Share tip of the week: new leadership should weather the storm

By Paul Hill Aug 29, 2008

Paul Hill

Over the past year, shares in our tip of the week, an international IT services group, have been about as popular as a hedgehog in a balloon factory, diving more than 60% from 120p after a series of profit warnings.

The latest shock came in July, with the departure of the chief executive and news that results for the year ending in June would fall short of City hopes. Most of the blame was put on softening markets, a weaker-than-expected performance in its Spanish unit and cost overruns on some fixed-price contracts. But with the valuation currently at rock-bottom, and the appointment of new, battle-hardened CEO, I believe this company can turn the corner. Let me explain why.

Morse (MOR), rated a BUY by Dresdner Kleinwort

Morse is a medium-sized IT specialist, offering design, implementation and support services to organisations mainly in Britain, America and Spain. The group generates sales of around £250m a year, of which more than a quarter are tied to long-term agreements, providing a predictable stream of recurring income. And Loosemore is wasting no time in cutting expenses to the bone. He's already kicked off a programme aimed at slashing overheads by more than £4.5m a year. The group also has sufficient strength in its balance sheet (net cash stood at £11m as of the end of December) not only to fund the required painful measures, but also to see it through to more prosperous times.

There has also been a recent spate of takeovers across the sector as the industry consolidates. The latest deal was Monday's £407m purchase of SAP consulting firm, Axon, by Indian group Infosys. With a new boss, an attractive valuation and plenty of disgruntled fund managers, I wouldn't be too surprised if Morse also became the target of one of its much larger rivals, such as Accenture, IBM or EDS. So under this scenario, how much would Morse be worth to a trade buyer? Let's prudently assume that revenues remain flat over the next two years as management focuses on realising the turnaround plan. At this point (bearing in mind that its peers typically achieve operating margins of 5%-10%), Morse should be able to deliver corresponding profit levels of at least 7%. Factoring in these projections, and using a discount rate of 12% on top of an earnings multiple of ten, I would estimate that on a standalone basis the shares are worth about 55p each – or 35% more than today. And assuming that the acquirer could extract substantial synergies from the deal, then a take-out price north of 70p looks very plausible.

However, Morse is not a "widows and orphans" stock just yet. There are still plenty of obstacles to overcome before hitting the desired returns. For example, almost half of the company's turnover comes from the fragile finance sector, and another 20% from the notoriously cyclical media industry. Finally, if the economic downturn proves more severe than envisaged, then staff utilisation and day rates could also come under attack.

That said, Loosemore clearly likes the risk-reward balance; last month he forked out £141,000, buying 300,000 shares at 46.9p each. Preliminary results are due out on 9 September.

Recommendation: SPECULATIVE BUY at 37.5p

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.

Published in Tips & advice | More articles by Paul Hill

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