Welcome,

in this issue of Under-Followed-Stocks, I will present you Circle Group SpA ($CIRC.MI).

Investment Summary:

• Mission-critical niche software embedded in European port and customs digitalization

• Regulation-driven demand creates structural tailwinds

• Positioned at the core of Europe’s logistics digitalization push, thanks to a deep integration with public institutions & EU strategy

• Gradual shift toward recurring and usage-based revenues, allowing higher margins and more predictable revenues

• Revenue CAGR of 25% since 2012

• Organic growth combined with a systematic M&A strategy

• EV/EBITDA of 6.7x and EV/EBIT of 13.1x

• Under-followed Italian micro-cap with limited analyst coverage & low free float

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1. Introduction

Circle SpA is a small Italian-listed company operating in a part of the economy that rarely attracts investor attention: the digital infrastructure behind ports, intermodal transport, and complex logistics chains. While the sector itself is unglamorous, it plays a critical role in how goods move across Europe and how efficiently, transparently, and sustainably they do so.

The company provides mission-critical software platforms and advisory services that help ports, terminals, freight forwarders, shippers, and public institutions replace fragmented, paper-based processes with integrated digital systems. Circle’s solutions sit deep within customer workflows, often touching regulatory, customs, and operational processes that are difficult to change once implemented, even with the help of AI. Circles solutions are used by large customers like IKEA as well as multiple ports, airports or freight forwarders.

Circle Group is active in a narrow niche with high entry barriers, sticky customers, structural tailwinds from regulation and digitalization and a business model that is gradually shifting toward more recurring and scalable software revenues.

Circle Group SpA has been listed on the Euronext Growth Milan since October 2018 under the ticker $CIRC.MI. The current market cap is EUR 43 million (USD 51 million).

2. The Company

Circle SpA was founded in 2012 in Italy with a clear focus on the digitalization of logistics processes, initially concentrating on ports and maritime transport. At the time, many European ports and logistics hubs were still operating with fragmented IT systems and paper-based workflows, despite increasing regulatory and operational complexity.

In its early years, Circle positioned itself as a specialized software and consulting partner for port authorities, terminal operators, and logistics stakeholders. Rather than offering generic IT solutions, the company focused on building domain-specific platforms that could handle the coordination between private operators and public institutions, particularly in regulated environments.

A first important milestone was the development of the Milos® platform, which became the technological foundation for Circle’s activities in ports, intermodal hubs, and logistics nodes. Over time, Milos evolved into a modular suite addressing planning, coordination, tracking, and optimization across different transport modes.

From 2017 onwards, Circle began to broaden its scope beyond purely port-centric solutions. This expansion accelerated around the time of the company’s IPO on the Euronext Growth Milan exchange in 2018, which provided additional capital to support both organic development and acquisitions.

Key acquisitions followed in the subsequent years:

• Info.Era (2017, 51%), specialised in the port sector through Sinfomar software

• Next Freight / Progetto Adele (2019, 100 %), specialised in freight forwarders and customs operator systems

• Magellan Circle (2021, 51%), advocacy services towards European institutions

• Cargo Start (2022, 51%), strengthening Circle’s presence in air cargo digitalization through the StarTracking® platform.

• eXyond (2022, 92%), adding capabilities in customs, digital trade, and regulatory processes, exyond also acquired 54.5% of Circle Garage and the business units owned by Telepass Innova SpA (InfoBlu & KMaster) in 2024 and formed a new leading player in the digitisation of logistics

Through these steps, Circle gradually transformed from a port-focused software provider into a multi-platform logistics digitalization group, active across maritime, intermodal, air cargo, and supply-chain visibility.

Circle has become an international company with multiple offices in Italy, but also in Belgium, Portugal and partners in Turkey and Greece.

This comprehensive offering has won over many major customers, among others:

• PSA Genova Prà: One of the most important terminal operators in the Mediterranean region.

• Terminal San Giorgio (Genoa): Uses the Group’s MILOS® Terminal Operating System.

• Ports of Trieste, Catania and Livorno: Use of software systems (e.g. Sinfomar® or MILOS®) to digitise port operations.

• European Commission: Through Magellan Circle, the group is directly involved in EU projects for the transport sector.

• IKEA, Milan Airports, metrocargo, ItalianSped and many more

3. Products & Solutions

Circle Group organizes its activities around three strategic areas. Together, these areas cover the digitalization of logistics processes, end-to-end visibility across supply chains, and advisory services related to European transport and trade policies.

3.1 Innovative and Smart Supply Chain

This area includes Circle’s core software platforms used to digitalize and optimize logistics operations, particularly in ports, intermodal hubs, and freight networks. The focus is on operational efficiency, coordination between stakeholders, and data-driven decision-making.

Milos Suite

Milos® (Making Intermodal Logistics Optimization Simple) is Circle’s flagship software platform and the technological backbone of the group. It supports ports, terminals, inland hubs, and intermodal operators in managing complex logistics processes.

Key functionalities include:

• planning and coordination of cargo flows

• operational tracking and status management

• data exchange between multiple private and public stakeholders

• optimization of terminal and hub operations

Milos® is modular and highly customizable, allowing customers to adopt specific components depending on their operational needs. Available modules are for example:

• Milos TOS: Effective global management of a multipurpose terminal, through full, digital streamlined processes and reliable federated interoperability with all the relevant stakeholder’s information systems.

• Milos MTO: Managing new rail connections, customer bookings, planning and execution of rail and intermodal transport as well as the full invoicing cycle.

• Milos Agency: Software solution tailored specifically for the needs of shipping agents, designed to support them in handling community customs procedures for import and export operations

• Milos Intelligence: Solutions designed to enhance the planning, optimization, and control of the Supply Chain by integrating ptimization and Artificial Intelligence. It streamlines first and last mile trips, aids in identifying optimal road carriers, optimizes rail operation planning, and enables real-time monitoring and scenario simulation in port areas.

Once implemented, it typically becomes deeply embedded in daily workflows.

Port Community Systems (PCS)

One stop shop to digitally connect public and private players, effectively implementing port community processes from the Customs Authority to the Coastguard, from shippers to transport providers and MTOs, from last mile logistic operators to shunting companies and from railway undertakings to inland terminals, it allows efficiency and fluidity of traffic to/from ports to be improved and simultaneously represents an important control and monitoring tool.

Star Tracking (Cargo Start)

StarTracking® is a digital air cargo tracking platform developed through the Cargo Start subsidiary.

It enables:

• airport-to-airport shipment tracking

• real-time status updates

• improved data exchange between air cargo stakeholders

StarTracking® extends Circle’s smart supply-chain capabilities into the air cargo segment.

3.2 Global Supply Chain Visibility

This area addresses the growing demand for transparency, resilience, and risk management across international supply chains, particularly for industrial companies and shippers.

Milos® Global Supply Chain Visibility (GSCV)

Milos® GSCV provides end-to-end visibility across complex, multi-modal supply chains.

The platform offers:

• real-time tracking of shipments across transport modes

• consolidation of logistics data into a single interface

• monitoring of disruptions and delays

GSCV is designed to support decision-making in environments where supply-chain transparency has become strategically and operationally critical.

Milos Federative and Customs Services

Milos® Federative Services & Customs Services (e-Customs, e-CMR, Controlled Corridors) is a set of tools and services that make it possible to share customs, documentary and transport information between the parties involved in the import/export process, guaranteeing greater data security and reliability. Integration with the latest services provided by national customs (in line with the national plan) and with the systems of national and international authorities (in line with European and national standards) makes the most advanced tools available to shippers, carriers and MTOs.

• Overall control of digitally exchanged data and information

• Improvement of the logistics process in terms of service quality

• Improvement of the logistics process in terms of security (preventing fraud and manual errors)

• Reduction of security and operational costs

• Reduction in transit and dwell time

• Positive environmental impact

MasterSPED® (Next Freight)

MasterSPED® is an ERP-style solution designed for freight forwarders and customs operators, integrated with goods tracking systems (also using IoT devices) and with intermodal transport informative systems (air, rail, road, maritime).

It supports:

• operational management of forwarding activities

• documentation and customs-related workflows

• integration with regulatory systems and authorities

As customs procedures across Europe become increasingly digitalized, tools like MasterSPED® move from optional efficiency upgrades to operational necessities.

