In late 2017, there weren’t many buyers of Blancco Technology Group. The CEO had just been fired, the company had overstated its revenue figures, its financial reports were delayed, and the share price had fallen over 80% in a matter of months. It’s understandable why most investors were running for the exits. The International Share Fund team at Forager, however, were willing to take a look.
Forager’s investment in Blancco was ultimately one of the Fund’s most successful in its 11-year history, ending with a tense fight for the company’s future where it was eventually taken private.
So what attracted the investment team to Blancco? And what lessons are there to help identify the quality turnaround stories from the duds?
History of Blancco
The company’s roots are in Finland, where in the 1990s two business partners developed software to permanently delete the contents of a hard drive at the end of a computer’s life. Over time, the process was tweaked to deal with different types of hardware – computers, laptops, tablets and mobile phones – and different types of drives.
Specialised IT Asset Disposal firms (ITADs) and large corporate clients deal with mountains of used hardware each week. If data security means anything to them, they’ll want to clear all those hard drives before recycling or re-selling their old hardware.
That can be done in one of three ways: by physically destroying the hard drive; by ‘scrubbing’ or overwriting the device (often multiple times); or by using software to methodically clear the drive in a process that is irreversible by hackers. Some such software is available online for free. But if you want a reliable audit trail and a guarantee it’s been properly cleared, you’ll use a piece of paid erasure software. Overwhelmingly, Blancco is the global leader in paid erasure. Its customers buy licences typically linked to usage, and repeat business is extremely high.
Only scrubbing and erasure software leave a hard drive intact for reuse or recycling, a growing tailwind for the business.
Up until March 2017, the business had been trading well. It had exited some of its other business operations to become a pure-play software company and its share price rose to 300p. In the following months, however, Blancco’s board began dropping clues that their reported revenue figures may not be entirely accurate.
April 2017 trading update
In April, commentary from management was that everything was going swimmingly. Sales were up 48% year on year and 34% for the 9 months to 31 March. Then they slipped in this paragraph:
“Since the interim results on 14 March 2017, the Company has undertaken a review of its cash flow forecasts. The Company has identified that costs associated with past acquisition activity, including earn‐outs and advisors’ fees, the later arrival of a large government contract and the slipping of larger contract deals to later in this current quarter will all build pressure on the forecasted cash available to the Company during Q4.”
Odd. Not great, but not the end of the world.
July 2017 trading update
Revenues were up 40% for the year, and 30% on constant currency. A slowdown on the previous quarter but still robust. Then the big gremlins started to come out:
“However, cash flow and net cash are below market expectations due to the non‐payment of £3.5m of receivables, the majority undertaken in the prior year. Taking a prudent approach to these receivables we have decided to provide against them by taking a charge of £2.2m, resulting in Adjusted Operating Profits of not less than £5.5m and Adjusted EBITDA of not less than £7.0m (subject to fully closing the accounts and audit). This reflects the Group’s intention to apply a more prudent approach to revenue and income recognition on this type of contract in the future.”
They seemed to be suggesting the previous year’s revenue was overstated. Yet the worst was still to come.
September 2017 trading update
“Blancco Technology Group Plc announces that, following matters that have recently come to the Board’s attention, the Board has decided to reverse £2.9m of revenues represented in two contracts that had previously been booked during the financial year ended 30 June 2017. As a consequence we now expect revenues for the financial year ended 30 June 2017 to have increased by approximately 29% over the prior year, approximately 15% in constant currency. This correction means that Adjusted Operating Profits will be not less than £2.6m and Adjusted EBITDA not less than £4.1m for the financial year ended 30 June 2017 (subject to fully closing the accounts and audit). Cash flow for the financial year is not impacted.
Pat Clawson, Chief Executive Officer, has decided that it is in the best interests of the Company that he should step down from the Board with immediate effect. Accordingly, he will be leaving the Company and Simon Herrick, our interim Chief Financial Officer, has agreed to become our Chief Executive Officer on an interim basis.“
Subsequently, the company’s full-year results were deferred to an unspecified date while they tried to work out exactly what the revenue was. By October that same year, the company was trading at 48p a share, down 84% and trading at one times revenue.
Inflated revenue figures, a delayed full-year report, no CEO and a share price down 84%. It was understandable why there were few buyers of the company at the time. Many were selling due to fear, others were no longer permitted to own it due to the accounting issues. The stock price fall might have been entirely justified, but it was also fertile ground for overreaction. Our analytical focus sharpened. We talked with one of the founders, with sales executives and with customers.
Sure, the problems were real but obvious. But we developed confidence that Blancco remained a growing business with significant tailwinds, happy customers and strong profitability. We laid out the following reasons in our internal 2017 research note:
- Despite overly aggressive revenue recognition, the business is clearly growing.
- Most of the revenue is recurring. In the 2016 financial year Blancco retained 91% of its clients and increases in revenue from the remaining clients more than offset the 9% lost. Once this software is embedded in a company or government department it is likely to be very sticky
- With a significant R&D budget and existing patents, it could outspend and stay ahead of the competition.
