A small-cap growth stock scaling up through M&A – should I invest?

Growth stock Gresham Technologies is acquiring Electra Information Systems, a buy-side financial services company. Does this make it a sound investment?

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Growth stock Gresham Technologies (LSE: GHT), is a software services provider assisting enterprise companies with compliance and risk management, among other things. Its share price has soared in the past year and it’s scaling up through M&A. Is this a growth opportunity worth investing in?

A growth stock growing through acquisition

This week, Gresham Tech announced it’s proposing to buy Electra Information Systems. This is a US-based company providing software solutions and services for processing trading data, to buy-side companies such as institutional portfolio managers.

Gresham will buy Electra using existing cash resources and a share placing. The total price to be paid is $38.6m (£27.2m) including a £21m share fundraise. Last year, Electra generated revenues of £10.1m, while Gresham generated £24.8m. Therefore, the Electra acquisition should accelerate Gresham’s earnings growth quickly.

Gresham’s current customers include many of the world’s largest financial institutions from banking, investment management, and financial services. Therefore, I believe this acquisition should complement Gresham’s existing business. It should also help Gresham make inroads in the US, providing an opportunity to grow the business further.

Gresham’s fluctuating share price

Gresham is a growth stock with a £117m market cap, a high price-to-earnings ratio (P/E) at 93, and a dividend yield of 0.45%. It makes money from subscription-based offerings.

This past year has seen the Gresham share price soar. Today, it’s down 6% from its 52-week high and up 62% from its 52-week low.

Looking back a bit further, the Gresham share price rose between 2016 and 2018, but collapsed by almost 70% by early 2019. It remains below those 2018 highs today, but certainly seems to be back on the right trajectory.

The reason for this share price collapse was a drop in its earnings. Delays to collecting revenue from new projects caused licensing fees to fall. This caused its adjusted earnings before interest, taxes, depreciation, and amortisation (EBITDA) to plunge a whopping 83%.

Nevertheless, fast-forward to this year and revenues are much improved. Its adjusted EBITDA came in at £4.5m, up from £4.1m in 2019 and £0.9m in 2018.

Notable customer base

Gresham’s core product, Clareti, is proving popular among leading investment banks and other financial institutions. Clareti is an industry leading cloud-based, data control platform. Financial services is a time-sensitive business and this platform helps companies ensure accurate data and real-time connectivity.

Growth stocks are undoubtedly riskier investments than well-established companies and Gresham’s blip post-2018 illustrates this risk. However, I think the financial services industry is becoming more dominant than ever, as retail interest in investing rises.

Gresham is a global fintech company with clear potential. Fintech is a loose term often applied to anything crossing the boundaries of financial and technology, which Gresham clearly does. But Gresham has been serving the financial industry for over 20 years, so it’s not a newcomer to the space. Nevertheless, it’s a competitive field in which many major companies are causing disruption.

In addition to competition, other risks facing the Gresham share price include failing to win new business, existing customers cancelling, product failure, and rising operational costs.

As Gresham appears to be building a scalable business with notable clients, I’m tempted to invest and add GHT shares to my Stocks and Shares ISA.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kirsteen has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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