3.3 European Affairs Consultancy

Magellan Circle

Circle’s third strategic area focuses on consulting and advisory services related to European transport, logistics, and trade policy. This activity complements the software business by aligning technology development with regulatory frameworks.

Circle supports companies and institutions in:

• navigating EU transport and logistics regulation

• participating in European research and innovation projects

• aligning digital solutions with policy initiatives such as the EU Green Deal

This advisory role positions Circle close to policymakers and public institutions, providing early insight into regulatory trends that later translate into software requirements.

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4. Business Model

Circle Group operates a hybrid business model that combines proprietary software platforms with domain-specific consulting and regulatory advisory services.

This hybrid model creates several competitive advantages:

• High switching costs: Once embedded in port or customs workflows, Circle’s software becomes difficult to replace.

• Regulatory know-how: Deep understanding of European logistics regulation and public-sector processes.

• Niche focus: Ports and intermodal logistics are complex, specialized markets with limited competition from generic software vendors.

• Cross-selling potential: Multiple products and subsidiaries allow Circle to expand within existing customer relationships.

Software Licenses and Recurring Services

A growing share of Circle’s revenues is generated through software licenses and recurring service contracts linked to its proprietary platforms, including Milos®, Port Community Systems, MasterSPED®, and other software solutions.

At the beginning, Circle generated revenues from these software solutions only in a license model, but in 2016, they started to also offer the solutions in more recurring models, where they get a one-time fee for the implementation (MAN/ Man-hours) and then receive recurring revenues via a Software-as-a-Service (SaaS) or Pay-per-use (PPU) model. Over time, the share of the recurring revenues for the proprietary software products became dominant, but licence revenues are also still growing and a big part of the revenues.

Once deployed, Circle’s software becomes deeply embedded in customer operations, particularly in ports, customs, and regulated logistics environments. As a result, contracts tend to be long-term, renewals are common, and price sensitivity is lower than in discretionary IT spending.

These solutions (Proprietary Software Products & Milos Federative Services) accounted for 42% of total revenues in H1 2025 and the share is expected to continue to grow.

Customization, Integration, and Project Revenues

In addition to standard software offerings, Circle generates revenues from customization, system integration, and project-based implementations.

These activities include:

• adapting software platforms to customer-specific workflows

• integrating Circle’s systems with third-party and public-sector IT infrastructure

• implementing large-scale digitalization projects in ports or logistics hubs

Project revenues are typically non-recurring but serve an important strategic purpose. They allow Circle to:

• embed its software deeply into customer operations

• establish long-term relationships

• create follow-on opportunities for recurring services and upgrades

This model reflects the reality of logistics digitalization, where standardized off-the-shelf software is often insufficient due to regulatory and operational complexity.

Consulting and European Affairs Advisory

Circle also generates revenues from consulting and advisory services, particularly in the area of European transport, logistics, and trade policy.

This includes:

• advisory work related to EU-funded research and innovation projects

• regulatory consulting for logistics operators and institutions

• participation in European initiatives related to digitalization and sustainability

While consulting revenues are generally lower-margin and more project-based, they play a strategic role in Circle’s ecosystem. They provide early insight into regulatory developments and allow the company to shape digital standards that later translate into software demand.

5. Market & Competition

Market Overview

Circle operates in the broader market for logistics, port, and supply-chain digitalization, a segment that is structurally important but historically underinvested in terms of IT and software. Large parts of European logistics infrastructure — particularly ports, intermodal hubs, and customs processes — are still characterized by fragmented systems, manual workflows, and heavy regulatory complexity. This has created a market where digitalization progresses gradually, often driven by regulation and public initiatives rather than purely by cost optimization.

Looking ahead, the long-term outlook for this market is shaped by several structural forces. Regulatory pressure from the European Union is increasing, particularly around digital documentation, customs harmonization, sustainability reporting, and emissions transparency. At the same time, supply-chain disruptions over recent years have highlighted the need for better visibility, resilience, and coordination across transport nodes. These trends are unlikely to reverse and support sustained demand for software platforms that can handle compliance, data integration, and operational coordination in complex environments.

From a market-size perspective, logistics IT and supply-chain software represent a multi-billion-euro market in Europe, growing at mid-single-digit rates overall. Within this, niche segments such as port community systems, customs digitalization, and intermodal coordination tend to grow slightly faster, supported by regulation rather than purely by discretionary IT spending. Growth is uneven and often linked to (lengthy & slow) public-sector investment cycles, EU funding programs, and regulatory deadlines.

Competitive Landscape

Competition in Circle’s markets is fragmented and can be broadly divided into three groups:

1. Large global software vendors and system integrators

   Players such as SAP, Oracle, or large IT integrators offer broad ERP and logistics solutions. While powerful, these systems often lack deep specialization in ports, intermodal transport, and European regulatory workflows, leading to customization-heavy and costly implementations.

2. Specialized niche software providers

   Numerous smaller companies, like cargowise focus on individual modules such as terminal operating systems, customs software, or tracking tools. These players often excel in narrow use cases but lack the breadth or integration capabilities to support complex, multi-stakeholder environments.

3. Public-sector or semi-public platforms

   In some cases, ports or authorities develop or sponsor their own systems. These solutions are often slow to evolve and limited in scalability, creating opportunities for specialized private providers.

Circle positions itself between these extremes: more specialized than large vendors, but broader and more integrated than single-module niche players. Its competitive strength lies less in technology alone and more in regulatory know-how, integration capability, and long-term operational reliability.

6. Growth Drivers & Catalysts

6.1 Regulatory-driven digitalization

One of the most important long-term growth drivers for Circle is the continued digitalization of logistics and trade processes mandated or encouraged by European regulation. Initiatives such as electronic customs procedures, digital transport documents, and harmonized data standards gradually increase demand for software platforms capable of handling compliance and data exchange across borders.

Circle’s close involvement in European affairs and regulatory initiatives allows it to anticipate these developments and align its product roadmap accordingly. This creates a structural tailwind that is largely independent of short-term economic cycles.

A key example is the EU eFTI Regulation (Electronic Freight Transport Information), which requires member states to accept electronic transport documents across all transport nodes by 2027. Magellan Circle (Circle’s European Affairs Consultancy) was part of the EU-funded eFTI4LIVE project to develop frameworks and the organization of the European stakeholders. Afterwards, the Circle subsidiary Next Freight entered into a contract to develop and pilot the eFTI platform. Being so closely involved in the development of regulations and their technical implementation naturally helps Circle to integrate this perfectly into its own suite of software solutions. Thanks to its interoperability with Circle’s Milos® Transport Federative Platform, the eFTI Platform enables the exchange of data with authorities in compliance with the eFTI Regulation, guaranteeing digital B2A (Business to Administration) interaction with control authorities.

Similarly, initiatives such as LogIN Business Network in Italy aim to standardize and digitalize data exchange across national logistics chains, connecting ports, inland hubs, and operators into a shared digital framework.

For Circle, these initiatives translate into:

• increased demand for Port Community Systems

• upgrades and extensions of existing Milos® installations

• new implementation projects triggered by compliance requirements

6.2 Increasing complexity of logistics networks / Need for end-to-end supply chain visibility

European supply chains are becoming more complex rather than simpler. Intermodal transport, sustainability requirements, and resilience considerations add layers of coordination between ports, inland hubs, freight forwarders, and public authorities.

The global economic volatility is increasing due to trade tensions and unpredictable government interventions. Industrial companies and shippers are increasingly demanding real-time visibility across their supply chains to monitor these risks and act accordingly.

This complexity increases the value of integrated platforms such as Milos®, Port Community Systems, and Next Freight, which are designed to manage multi-stakeholder environments rather than isolated workflows. Circle has developed its MILOS intelligence solutions to bring together all necessary information of the three key logistic players: Terminal & Ports, Road Hauliers and Freight Forwarders / Industries. Covering the entire logistics chain with a dedicated software solution and then being able to analyze & interpret this data to optimize the overall process can be a key advantage for Circle over other isolated solutions.

6.3 Cross- and Upselling / New products

Circle typically enters customer relationships through a specific operational or regulatory use case — for example a Port Community System, a Milos® implementation at a terminal, or a customs-related solution. Once embedded, the company gains deep insight into customer workflows, regulatory constraints, and data flows.

