Digitisation and artificial intelligence are set to sweep further across the public and private sectors in the UK. Bytes Technology Group sells software, AI and cybersecurity products to both, meaning it stands to benefit from a surge in spending on these services.
BTG is made up of two companies: Bytes Software Services, which sells IT products to private companies and the public sector, and Phoenix Software, which prioritises the public sector. The group generates 97 per cent of its revenues in the UK, with about 50 per cent of its gross profits coming from its partnership with Microsoft.
The group’s annual financial results are imminent. In a full-year trading update ahead of those, BTG revealed that its gross invoiced income (GII) — which measures income billed to its customers — had “comfortably exceeded” £2 billion for the first time.
Operating profits grew in the mid-to-high teens, while BTG’s cash conversion exceeded the group’s target of 100 per cent, yielding a cash balance of more than £110 million. BTG shares jumped nearly a fifth after the trading update was announced.
In its past financial year, BTG’s public sector GII sat at £1.1 billion — a 33 per cent increase from £857 million in the prior year — while its corporate GII registered at £685.5 million, up from £583 million. This double-digit growth is promising given the group’s UK market share of just 4 per cent. While this may seem small, this is only just shy of peer Softcat’s 5 per cent market share.
Opportunities appear particularly bountiful in the public sector, as the government has committed to using AI to revolutionise public services. Forty-seven per cent of central government and 45 per cent of NHS services still don’t have a digital pathway, per Shore Capital analysts. BTG is already integrating AI with Microsoft Copilot, a generative AI tool, into organisations such as the NHS and HM Revenue & Customs.
While BTG’s deep relationship with Microsoft is viewed as a strength, recent changes by the technology giant to its partner incentives have raised questions about their partnership.
In January, Microsoft implemented changes that encouraged partners to convert small to medium-sized clients from old “enterprise agreements”, which are typically agreed for a three-year cycle and are billed once a year, to “cloud solutions provider” agreements, which are billed on a monthly basis.
“They are moving away from rewarding the partners for transacting … and moving more towards the partners influencing the customer base into consuming certain products,” says Andrew Holden, BTG’s chief financial officer.
Microsoft’s incentive changes have affected two full months of the second half of BTG’s financial year, according to Berenberg analysts, a nevertheless strong period that they believe will have allayed some fears in the market. “Concerns about Microsoft’s incentive changes appear overdone,” they said in March.
The group’s source of gross profits has also diversified over the years. BTG generated about 85 per cent of its gross profits from Microsoft at the start of the last decade, Holden estimates, far above its current level of 50 per cent.
The BTG story has not been without its own controversy. There are painful memories of an investigation last year into the conduct of former chief executive Neil Murphy, who resigned after having carried out 119 unauthorised and undisclosed transactions of BTG shares between 2021 and 2023.
However, a subsequent PwC investigation gave the group a “clean bill of health”, Holden says, and BTG continues to talk to investors as it fights to win back their confidence. “It was foolish of me to disregard the guidelines and governance regarding share trading,” Murphy told this publication.
It is plausible that some shareholders have steered clear of the shares owing to governance concerns. Yet BTG shares still trade at 22 times forward earnings, just below Softcat’s forward earnings of 23. BTG shares are, however, cheap compared with recent history, trading at 26 times 2024 earnings per share.
While much of the year’s gains will now be priced into the shares after its recent trading update, BTG offers a better entry point than Softcat into Britain’s AI revolution.
Advice: Buy
Why: Valuation is high but at a discount to Softcat and growth prospects are appealing
