company,” he explained.

“We have made four acquisitions in 36 months. And all of them were good purchases at very good multiples.”

Allocate, which has its own mergers and acquisition specialist, says its current batch of targets span the range from small to large.

And while Bowles said that drawing on cash and debt to fund takeovers would be his preferred route, he won’t balk at tapping the equity market for funds if the right opportunity came along.

“From an investor perspective, if we can do it from cash and debt that is preferable because there is no  dilution for existing shareholders,” the Allocate chief executive explained. “But I if we went to our institutional investors with an appropriate acquisition that required us to issue new equity I believe we would get the support we needed.

“Of the ones that we are currently looking at there is a really broad range. 

“There are a couple of really small complementary application companies that we could probably buy for cash because they are relatively small.  There are a couple of others that are in the price range and the size of transactions we have already done.

“We are getting to be more ambitious. But the (large) deals are further away and require more detailed consideration before I would be confident enough to put them to the board and eventually put them to shareholders.” 

According to Numis, Allocate is expected to post pre-tax profits of £5 million in 2011 rising to £5.4 million in 2012, valuing the company at 11 times prospective earnings.

It has set a price target of 89p a share, while HB Markets values Allocate at 88.5p.

“Allocate shares feel too cheap to us, particularly given the international momentum and consistent out-performance,” Numis said. 

“The key risks we see are acquisition integration and the healthcare spending environment.”

Bowles believes these risks are very manageable.  “Integration can be difficult, but we have completed two and the other two are working to plan,” he said.

“For each acquisition we have a detailed integration plan with specific time lines and deliverables.  

“The healthcare spending issue we cannot change but we deliver value and we are generating interest overseas."