This positioning creates several cross- and upselling opportunities:

• Module expansion:

  Customers using a limited set of Milos® modules can add planning, tracking, optimization, or analytics components over time as digital maturity increases.

• Vertical expansion across the logistics chain:

  Port or terminal customers can later adopt intermodal, inland, or air-cargo-related solutions, while freight forwarders can add visibility or customs modules.

• Regulatory add-ons:

  Customers initially focused on operational efficiency may later require customs, compliance, or sustainability reporting solutions, particularly as regulation evolves.

• Usage-based scaling:

  Pay-per-use (PPU) models allow revenues to grow naturally with transaction volumes without renegotiating contracts.

Due to its close cooperation with all players in the supply chain, Circle often quickly recognizes their need for new or complementary products and can develop these based on its own expertise and then offer them to customers.

6.4 Shift to recurring revenues

Circle is gradually evolving its revenue mix toward recurring software revenues and usage-based models (SaaS and PPU). In the first half of 2025, the recurring revenues (Proprietary Software & Milos Federative Services) grew significantly faster than the other revenue lines.

While project and consulting revenues remain relevant, the increasing installed base of software platforms creates opportunities for:

• recurring maintenance and service contracts

• module upgrades

• volume-driven PPU revenues as transaction volumes grow

This shift supports operating leverage and improves the quality of revenues over time as well as the margin profile.

6.5 Geographical Expansion

Italy is Circle’s core market, but the company has also worked on projects in multiple countries in and around Europe. In 2024, Circle generated 28% of revenues in markets outside of Italy (vs. 26 % in 2023). In the near-term, Circle aims to develop a presence in some chosen foreign markets like the Balkans, Morocco, Turkey, Egypt, Greece, Central Europe and in the Middle East. Thanks to a tender launched by the European Maritime Safety Agency (EMSA), a feasibility study on the development of the One Stop Maritime Shop for the neighbouring countries Algeria, Jordan, Palestine, Tunisia, Moldova, Turkey and Ukraine was carried out, which can be a good entry point for Circle if it comes to the implementaion. Especially foreign countries where large investments in infrastructure & the transport sector are planned, can present a lucrative target for Circle.

6.6 M&A

The management has historically used acquisitions to expand Circle’s capabilities into adjacent niches such as air cargo and customs. Future acquisitions are likely to remain selective, aimed at reinforcing existing platforms rather than transforming the group’s strategic direction. So one can expect further bolt-on acquisitions in areas where the management is seeing opportunities to expand its offering.

7. Shareholders & Management

Management

Luca Abatello — Founder & CEO

Luca Abatello is a co-founder of Circle and has served as Chief Executive Officer since inception. He has a degree in Economics and Commerce from the University of Genoa, as well as the Executive MBA from SDA Bocconi in Milan. In addition, he has a background in logistics, software, and digital transformation and has overseen Circle’s evolution from a niche Italian logistics software provider to a multi-platform group focused on ports, intermodal logistics, customs, and supply-chain digitalization.

Alexio Picco — Co-Founder & Director

Alexio Picco is another co-founder and has historically been involved in Circle’s strategic and operational activities, particularly in areas such as internationalization and EU regulatory engagement. He graduated in Transportation Engineering from the University of Genoa in 2004 and has held the position of independent expert for the evaluation of innovative projects at the European Commission since 2007.

Shareholders

The CEO & Founder, Luca Abatello, still owns 45.11 % of Circle via its investment company, Innotech Srl. Other large investors include the investment companies Eiffel Investment Group (10.77%) and Algebris Investments Limited (5.13%). Eiffel Investment Group became a shareholder in June 2025 via a capital increase reserved for institutional investors of 514,800 newly issued shares for EUR 7 per share. Algebris became a larger shareholder in December 2025 during a capital increase to finance the acquisition of the Telepass business units. Circle issued 165,000 new shares for EUR 7.15 per share.

The free float of Circle is only 30.5 %.

The CEO’s remuneration appears normal and there were no other notable related party transactions.

8. Financials

Since 2012, Circle has been able to continuously increase revenues thanks to organic growth as well as systematic M&A. The Value of Production grew with a CAGR of 25% from 2012 to 2025.

At the end of 2024, Circle acquired via its subsidiary exyond (92% ownership) two Business Units from Telepass (Infomobility & Telematics) for EUR 6.2 million. These two Business Units added EUR 6.5 million in revenues in 2024 (of which EUR 3 million was from proprietary products) and EUR 1.3 million in EBITDA (EV/EBITDA multiple of 4.8x). In addition, exyond acquired 54.54 % of Circle Garage, adding EUR 0.3 million in revenues and EUR 0.1 million in EBITDA. Circle integrated these companies into exyond to form a leading player in the digitisation of logistics, providing advanced solutions to optimise the entire intermodal supply chain.

On a pro forma basis (including the acquisitions from December), revenues in 2024 reached EUR 21.4 million and EBITDA EUR 4.3 million. Without consolidation, Circle would have reached revenues of EUR 14.6 million (+10% yoy) and adj. EBITDA of EUR 3.3 million (+5%).

In the first half of 2025, Circle achieved revenues of EUR 9.7 million and a Value of Production (VoP, which includes other revenues & activated internal developments) of EUR 11.8 million (+62% yoy). Proprietary Software Products (license & recurring SaaS revenues) increased overproportionally by 105 % yoy and the Milos Federative Services (PPU) by 80%. Combined, these revenues with recurring characteristics accounted for 42% of the VoP in H1 2025.

The backlog of the group reached EUR 31 million.

EBITDA reached EUR 2.7 million (+52%) in H1 with an EBITDA margin of 22.9 % (vs. 24.7 %). EBIT decreased by 4% yoy due to amortisations in relation to the re-organisation of exyond after the meaningful Telepass acquisitions.

Net income reached EUR 1.05 million (+2% yoy) of which EUR 0.03 million are related to third parties. So despite some acquisitions where Circle hasn’t bought 100% of the company, the vast majority of income (97% in H1) is related to the Circle Group and only 3% to third-party minorities.

The company currently has a net debt of EUR 0.8 million, including EU credits they will receive they have net cash of EUR 2.2 million.

The long-term target of Circle is to reach revenues of EUR 50 million in 2029 through organic growth and systematic M&A integration.

9. Valuation

With the presentation of the H1 2025 results, Circle also increased the guidance for the full year, as well as for FY 2026. The management is now expecting VoP of EUR 24 - 26.4 million (prev. EUR 22.8 - 26.3 million).

Compared to the pro forma VoP in 2024, this would imply growth of 12.7 % - 24 % in 2025 and in 2026 growth of around 10% in the midpoint of the guidance.

EBITDA is expected to increase even faster, with an EBITDA of EUR 5 - 5.7 million in 2025, implying growth between 16.3% and 32.6% and an EBITDA of EUR 6 - 7 million in 2026, implying growth of 21.5 % in the midpoint of the guidance.

If the company is reaching the midpoint of these guidance ranges, Circle currently trades at single-digit EV/EBITDA multiples for 2025 (8.2x) and 2026 (6.7x) as well as low double-digit EV/EBIT multiples for 2025 (16.4x) and 2026 (13.1x).

Even without further acquisitions, it is likely that Circle will be able to continue to grow by at least 10% in 2027, given that many EU digitization projects are multi-year projects and that many countries are just at the beginning of the process. If the trend to more recurring revenue models also continues, an EBITDA margin expansion to 24% and 14% seems also achievable in 2027, the EV/EBIT multiple for 2027 would be around 10x.

To achieve the target of EUR 50 million in revenues, further acquisitions will be needed. With the last, bigger acquisition of the Telepass Business Units at an EBITDA multiple of just 4.8x for a business with an EBITDA margin of 20% and a large part of recurring revenues, the management has shown that they are able to do value-creating acquisitions, even when this includes a dilution of existing shareholders.

The company has traded at lower multiples and in the past 3 years & the stock already increased by more than 100%. The higher multiple is at least partially deserved as the company has shown consistent organic growth in combination with value accretive acquisitions and an increasing share of recurring revenues since the IPO.