- The business was and should be high margin. Most of the cost increases in recent years have been people and that should be relatively easy to reverse.
- One times revenue is a very low multiple for a business that has been growing quickly and should be high margin (20-30%+). It could easily be worth four to six times revenue.
- Blancco and its customer base make for a very logical acquisition target
At this point, we made an initial investment in the company right into the teeth of the market panic. On several days, we were the only buyer, buying 100% of the shares traded on the exchange. It’s quite likely the share price nadir would have been lower without our buying, but when it’s bargain basement time, you take the liquidity you can get.
Increase weightings with increased confidence
A new CEO, Matt Jones, joined the business in March 2018 and released his first set of results a few months later. This also included an updated strategy for the company. These results confirmed that Blancco’s problems were temporary. And the updated strategy was simple: focus on what the company already did well. These developments helped confirm the team’s initial thesis.
At this stage, six months after the share price nadir, the stock was already up 50% or so. We not only held on tight but bought more shares. The risk had fallen a lot, and the risk-adjusted potential returns had improved.
During the next couple of years, by June 2019, Blancco moved firmly out of recovery mode and into growth mode. Sales and profit expectations for the financial year 2019 were upgraded and, more importantly, the company began investing sensibly in both new product capabilities and improved sales channels. By June 2019, Blancco was a 10.3% weighting in the Fund, having risen 73% during that financial year.
“Let your winners run” is one of those trite sayings that is wrong as often as it is right. But business valuation is an inexact science and risk is a variable. Forager’s “upside” valuation didn’t change dramatically through this period, but the probability of that case unfolding increased dramatically alongside Blancco’s growth, profitability and cash flow. Conversely, the likelihood of our downside case arising kept getting smaller. This reduced the risk of the investment and increased our team’s confidence, justifying a much higher weighting despite the higher share price.
In the latter stages of 2019 and into 2020, we sold a lot of shares, pushing down the weighting despite continued strong share price growth.
Portfolio management matters
By June 2021, Blancco had increased meaningfully for the fourth year in a row, with its share price rising in line with Forager’s investment team’s estimate of its value. Things were looking good for the business.
In the middle of a tech bubble, though, enthusiasm was running high. While still liking Blancco’s prospects, it no longer justified a maximum weighting. By number of shares held, we’d already sold more than 70% of our peak holding from 2 years earlier.
That proved fortuitous. In both financial years ended June 2022 and 2023, Blancco’s share price fell. Prior selling meant that, in the latter months of 2022, we were able to start adding to the investment again. We should have bought more aggressively.
A Frustrating Ending
Unfortunately, it wasn’t just the investment team at Forager who were optimistic about the future of Blancco. These “good years ahead” came to a rapid conclusion.
In mid 2023, Francisco Partners put in a bid for the shares of 223p in order to take the company private. Although this was an uplift on the share price at the time, the team at Forager believed it massively undervalued the company.
The team worked hard to convince other shareholders and the Board at Blancco not to accept the bid, as there was still a huge opportunity for years to come. The fact that shareholders collectively couldn’t see that opportunity as a listed entity cost us all dearly.
There were a few factors going against us. Firstly, UK stock markets are depressed. The bulk of Blancco’s revenue came from elsewhere, but UK institutions were an important part of the shareholder base, and they’ve had a rough few years. They also have lots of cheap investment opportunities to redeploy capital into.
And while we didn’t know it at the time, Blancco’s second largest shareholder was contemplating winding up its operation and returning proceeds to investors. Immediate liquidity was more important to it than absolute price.
Ultimately, the bid went through in October and the battle was lost. Although, arguably, we won the war.
Lessons from Blancco
They say you learn the most from mistakes but successes can be instructive too. This investment contained both. We give ourselves an 8 out of 10 in this stock. We should have sold the lot in mid 2021 and we should have bought a lot more in late 2022 and early 2023. We were also never entirely happy with the makeup of the board, and should have worked on that more aggressively over our years of ownership. But we got a lot right too. Blancco has been a great success for Forager investors and a treasure trove of lessons for all of us.
General lessons? Developing a thesis that is both contrary and, ultimately, correct is everything when it comes to stock market outperformance. It’s periods and locations of immense pessimism where such opportunities are most likely to be found. Just because a stock is down 80% doesn’t mean the market has it wrong. But it’s a very good place to concentrate one’s analytical efforts.
Due diligence is crucial here, it can enable you to confidently turn a loose theory into a firm thesis. And you’re going to want a firm thesis if you’re buying what everyone else is selling.
Don’t forget risk management, but also rework your odds as new information arrives. Just because a stock has doubled since you bought it, doesn’t mean that the risk/reward equation has deteriorated. Sometimes, often even, that’s exactly the time to be max sizing your position. The real money is made by having the biggest weighting at the right time.
Managing position size as your perceived edge grows or shrinks, that’s a key lesson for both profit maximisation and risk management.
*For more information on the takeover offer see: Open Letter to all shareholders in Blancco Technology Group