MForthright,
What do you know about Rampart Securities - credibility, size, customer base, etc ... ? Any comment on their report?
"Group West Systems Ltd. Rampart Securities Inc.
GPW, TSE 55 University Ave.
Suite 1000
Price: $1.20 Toronto, ON
12-Month Target: $3.50 Vigen Ghazarian
416-867-6000
Initiating as a Speculative Buy
August 10, 1999
Key Statistics
Market cap: $8.56 mil 52-week range: $4.25/$0.95
Shares O/S: 7.13 mil Cash (31/3/99): $0.43 mil
Shares FD: 8.46 mil LT debt (31/3/99): $0.17 mil
Management: 37% Employees: 140
Fiscal Year Ending September 30
1997A 1998A 1999E 2000E
Sales ($ mil) 4.47 11.33 17.50 21.37
Net income ($ mil) (0.10) 0.65 (0.24) 1.15
EPS ($) (0.03) 0.11 (0.03) 0.14
Highlights
 Group West Systems Ltd. is an IT services firm serving over 350 mid-sized companies and government agencies in Canada and the US. The Company was established in 1976 and was part of the Canadian IT practice of Ernst and Young between 1991 and 1993. The Governments of Ontario and BC, Microsoft, and BC Rail are among Group West's clients. The Company's strategic partners include Microsoft, IBM, Hewlett Packard, and Compaq.
 Group West has embarked on an ambitious acquisition strategy and has positioned itself as an outsourcing and Application Service Provider (ASP) company. It expects to enter into partnerships with a number of software development firms shortly to solidify its position in the outsourcing and ASP markets that are growing at a tremendous pace. The US outsourcing market alone may reach US$70 billion in 1999.
 Forrester Research estimates that the global ASP business will exceed US$20 billion by 2001, from almost nothing in 1998. ASPs host software applications on their servers and provide them to users over the Internet on a rental basis. We believe ASP is the next huge wave in computing.
 Management is highly experienced. William Ste. Marie, Chairman, CEO, and a founding shareholder, has grown the firm from a small programming boutique to a company with revenues of $17.5 million (exp., F1999) and operations throughout North America.
 Most risks with Group West are typical of micro-cap companies. They include relative illiquidity of shares, risk of dilution, difficulty to finance and manage growth, etc. Intensifying competition and rapid technological change are other sources of risk.
 With its strong fundamentals, Group West is well-positioned to capitalize on the explosive growth of the outsourcing and ASP markets. The Company's large customer base and ability to provide comprehensive IT services to its outsourcing clients are critical competitive advantages.
 Group West is significantly undervalued compared to its average peer that is trading at 16.3 times earnings and 1.4 times sales. We believe that the Company is worth at least twice its current market value. Our 12-month target price of $3.50 is based on a P/S ratio of 1.4.
Company Description
Established in 1976, Group West Systems Ltd. provides IT outsourcing and systems integration, consulting, e-commerce services, computer hardware and software, and other IT products and services to mid-sized companies (revenues of $50 to $500 million) and government agencies in Canada and the United States. The midrange market is under-served by the major market participants.
Over the last year, Group West has been positioning itself as an Application Service Provider (ASP), to offer business applications over the Internet on a rental basis. The Company recently announced that it will be entering into partnerships with several software development firms shortly to solidify its position in the outsourcing and ASP markets that are growing at a tremendous pace. According to Forrester Research, the global ASP revenue will exceed US$20 billion by 2001, from almost nothing in 1998. We believe software rentals over the Internet are the next huge wave in computing.
Group West is the largest company of its kind in Western Canada. The Company's more than 350 customers include Microsoft Corp., British Columbia Rail, the provincial Governments of Ontario and British Columbia, Molson Inc., and The LA Times. Having longtime relations with many of its current customers and more than two decades of experience in serving the midrange marketplace, Group West is well positioned to offer application services to a large number of companies, expand its ASP business and capture market share. We believe this is a significant competitive advantage. Group West's position is further enhanced my its strategic relationships with several high technology heavyweights, such as Microsoft, IBM, Hewlett Packard, and Compaq.