Below is a try of a peer group comparison. But with a market cap of only USD 52 million, Circle is obviously a very small company operating in a niche sector. So finding really good comparable companies that are also listed on a stock exchange is not easy. All the companies are in some parts comparable with some of Circle’s offerings, but I wouldn’t call one of them a real direct competitor, which makes the comparison quite difficult, but at least it gives a certain feeling of valuation multiples that are currently paid for these somewhat similar companies.

Circle is not stupidly cheap at the moment, but also not expensive. It seems to be somewhere between a fair valuation and a small undervaluation, which is of course dependend on the execution of the ambitious long-term targets of the company. At present, an initial starting position could be reasonable in order to observe further developments more closely, gain a feel for the company, and then eventually increase the position with a larger margin of safety if the price weakens and/or the company performs well.

10. Risks

Dependence on Regulation and Public-Sector Dynamics

A significant part of Circle’s growth thesis is linked to regulatory-driven digitalization, such as eFTI, customs reform, and port modernization. While regulation provides long-term demand visibility, it also introduces risk.

Implementation timelines can be:

• delayed by political processes

• fragmented across countries and regions

• slowed by public procurement procedures

As a result, revenue realization may be uneven and lumpy, even when the strategic direction remains intact. Regulatory momentum does not always translate into short-term commercial execution.

Competitive Pressure from Larger Players

Circle operates in niches that are increasingly attracting attention from:

• large logistics software vendors

• ERP providers expanding into supply chain modules

• international SaaS platforms offering visibility and compliance tools

While Circle benefits from domain expertise and regulatory knowledge, larger competitors may:

• bundle solutions

• price aggressively

• leverage broader sales networks

This risk is particularly relevant in the global supply chain visibility segment, which is more competitive and less protected by regulation.

Execution Risk in Platform Integration and Acquisitions

Circle’s strategy includes integrating multiple platforms and selectively acquiring complementary businesses. While acquisitions have historically been small and strategic, they still carry risks:

• integration complexity

• cultural and technical alignment

• management bandwidth

Failure to fully integrate platforms or extract expected synergies could dilute margins and distract from core execution.

Project-Based Revenue Volatility

Although Circle is gradually shifting toward recurring revenues, a meaningful share of revenues is still generated through:

• implementation projects

• consulting and integration work

• public-sector-related contracts

This can lead to variability in quarterly or annual results, which may not always reflect the underlying long-term progress of the business.

Faster In-House Development by Customers with the help of AI

AI tools may enable large logistics players or operators to:

• develop internal dashboards or optimization tools

• automate document handling and data extraction

• reduce reliance on external software for basic functionality

In theory, this could compress demand for standardized visibility or planning software. However, In customs, ports, and intermodal logistics, “working software” is not sufficient — it must be accepted by authorities and embedded in legal workflows, which is where Circle’s core value proposition lies.

Protectionism and Fragmentation of Global Trade

The gradual shift toward greater protectionism and fragmentation of global trade represents a structural risk for companies exposed to international logistics flows. Rising trade barriers, sanctions regimes, and regionalization of supply chains can lead to:

• reduced cross-border trade volumes

• increased uncertainty in global freight flows

• postponed investment decisions by logistics operators

For Circle, this could translate into slower growth in transaction-based revenues and delayed implementation of discretionary digitalization projects, particularly those linked to international trade optimization rather than regulatory compliance.

At the same time, protectionism often increases regulatory complexity, rather than eliminating it. Additional customs procedures, reporting requirements, and compliance checks tend to raise the need for digital systems, especially in customs, documentation, and trade compliance.

11. Summary

Circle SpA stands at the intersection of digital transformation and essential logistics infrastructure. While the company operates in a niche that is not flashy, its work underpins the operational backbone of ports, intermodal hubs, and supply-chain participants across Europe. By focusing on mission-critical workflows and regulatory compliance such as eFTI-driven document digitalization, interoperability of freight systems, and customs modernization, Circle has positioned itself less as a discretionary software vendor and more as a provider of indispensable digital infrastructure.

This is reflected in an evolving revenue mix. Although legacy project and consulting work remains part of the business, there is a clear shift toward recurring contracts, cloud services, and usage-based models. These increasingly predictable revenue streams, including maintenance, SaaS subscriptions, and pay-per-use align with the gradual digital upgrade cycles typical of regulated logistics environments. As platforms like Milos® continue to gain traction, cross- and upselling within the existing installed base offers additional optionality for long-term value compounding.

However, investors should expect a gradual rather than exponential path to scale. Regulatory timelines, long sales cycles, public-sector procurement processes, and required integrations can make revenue recognition lumpy. The business might also face competitive pressure from larger supply-chain software vendors and potential shifts in geopolitics that can impact trade volumes.

Circle’s positioning in a structurally growing segment, combined with improving revenue quality and ecosystem integration, makes it a compelling consideration for investors willing to take a patient, long-term view.

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Welcome,

in this issue of Under-Followed-Stocks, I will present you Elliptic Laboratories ($ELABS).

Investment Summary:

• Software solution that replaces Hardware sensors with the help of AI

• Reducing costs and allowing new design options for OEMs

• Leading market position with 500 million devices already equipped

• 6 of the top 10 smartphone OEMs are customers like Xiaomi, Transsion or Lenovo

• 248 granted and pending patents that are protecting the IP

• highly scalable business model with potential EBITDA margins of >50%

• New sensor fusion solution aims to break up the Apple ecosystem

• 2025 will already be a record year within laptops, which will be the major driver of growth going forward

• Revenue growth of 93% in 2024, reaching profitability for the first time with an EBITDA margin of 19%

• clean balance sheet with net cash and no need for further dilution

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1. Introduction

Elliptic Laboratories (ELABS) is a software company that develops and sells licenses to a patented AI Virtual Smart Sensor Platform. Thanks to the software-only sensors by Elliptic Laboratories, smartphone or laptop manufacturers can replace hardware sensors, which allows them to cut costs, reduce sourcing risks, minimize their CO2 footprint and enable new design options for the devices. ELABS uses proprietary deep neural networks to create AI-powered Virtual Smart Sensors that improve personalization, privacy, and productivity.

Some of the biggest manufacturers in the world are among ELABS customers like Lenovo, Xiaomi, Vivo, Motorola or Honor and they are partnering with companies like Intel, ARM, Texas Instruments or Qualcomm. Over 500 million devices are already equipped with AI virtual smart sensors by ELABS. No other company has deployed AI virtual smart sensors at scale.

Elliptic Laboratories ASA had its IPO in 2020 and is now listed on the Oslo Børs in Norway under the ticker $ELABS. The current market cap is NOK 1,320 million (USD 139 million).

2. The company

Elliptic Labs was founded in 2006 as a research spin-off from the University of Oslo and is still based in Oslo, Norway. After years of R&D work, ELABS launched the first SDK for touchless gesturing on Android smartphones using ultrasound in 2013 and entered into a first sales partnership with Murata Electronics in 2014.

The business gained real traction with the presentation of its BEAUTY proximity sensor in 2016 which was able to replace hardware proximity sensors in smartphones, making them sleeker and less expensive. In 2017, Xiaomi launched the MIX phone, the first one with an ELABS sensor onboard, followed by the Mi MIX 2 which went into mass production in September 2017. Xiaomi was able to create the thinnest bezel on any phone at that time, thanks to the technology of ELABS.

In 2019, Elliptic Labs signed additional licensing agreements with 2 major Asian smartphone manufacturers and over the years, the INNER BEAUTY proximity sensor by ELABS became a dedicated solution among multiple large Asian smartphone manufacturers. 6 of the Top 10 smartphone manufacturers worldwide are among ELABS customers and to date, 166 smartphone models have been launched with its virtual sensors.

After succeeding in the smartphone space, ELABS announced a first Proof-of-Concept contract with a top 3 PC manufacturer, which was followed by the first enterprise software license contract with a leading laptop OEM in 2021. In 2022, ELABS & Lenovo jointly launched the first software-only human presence sensor on Lenovo’s ThinkPad T14. In addition to that, ELABS also started to target additional markets like IoT devices, smart TVs or the automotive market with first PoCs.

In the past years, ELABS was able to continuously add new customers, new products and the types of devices.

