What should have been a routine trading statement turned out to be a nightmare for investors in data erasure firm Blancco Technology (LSE: BLTG) this morning. The company announced that an analysis of its cash flow projections had turned up a £4m shortfall that will need to be patched in the coming weeks to provide necessary working capital for Q4.
This unsurprisingly turned out to be disastrous for the share price, which was off over 25% in early trading. But now that this fast-growing small-cap is more attractively priced at 28 times trailing earnings, is now a great time to begin a position?
On one hand, the company’s two core segments are growing rapidly. Data erasure, which scrubs companies’ IT assets of all data to comply with regulatory requirements, grew sales 36% year-on-year in constant currency terms. And the diagnostics division, which troubleshoots IT problems with companies’ mobile devices, increased sales 189% during the period. Together, this meant sales for Q3 were up a whopping 48% year-on-year.
However, there are warning signs that have me nervous. The largest is that the company is still firmly in start-up mode, which means opening new offices, hiring new employees and generally burning through cash. There is nothing inherently wrong with this. But if the company is having problems accurately projecting costs associated with previous M&A activities and judging when customers will actually pay (the main causes of the cash flow shortfall), it does not speak well of how its expansion is being handled.
This is especially worrying with AIM-listed tech companies, which have a long history of failing minority shareholders. Blancco’s business appears to be moving along nicely, but the company’s inability to forecast cash flow, rising debt and questions over where it will raise the necessary £4m are red flags that would stop me from investing at this point.
Similar business, safer choice
That said, a safer option in a similar market does exist in the form of Restore (LSE: RST). The company is best known for its document management services, which allows law firms, hospitals, accountants and the like to securely store critical paper documents in its facilities.
The company is now the biggest provider of these services in the UK, second largest provider of shredding services, and is also a major player in the data erasure and relocation businesses. Offering this array of services is winning over new clients at a rapid clip and together with acquisitions sent sales rising 41% year-on-year in 2016.
EBITDA and statutory profits grew in line with this increase and look set to rise further in the coming years as the company cuts costs from acquisitions and bundles more services. With net debt rising to 2.46 times EBITDA at year-end due to acquisitions, the company will likely avoid big acquisitions for the time being. But with impressive cash flow, this level of leverage shouldn’t be a worry in the long term.
Restore’s shares are priced for growth at 19.1 times forward earnings, but with a stellar record of growing sustainably, a market leading position in its core business and increasing regulatory-mandated demand for its services make the company one to watch.
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Ian Pierce has no position in any 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.