Group West has embarked on an aggressive acquisition strategy. The Company acquired five IT services companies in 1998, one in July 1999, and is on track to acquire one more by September 1999. An additional four to five acquisitions are under consideration for F2000. Acquisition candidates must be in line with the Company's strategic ASP and outsourcing direction, expand its operations geographically or strengthen its position in the existing markets. Successful future acquisitions would make the Company more competitive and increase its share of the emerging ASP market.
Group West is headquartered in Burnaby, British Columbia and has offices in Winnipeg and Markham in Canada and in Boston, Seattle, Auburn and Huntington Beach (California) in the United States. Between 1991 and 1993 the Company was part of the Canadian IT practice of Ernst and Young. In 1997 Group West went public through an IPO on the Vancouver Stock Exchange, selling 1.3 million shares at $1.10 per share. In February of this year the Company moved its listing to the Toronto Stock Exchange.
Business Divisions
Associated Information Systems International Inc.
Acquired in September 1998, Auburn, California, based AISI and its wholly-owned subsidiary, Nova Publishing Systems Inc., provide systems integration services and specialized software to companies in the publishing field. The LA Times, Denver Post and The Toronto Star are among the Company's clients. AISI recently announced the hosting of its e-commerce advertising system for the publishing industry.
Candlewest Management Consultants
This Burnaby, British Columbia, based division provides management consulting services and manufacturing, distribution, and accounting software to mid-sized companies. Group West owns 51% of Candlewest.
AASKI Technologies Ltd.
Markham, Ontario based AASKI Technologies was acquired by Group West in May 1998. AASKI provides legacy mainframe related services as well as Y2K conversion. The Government of Ontario is a client.
RJV Data Resources Inc.
Group West acquired RJV Data Resources Inc. in December 1998. Located near Boston, Massachusetts, RJV is engaged in circulation fulfillment services for companies in the magazine publishing industry.
Wescom Computer Services Ltd.
Established in 1978 and based in Victoria, British Columbia, Wescom Computer offers software to the public sector. Group West acquired Wescom in July 1999. Wescom's software can be delivered through Group West's ASP infrastructure.
Group West Manitoba Ltd.
Acquired in April 1998, Group West Manitoba is based in Winnipeg and provides services very similar to Group West's.
The Market
According to IDC Canada, the global IT services market will remain strong in the next three years, growing at an annual rate of 9.6% through 2002. The North American market is expected to expand faster, at an annual rate of 10.4% until 2001. The size of the market is estimated to be about US$81 billion. The growth is led by outsourcing that currently accounts for 30% of industry revenue. According to EDS, the US outsourcing market alone may reach US$70 billion in 1999.
The expansion of the IT services market is driven by the increasing importance of information technology for productivity growth across all industries, the large and uncertain costs of owning and maintaining IT infrastructure, and the shortage of skilled IT professionals in North America.
In the last few years, a new sector has emerged within the IT services industry, called Application Service Provision. ASP is a new computing paradigm, one in which software rentals take the place of ownership. ASP companies host software applications on centralized servers and provide them to users on a rental basis via the Internet or other networks. This enables users to reduce and control IT costs, focus on their core activities, and thus operate efficiently.
According to Forrester Research, the market for application services will grow explosively in the next two years, reaching US$21 billion by 2001. Among market drivers are the tremendous growth in server-based computing, networking and the Internet, standardization of software, small and mid-sized companies' need for affordable enterprise software applications, increasingly expensive and difficult-to-manage IT infrastructure, and scarcity of IT talent. We believe that the lucrative ASP market will quickly attract numerous players since barriers to entry are low.
The ASP industry is getting increasing attention in the media and the financial markets. The recent successful IPOs of pure-play ASPs USinternetworking (USIX) and Interliant (INIT) further stimulated interest in ASPs. We believe these developments will bring better growth prospects and higher valuations to publicly traded ASPs.
Management
William Ste. Marie, Chairman of the Board, President, CEO and a founding shareholder, has grown Group West from a small programming boutique to a company with operations throughout Canada and the United States. Steven Pettigrew, CFO and a Chartered Accountant, also manages his own accounting firm in West Vancouver. Ray Medway, VP of Sales and Marketing, has eleven years of experience with IBM Canada. He has been with Group West since 1988.