To accelerate growth and invest more in R&D, the company carried out an IPO in the Euronext Growth market in October 2020 and transferred to the Oslo Stock Exchange main list in Q1 2022. It is headquartered in Oslo, Norway, with a presence in the USA, China, South Korea, Taiwan, and Japan. Its technology and intellectual property (“IP”) are developed in Norway and solely owned by the company. In 2024 alone, ELABS had 49 newly granted and pending patents. They have a total of 248 granted and pending patents that are protecting the IP.

3. Technology & Products

Technology

ELABS uses existing hardware sensors like speakers and microphones or any other on-device sensors. The speaker transmits an ultrasound wave and the microphone receives the ultrasound wave. Advanced machine learning and proprietary deep neural networks are translating these ultrasound waves into contextual information. This approach offers highly accurate sensing capability that delivers up to a 360-degree field of view and works in all lighting conditions and even around corners.

The AI processing happens completely on the device as it only requires 25 MIPS and less than 100K memory which makes it highly secure and safeguards user privacy with no need for a camera or network connection.

Over the years, Elliptic continuously improved its platform, moving up the software stack of its solutions and creating more value for its customers. It started by simply replacing hardware sensors, which allowed the customers to reduce costs and power. Currently, the company is in the second phase, where they focus on device interoperability. Thanks to their AI sensor fusion solution, they can leverage the information of multiple already existing hardware sensors into completely new use cases like enabling easy “Apple-like” sharing between two devices. Going forward, they are working their way into the third phase with their partners like Intel or Qualcomm, to deliver contextual intelligence. With contextually aware AI agents, they intend to unlock actionable insights and generate groundbreaking AI-driven use cases by adapting to real-world context and user behavior.

With its technology, Elliptic is, for example, able to replace the following hardware sensors:

• Infrared hardware sensors

• Time-of-flight hardware sensors

• Radar hardware sensors

• Ultrasonic hardware sensors

Products

AI Virtual Proximity Sensor “INNER BEAUTY”: Proximity sensors are an indispensable part of every smartphone, alerting the phone to turn off the screen and to disable touch functionality whenever a user is on a call. Before INNER BEAUTY’s debut, this functionality was provided by hardware-based optical proximity sensors, which took up important device real estate, increased manufacturing complexity and cost, and required thick bezels to operate. According to the company, INNER BEAUTY was the world’s first software-based proximity solution to match and even exceed hardware-sensor performance. ELABS’ highly accurate proximity detection has already been shipped on hundreds of millions of devices and was Elliptic’s breakthrough product in the smartphone market.

AI Virtual Tap-to-Share Sensor (Seamless sensor): While the proximity sensor was the breakthrough in the smartphone market, the AI Virtual tap-to-share sensor has the potential to become the next bestseller. It allows devices to share photos, contact information and more between iOS and Android smartphones with a simple tap, all without a pre-existing connection between the two phones. With the AI Virtual Tap-to-Share Sensor, users can effortlessly tap their iOS or Android phone against another to instantly exchange information, eliminating the need for Bluetooth pairing, Wi-Fi setup, or other complex configurations. The process is fully automated, ensuring a smooth, intuitive experience for users. The solution was presented at the MWC in Barcelona in March 2025. It doesn’t only work between two smartphones, but also between a laptop and a smartphone. The new “Aura” laptops from Lenovo have the Lenovo Smart Share function, which is based on Elliptic’s technology. In the video below you can see how easy this works.

This smart share function was already recognized as a breakthrough solution for seamless device-to-device interaction and was celebrated as the “AirDrop” killer by the press.

CEO of Elliptic, Laila Danielsen, also commented on this in the last earnings call:

The Smart Share function by Lenovo was presented in 2024 and it is actually less seamless than it looks at first glance, as it still requires that both devices have the Intel Uniso app. But now in March 2025, Elliptic presented the improved AI Virtual Tap-to-Share sensor that doesn’t need any pre-existing connection or work to share data and this really has the potential to become the airdrop killer in the smartphone and laptop market.

AI Virtual Human Presence Sensor: The sensor delivers presence-detection capabilities that enable a device to respond automatically when a user enters or leaves an environment. For instance, a device might “wake” itself up when a user enters the room and then go to sleep/turn off to save power when it perceives that the user has left. In addition, the automated lock of the screen helps to protect sensitive data. Typically, laptop manufacturers do this with a hardware time-to-flight sensor, which can simply be replaced by ELABS, reducing costs and materials.

AI Virtual Connection Sensor: The sensor provides a convenient way to pair and authenticate smart devices that are in the same room. It uses ultrasound to provide a quick, simple, direct, and accurate connection, eliminating the possibility of private information being accidentally received by a device in another room or even outside the building. The AI Virtual Connection Sensor also allows for easy network authentication by enabling building visitors whose devices have the sensor to join a Wi-Fi network without needing to type in a code or password, while still keeping external users out.

AI Virtual Position Sensor: The AI Virtual Position Sensor allows a laptop/display to correctly extend itself onto an ancillary device by determining the position of that device relative to the main display. This eliminates the need for users to use complicated settings menus to correctly link the displays together. The secondary display can even be moved around the main display and the sensor will correctly track its position and update the content it displays in accordance with the primary system.

AI Virtual Gesture Sensor: Elliptic Labs’ AI virtual gesture sensor is a 3D touch-free gesture technology based on ultrasound that enables simple, intuitive user interactions. It features a 180-degree-wide field of view that allows users to perform natural hand movements in the air above, below, in front of, or to the side of their device. The AI Virtual Gesture Sensor enables many types of 3D gestures that can be customized to produce a variety of effects, such as swiping the air to scroll through pictures without touching a screen, double tapping in the air to turn off alarms and take pictures remotely, and approaching a phone with one’s hand to increase/decrease its volume.

AI Virtual Vitals Sensor: The sensor detects a person’s heartbeat and breathing rates. Elliptic Labs’ AI Virtual Smart Sensor Platform leverages the increased granularity and sensitivity of mm Wave radar hardware sensors. The sensor uses AI and signal processing to successfully handle the complex process of detecting the micro-movements involved in a person’s breathing motions and heartbeats. The sensor can help to detect when a person is starting to experience respiratory distress or detect when a child is left alone in a car or just help to provide health data to the user.

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4. Business Model

Elliptic Labs is licensing its patented software to OEMs (Original-Equipment-Manufacturers). ELABS typically receives a milestone payment at the beginning of a contract. This milestone payment is a minimum fixed fee that is paid for a certain number of devices sold. Once the number of devices sold exceeds this minimum volume commitment, Elliptic generates additional revenue with every new device sold by the manufacturer to the end customer. Below, you can see a typical revenue journey for a laptop model. In Q2, the contract is announced and ELABS receives a certain amount for a minimum volume. Two quarters later, the actual product is launched on the market and then around 3 quarters later, the number of devices exceeds the minimum volume and Elliptic is getting paid a fee per device until the manufacturer decides that the model is too old and stops selling it. So if a model is very successful, ELABS also profits from it.

Due to the relatively high milestone payments at the beginning of the contract, the revenues of ELABS can be lumpy from quarter to quarter. But as long as the products that are in the market continuously increase, the lumpiness will decrease as the ongoing pay-as-you-go revenues will have a bigger share. Below you can see the number of models & products launched in the past years. The number continuously increased over the years from 1 product in 2016 to 241 in May 2025. The start in 2025 has been very encouraging as ELABS has already launched with 23 new smartphones and already secured minimum commitments for 45 additional models so far. The development in the laptop market is even more encouraging as ELABS already launched 23 of its sensors in 16 different laptop models so far, compared to “only” 15 sensors throughout full year 2024. Why especially the high number of launches in laptops is very promising will be covered in the “Growth Driver” section. So after nearly 6 months of 2025, ELABS can already announce that they will again increase the number of models launched year-over-year. And remember that from the launch date, it typically takes 2-3 quarters until further revenues per device are recognized, so ELABS will continue to profit from the strong number of product launches in 2024 and from the already very strong numbers from 2025 in the coming quarters and years. For royalty-based contracts, payments are invoiced quarterly, based on actual shipment data received from the customer.

Elliptic Labs uses a partnering and collaboration strategy. It leverages its partners’ sales organizations to identify and drive sales opportunities and also works with its ecosystem partners to embed its AI Virtual Smart Sensor Platform into their respective platforms. Finally, Elliptic Labs collaborates with these partners to create new standards for ultrasound and AI virtual smart sensors. The platform partners include Intel, Qualcomm, Samsung, Cadence, MediaTek, Knowles, and others. Go-to-market partnerships promote Elliptic Labs’ solutions to potential new platform partners and include companies such as Infineon, ARM, AAC Technologies, Cirrus Logic, and Texas Instruments.

Over the years, ELABS has also continuously improved the integration process of its products into the devices to make it as easy and smooth for its customers. In the beginning, every new smartphone model had to be manually fine-tuned, which was very labor-intensive. The process has been mostly automated between 2018-2020, which significantly reduced the manual labor needed. From 2021 on, Elliptic has developed its full AI Virtual Smart Sensor Platform, which is already pre-loaded on the chipsets of the devices. This makes it even possible that customers could retrospectively add Elliptic’s functionalities like tap-to-share with a software update to older models.

5. Market, Customers & Competition

Market

As Elliptic is selling its sensors mainly in smartphones & laptops and gets paid per device, they are reliant on the overall smartphone & PC/laptop market. After reaching a top in 2017, global smartphone shipments continuously decreased until it reached a low in 2023. In 2024, the numbers started to increase again by 7% yoy and the market is expected to continue to slowly grow by around 2% until 2028. So the market is not expected to grow fast (if at all). But ELABS was able to successfully establish its software sensor solution while the market was shrinking and to continuously increase its market penetration. Below, you can also see that ELABS customers were able to outgrow the market by 6 percentage points in 2024, which was also helpful.

Pareto estimates that ELABS only reached a market penetration in the smartphone market of 7.4% by 2024, which leaves a lot of opportunity to continue to grow fast inside this slowly growing or stagnating market.

Since 2022, ELABS has also generated revenues in the PC market. The market dynamics in the PC market are similar to the smartphone market. PC shipments reached a low in 2023 and are expected to grow slowly by 2% in the coming years. Officially, ELABS has only announced one PC OEM as a customer (Lenovo) and Pareto is estimating Elliptic’s market penetration at only 2.6% of the total PC shipments worldwide. So the opportunities in this market are even higher and as already outlined, the number of laptops with Elliptic’s sensors already increased significantly in 2025.

With the current offering, Pareto is estimating a TAM of USD 400 million for ELABS products, This equates to more than 30x of 2024 revenue.

Besides the smartphone and PC market, ELABS will also target the IoT/Accessories, smart TV and automotive market in the mid-term. Especially the Accessories market can be interesting as ELABS has already developed the virtual tap sensor for easy Bluetooth connection with devices. Apple devices are loved because the connection between the devices is so easy for users & Elliptic can deliver a similar seamless integration of all non-Apple devices with its solution. But as the adoption in the smartphone & laptop market took years until it took off, these new verticals will also probably take years until they can contribute meaningful revenues.

Customers

Among the Chinese smartphone manufacturers, ELABS is already well established with customers like Xiaomi, Transsion, Oppo, Vivo, Honor or Lenovo. The largest smartphone manufacturers in the world, Apple & Samsung, are not customers and it is not likely that they will become customers in the foreseeable future. But as already outlined, the Chinese manufacturers are outgrowing the “established” and in the past, all new aspiring OEMs came from China and most of them became customers from ELABS soon. So I believe that if a new large (Chinese) OEM were to emerge in the future, the chances are high that they would become ELABS's customer soon. The Chinese smartphone market is the most important one anyway and recently, China started to subsidize smartphones up to CNY 6,000, so it is likely that the Chinese smartphone OEMs continue to outperform and ELABS alongside.

As already mentioned, in the PC market, ELABS only officially disclosed Lenovo as a customer. Below you can see the list of smartphone & laptop launches since Q4 2024 and by looking at the laptop OEMs, one can see that the majority of the OEMs are undisclosed, as ELABS is not allowed to mention them publicly. Statements from the call suggest, however, that these are also Lenovo laptops and not a new laptop OEM.

The management states that they are actively working with several other OEMs and in the previous year, they mentioned that they would expect to announce a new OEM during 2024, but so far, it hasn’t happened. CEO Laila Danielsen commented on that topic:

Competition

So far, Elliptic Labs has been the only company that implemented pure software-based sensors on devices at scale. So in this particular space, there is no real competition and ELABS is protecting its know-how with its patent portfolio. But other technologies could potentially offer similar solutions in the future. The new Wi-Fi standard, for example,e also offers Wi-Fi sensing which could also maybe be used to replace some functions of Elliptics sensors, but according to the management, this is not the case as this solution is not precise enough.

Elliptic’s main competitors are hardware sensor manufacturers. ELABS’ value proposition compared to hardware sensor manufacturers is that it reduces costs, supply chain risk, and the carbon footprint of devices, while giving similar or enhanced performance. Most of Elliptic Labs’ competitors are large corporations with significant financial resources compared to Elliptic Labs. Below you can see some examples of industry players/competitors.

Some of Elliptic Labs’ hardware “competitors” like Infineon or Texas Instruments have nonetheless chosen to partner with Elliptic Labs as either a platform partner or a go-to-market partner, to take advantage of the enhanced performance that Elliptic Labs’ software may bring to their hardware sensors. Hardware sensors are still the default choice for many use cases and OEMs and besides the already mentioned advantages of the software alternative, ELABS of course also competes on the price of the hardware solution. Elliptic’s products are typically priced cheaper than the comparative hardware alternative. Below you can see the typical costs of the respective hardware sensors and you can also see that the average price of a hardware sensor for laptops is significantly higher than smartphone sensors.

So software-based sensors seem to be superior to hardware sensors in all aspects. Nevertheless, it took ELABS a lot of time to convince OEMs that these are reliable alternatives. But so far, once a customer has been convinced, they have continuously expanded the number of models that are equipped with ELABS sensors, starting with just one model and one sensor and then expanding to multiple models and sensors.

6. Growth Drivers & Catalysts

Elliptic Laboratories expects to reach NOK 500 million in revenues (133 million in 2024) and an EBITDA margin of more than 50% in the mid-term.

More Products

In 2016, Elliptic started with just one sensor (proximity). Thanks to its scientific background, the company continued to invest in R&D, which resulted in multiple more products. Now, they have a complete suite of a dozen different sensors for multiple applications. The new tap-to-share sensors are proof that ELABS is still able to develop sensors that evoke highly positive market reactions, and the fact that they were granted 49 new patents in 2024 shows that they are not stopping here.

More devices

In the smartphone market, Elliptic was already able to acquire a lot of the OEMs as its customers and as already explained, it is unlikely that the two largest players (Samsung & Apple) will become customers in the short term. But for Elliptic, there is still a ton of opportunities just with the existing customers as currently just a few of their models are equipped with Elliptic sensors. Pareto estimates that Elliptic’s penetration with existing customers is at about 15 %, leaving a lot of room for further growth with existing customers.

As already mentioned, customers often start with one model and then continuously expand the models equipped with ELABS sensors as you can see in the graphic below.

More customers

Besides the device expansion with existing customers, there are also big opportunities to expand with new customers, especially in the laptop/PC segment. Officially, only Lenovo is a customer of ELABS in this segment and Pareto is estimating Elliptics’ penetration within Lenovo laptops at just 10%. Compared to the smartphone market, the PC market is much less fragmented. That’s why Elliptic’s total market penetration is estimated at only 2.6%. Winning just another customer could significantly expand the market reach. According to the management, the company is in direct contact with multiple other laptop OEMs and was already expecting to present another OEM during 2024, but due to a difficult market situation in the PC market, it hasn’t happened so far. The market is now stabilizing, so ELABS might be able to present a new OEM, which could be a game changer for the company.

In addition to the smartphone & PC segment, Elliptic has also done multiple Proof-of-Concepts with OEMs in the IoT device, smart TV and automotive sectors.

Breakthrough in the PC/laptop segment

In less than six months of 2025, ELABS launched 23 sensors in 16 laptop models, which is already 50% more than in all of 2024 and it is likely that in the second half of 2025 some more models will be launched.

So it seems like the ELABS PC segment is taking off. AI-capable PCs/laptops are a megatrend and Elliptic is well-positioned to capitalize on this trend with its AI Virtual Smart sensor platform.