Financials
In F1998 Group West generated revenues of $11.33 million, up 153% from $4.47 million in 1997. Earnings per share was $0.11, up from a loss of $0.03 in F1997. For the first six months of F1999 the Company recorded revenues of $9.78 million, up 208% from $3.18 million in F1998. Net earnings were $0.20 million or $0.032 per share, up from $0.007 in F1998.
We expect revenues of $17.50 million and a net loss of $0.24 million or $0.03 a share in F1999. The loss will come from a sooner and larger than anticipated drop in the Y2K-related business and from the refocusing of the business on the ASP marketplace. Group West expects Y2K-related revenue to account for no more than 15% of F1999 revenue, down from 26% in F1998. Internal growth should increase revenues in F2000 to about $21.4 million. With the acquisitions that are under consideration for the next year, the Company expects to generate about $38 million in revenue in F2000. To accomplish its acquisition plans, Group West will likely need additional financing.
Currently, the Company generates about 25% of its revenue in the United States. The share of the US operations may reach 50% in F2000. We expect outsourcing to account for about 7% of F1999 revenue and 20% of F2000 revenue.
Competition
The North American IT services industry is highly fragmented. Thousands of firms compete in a highly competitive and rapidly changing environment. We believe competition will continue to intensify as the outsourcing and ASP markets develop and new firms enter the market.
Group West's competitors come from different market segments. They include IT outsourcing companies, the Big Five accounting firms, systems integration and consulting companies, programming firms, computer hardware and software companies, telephone companies, and ISPs. There are very few pure ASP companies. They include FutureLink Distribution Corp. (FLNK), USinternetworking Inc. (USIX), and Interliant Inc. (INIT) that have established a high profile. Many companies have announced plans to engage in the provision of application services.
We believe strongly that Group West has a critical competitive advantage as an ASP and outsourcing company. Its developed IT services business will play a crucial role in the provision of comprehensive IT support services to the Company's ASP clients.
Risks
The risks with Group West include those typical of micro cap companies, such as relative illiquidity of shares, risk of dilution, and larger and powerful competitors. The Company may experience difficulties acquiring and integrating other IT service companies. In addition, the Company may not achieve the projected levels of revenue and earnings. The increasingly intense competition in the IT services industry as well as in the emerging ASP segment could lead to price competition and lower margins.
To be at the forefront of the ASP industry, Group West will need to forge strategic agreements with software vendors to offer their software on a rental basis, to constantly modernize its infrastructure and expand the ASP content of its offerings. We understand that Group West is actively seeking partnerships with software developers, and has already made significant steps in this direction.
Valuation
Group West is trading at 8.89 times trailing earnings and 0.41 times trailing sales. The table below shows the valuations of a number of comparable companies. The median P/E and P/S ratios of the group are 16.31 and 1.37 respectively, and are conservative estimates of the valuation of an ‘average' IT services company. Compared to its average peer, Group West is clearly undervalued. At a 20% discount to the average valuations, the Company would trade at 1.10 times sales and 13.05 times earnings, which appear to be very conservative given the company's strong fundamentals and growth prospects. These valuations translate into share prices of $3.22 and $1.76, or an average price of $2.50, which is a reasonable value for the Company's shares. Group West is trading at less than half of what we believe it is worth.
It is difficult to place a 12-month target value on Group West's shares because of the uncertain impact of possible acquisitions and rapidly changing valuations in the market. The bottom line is that today the Company is worth twice its current market value. There is a significant upside potential from $2.50 per share if the company makes successful acquisitions and the investment community reevaluates the Company. As Group West builds its ASP business and signs up customers for such services, it is likely to trade at much higher valuations. Pure-play ASP USinternetworking (USIX), FutureLink (FLNK) and Interliant (INIT) currently trade at 66 times trailing sales. If Group West generates significant revenues from application services in F2000, a P/S ratio of at least 1.40 would be reasonable to expect. At this valuation, the Company's stock would trade at about $3.50 per share, assuming sales of $21.4 million and 8.5 million shares outstanding in F2000."
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