Recently, ELABS and Intel also expanded their long-term partnership to bring smarter, more intuitive AI features to Intel’s next-gen laptops. Together, they’re turning PCs into intelligent devices that can sense and respond to their environment, like knowing when you're present or automatically connecting and sharing across devices.

Another encouraging trend in the laptop segment is that the number of devices with 2 Elliptic sensors is strongly increasing. A driver for this is the new Seamless/Tap-to-share sensor. Typically, the laptop models are equipped with a Virtual Human Presence sensor and this sensor is now more and more supplemented with a Seamless sensor as we have seen in the Laptop launches since Q4 2024.

But why can a breakthrough in laptops be a major catalyst for the company?

Let’s again have a look at the prices for the sensors of smartphones & laptops.

One can see that a typical laptop sensor is approximately 10x the price of a smartphone sensor. Currently, the main ELABS sensor placed in a laptop is the Virtual Human Presence sensor, which is a sensor that replaces the hardware Time-of-Flight sensor. And as already mentioned, when replacing a specific hardware sensor, ELABS is pricing its solution below the price of the hardware sensor. But with the new interoperability sensors like seamless/tap-to-share, ELABS is not just simply replacing another sensor, they are adding completely new capabilities to the device. That means they are not bound to any hardware sensor prices and they were able to increase prices for these.

So while the laptop devices sold with ELABS sensors will be significantly lower compared to smartphone sales, revenues can potentially be way higher and the laptop segment is just starting to take off. Below you can see that laptop revenues already had a big share of revenues in 2024 (41%), although the number of models was still low. But as we have seen, a lot of laptop models have already launched in 2025 and a lot of initial milestone payments for these launches are likely included in the 2024 numbers, so this might not paint the right picture.

But it is for sure that the opportunities, especially concerning revenue opportunities, are immense. Pareto is estimating that the potential TAM for advanced sensors just with the existing customer could be NOK 0.4bn, which is around 8x the revenues that ELABS generated in the laptop segment in 2024. For the total laptop market (excl. Apple), Pareto is estimating a TAM of NOK 2.4bn.

Profitability

Ellitpic Labs has a highly scalable business model and its mid-term target is to reach EBITDA margins above 50%. But this is just possible with a certain scale of the business. 2024 was the first full year for Ellitpic where they reached profitability on an EBITDA basis, thanks to the strong increase in revenues while costs were relatively stable. The biggest costs for Ellitpic are R&D costs and employee expenses. These costs can stay relatively flat while more ELABS sensors are deployed on more devices. If ELABS can continue growing the top line while maintaining the cost basis stable, they will be able to show high(er) margins and profitability in the coming years. When a historically unprofitable company turns to (high) stable profitability, this can be a major catalyst for the stock.

7. Shareholders & Management

Laila Danielsen is the CEO of ELABS since 2013. She is a serial entrepreneur and an experienced tech executive with expertise in enterprise software and technology at both Fortune 500 companies and Silicon Valley start-ups. Due to her exceptional leadership skills and strong customer orientation, Ms. Danielsen has a long history of success in bringing technology to market and building focused teams, including FastScale Technology Inc. (acquired by EMC/VMware), Scali (acquired by Platform Computing), and HotLink Corporation. She was awarded an MS at the Norwegian School of Economics and a BA at the University of San Francisco.

Lars Holmøy is the CFO since 2021. Before joining Elliptic, he served as CFO at two different international tech companies with a focus on finance, business development, strategy, and mergers and acquisitions. Prior to joining the tech industry as a CFO he worked seven years at PwC. Holmøy has a Master of Accounting and Auditing from NHH, and a Master of Law from UiB, specializing in cross-border taxation for e-trading companies, with additional international law studies from the University of Alberta Law, Canada.

Espen Klovning is the EVP of Engineering. He has more than 16 years of engineering proficiency in his position as VP of Engineering at Elliptic Labs. Previously, he was director of engineering at Cisco Systems, worked for Tandberg and was VP, R&D at Birdstep Technology. He is the author of several Institute of Electrical and Electronics Engineering (IEEE) RFCs and has written over ten scientific papers on communications protocols.

The biggest shareholder with 9.2 % of ELABS is MP Pensjon PK, a Norwegian pension fund. The second largest shareholder is ALDEN AS with 7%. ALDEN AS is indirectly controlled by Edvin Austbø, a member of the Board of Directors. The CEO of ELABS, Laila Denielsen owns 4.2 % of the company. Company insiders collectively own around 10.8 % of the company.

The company has a share option program in place that includes a total of 70 employees and 4 board members. The option program entitles the employees to approximately 5.54% of the fully diluted outstanding shares, which includes all outstanding options. The fully diluted outstanding share count on 31 March 2025 was 111,451,707.

8. Financials

Elliptic Laboratories increased revenues from only NOK 10 million in 2017 to NOK 132 million in 2024 (CAGR of 43 %). In 2024, ELABS achieved revenue growth of 93 % and EBITDA profitability for the first time for the full year with an EBITDA margin of 18.8 %.

In 2024, 41% of revenues were generated from laptops, while 59 % were generated with smartphones, showing how important the laptop segment already is for the company’s financials, although the number of deployments there is still at a low level, showing the huge financial opportunities that exist there.

In Q4 2024, they even reached an impressive EBITDA margin of 34.5 % and the operating cash flow turned positive thanks to multiple milestone payments that ELABS received for future product launches. However, as already mentioned, these milestone payments are lumpy and don’t happen every quarter in that size. Due to that, EBITDA turned negative again in Q1 2025 (NOK -1.6 million) as ELABS only generated NOK 26.6 million in revenues in Q1 ‘25 vs. NOK 47.5 million in Q4 ‘24. But this quarter-over-quarter decline is normal for the business as ELABS is (besides the lumpy milestone payments) reliant on the sale of the smartphone & laptop models. Electronic devices are usually sold the least in the first quarter, and then more and more in the following quarters, peaking in the last quarter with major events such as Black Friday or Christmas. So there is some kind of underlying seasonality in ELABS’ business. But Elliptic is full on track as one can see in the year-over-year numbers, where revenues increased by 20 % and EBITDA improved from NOK -3.3 million to NOK -1.6 million while Elliptic was able to announce again a positive operating cash flow of NOK 12 million.

The company is capitalizing some of its R&D costs as intangible assets if they meet the capitalization criteria according to accounting standards and is amortizing these over the expected useful life. If fully expensed in the income statement, the EBTIDA would have been lower in the past, which should be taken into account when looking at the profitability of the business. However, ELABS is amortizing its R&D costs over 5 years, which is not that much, so the capitalized costs will have an effect on the P&L over the next 5 years, which will lower the EBIT. So, when looking at the EBIT, one can still get a fair impression of the underlying profitability of the business. In 2024, Elliptic capitalized NOK 22.3 million in R&D work while the amortization charges amounted to NOK 14.1 million and in addition to that, Elliptic also recognized NOK 12.5 million in the income statement that is related to R&D.

ELABS has a clean balance sheet with cash on hand of NOK 76.89 million, no long-term debt and an equity ratio of 90 %, so that there is no need for dilution to fund further growth.

At the end of 2024, the company had unused loss carry forwards of NOK 331 million. So the company will not have to pay taxes on future profits until these are used up. The value of these loss carry forwards is estimated at NOK 75 million and the company expects to utilize these remaining tax losses within the next 3-4 years.

9. Valuation

As Elliptic Laboratories is a company that is still on the cusp of profitability, it will be necessary to look several years into the future to grasp the company's true potential. Although the implementation of the products has been slower than initially expected, the company has proven that there is a large market for its products and has been able to show that its customers are gradually equipping more and more models with ELABS products. Even just with the expansion of current customers, ELABS still has a large untapped addressable market. Assuming that ELABS will reach its target of NOK 500 million in revenues and an EBITDA margin of more than 50 % within the next 5 years, it could reach more than NOK 200 million in EBIT at the end of 2030.

The assumptions are based on a more gradual growth curve, where the growth mainly comes from the existing customers that are adding more models with Elliptic products as well as some additional second sensor based on sensor fusion (like tap-to-share) in the high(er) end models at the beginning (what we already see in 2025) and then gradually in more models over the years. Based on the highly scalable business model and on the margins that Elliptic already showed in Q4 2024, the company could theoretically reach the 50% EBITDA margin probably earlier than the NOK 500 million target, but in these assumptions, a more conservative approach was chosen that margins are gradually increasing until they reach 50% in 2029.

Assuming an Exit multiple of 15x on the EBIT number in 2029, you end up with a share price of NOK 28 per share (fully diluted). This would mean a doubling of the share price by 2029, which would correspond to an IRR of approx. 17% p.a. It is very hard to estimate if and when Elliptic would be able to ship more of its (new) sensors to customers or add another OEM customer so it should be noted that these assumptions are likely completely wrong. This is just meant as a starting point for a valuation scenario, which has now to be updated once more detailed information is available.

As outlined in the “Growth Driver & Catalyst” section, a new PC/Laptop OEM could have a material impact on the company’s financials. Such a scenario is not included in the previous assumptions. Pareto has developed three different scenarios in its initiation coverage. The scenarios are mainly based on changes in the PC/Laptop segment as these are the key drivers for higher profitability. In the base case, Pareto assumes that the current PC OEM, Lenovo, implements the human presence sensor in all mid- and high-range laptops as well as the seamless (tap-to-share) sensor broadly by 2027. The bull case scenario includes a third sensor in Lenovo laptops, as well as another large PC OEM. In that scenario, Pareto assumes that ELABS already reaches NOK 674 million by 2027, compared to “only” NOK 357 million in the base case. This shows the major changes a new OEM or another „breakthrough“ sensor can have on a forecast. In contrast to that, in the bear scenario, Pareto assumes that in 2025 & 2026 the traction of the past years falls off before returning to growth in 2027.

Therefore, it will be necessary to keep up to date with the company's developments and news to quickly incorporate them into the assumptions.

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10. Risks

Chinese Customers

All customers from ELABS are based in China. This is a significant country concentration risk, especially in the current uncertain geopolitical environment. However, although there are other smartphone & laptop manufacturer that are not based in China, nearly all of them are also still producing their products mainly in China. So the risks with these OEMs would practically be similar. It was also significant that Trump had to withdraw or pause his tariffs on smartphones and laptops from China relatively quickly, as the government probably quickly realized that they were quite dependent on them. Nevertheless, there are tensions between China and multiple other countries (especially Western) and political risks are often unpredictable. So a more diversified customer base would still be a big win for ELABS.

Technological / IP risks

The technology in the markets in which Elliptic operates is rapidly evolving and has been through a series of disruptive changes. To survive and grow, it must continue to enhance and improve the functionality of its products and technology to address the customers' changing needs. If new industry standards and practices emerge, the group's existing products and technology may become obsolete. The Group's future success depends on its ability to:

• Develop new products and technologies that address the increasingly sophisticated and varied needs of prospective customers; and

• Respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.

Elliptic is securing these technological advantages with patents. If the ELABS’ protection of its intellectual property rights is not sufficient or if the group does infringe third party intellectual property rights, this may result in an adverse effect on its business, results of operations and prospects.

Continued unprofitability

If the market for ELABS products does not evolve as the Group anticipates, this could have a materially adverse effect on the Group’s business, prospects, financial position, and results of operations. Although the company has been cash flow positive in the past two quarters and EBITDA profitable in 2024, there is no assurance that this trend will be sustained, as the revenues will continue to be lumpy. If the turnaround from unprofitability to profitability can not be confirmed in the current year, this could have a severe impact on the stock as investors are calculating on this turnaround.

Bad guidances

In 2020, Elliptic released its target of reaching NOK 500 million and an EBITDA margin of 50 % within the next three years. A very bold guidance for a company that had only NOK 30 million in revenues in 2020. Three years later, the company had revenues of NOK 68 million and was unprofitable. Today, the company still has the target of reaching NOK 500 million in revenues and an EBITDA margin of more than 50 %. They have just cut the exact time frame and now it is just a “mid-term” target. So the management is pretty bad at giving guidance and one should not count on that and instead have a look at the development from quarter to quarter. Another example is that the management announced during a call that they expect to announce another PC OEM in the second half of 2024, but so far, they haven’t presented any. While the management is still expecting another PC OEM, it seems like they are significantly underestimating the time frame of the adoption processes of its technology. Such statements fuel investors' expectations and if these cannot be met, this will have a negative impact on the share price

11. Summary

Elliptic Laboratories is a highly interesting company. With its unique AI software technology, it can bring its customers several advantages compared to the legacy hardware solution. These advantages alone have already convinced a large number of customers. Thanks to Elliptic's new sensor fusion and interoperability solutions, you can now offer existing and potential new customers even more reasons to choose Elab's products. If devices can share data and connect with each other in a similar way to Apple devices, then this could be a key selling point. More sensors in more devices will lead to a further increase in sales and Elliptic Laboratories can finally demonstrate the high profitability of its highly scalable business model. The prospects are therefore excellent at first glance, but the risks remain due to the high concentration of customers and the high expectations raised by the management to date, which have only gradually been fulfilled. Investors should therefore keep a close eye on operational developments. The financial development can sometimes deviate more strongly from the underlying operational development when milestone payments fluctuate, but product launches continue to accelerate. The share price has already risen in recent weeks, even if the full potential has not yet been exploited. Should investors be disappointed by the financial development in the future, even though everything is going well operationally, this could be a good entry point for long-term investors.

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Welcome,

in this issue of Under-Followed-Stocks, I will present you ErreDue SpA ($RDUE).

Investment Summary:

• traditional on-site gas generation business with high margins (>20% EBIT margin) and steady double-digit growth

• new green transition business in the large hydrolyser market at a pivotal point

• high growth expectations in the new business, confirmed by a high order backlog

• one of the few companies able to capitalize on the H2 opportunity while remaining highly profitable thanks to the combination of the two segments

• pioneer in electrolytic hydrogen generation with multi-decade experience

• 25 employees collectively holding 70% of the company

• Revenue CAGR of 17 % from 2016-2023 (traditional business) and expected growth of over 50 % in 2025 and beyond (thanks to the green transition business)

• temporary headwinds in the domestic (Italian) industry and large investment in the new business negatively affected 2024 results, presenting a good opportunity at a low valuation

• EV/EBITDA of 3.4x and EV/EBIT of 5.4x for 2025 while growing by 50 %

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Let’s go!

1. Introduction

ErreDue designs, manufactures and markets highly innovative and customized solutions for the on-site production, mixing and purification of technical gases (hydrogen, nitrogen, oxygen) for use in small, medium and large industrial sites, laboratories or medical applications. Thanks to its multi-decade expertise in electrolytic hydrogen generation, ErreDue looks well set to contribute to the energy transition process with new, larger-size hydrogen electrolyzers to be applied to green mobility and power-to-gas systems where they have already won multiple large contracts.

The combination of the two segments (“traditional” on-site generators & large “green transition” generators) makes Erredue one of the few companies able to capitalize on the H2 opportunity while remaining highly profitable.

Erredue is listed in the Euronext Growth Milan since 2022 under the ticker $RDUE. The current market cap is EUR 44 million (USD 45 million).

2. The company

ErreDue was founded in 2000 by Enrico D’Angelo and is based in Livorno, Italy. The company was able to play a leading role immediately, thanks to the background of its founder, who as early as the mid-1980s began to take a strong interest in the hydrogen market, producing its first alkaline generators. Over the years, the company added multiple other generators to its portfolio like their own “Ultrapure Nitrogen Generator” and oxygen generators. In 2016, Erredue developed the PEM technology, thanks to which it was able to diversify its commercial offerings and also offer small generators for laboratory applications.

Thanks to its internal research laboratory and collaboration with private and public entities operating in the technological and scientific research sector (in particular ENEA, of which ErreDue has been a privileged partner for hydrogen research since 2006, as well as other entities such as CNR and the University of Pisa), Erredue can be considered a pioneer in the production of electrolytic hydrogen generators. As proof of its experience in the sector, in 2014, ErreDue was one of the first companies to achieve cells capable of producing hydrogen with alkaline technology at pressures up to 30 bar, enabling significant energy savings during the compression phase, whereas in 2016 it developed its proprietary PEM technology for electrolysis, an alternative method to the classical alkaline one. Thanks to continuous research and innovation, ErreDue has developed and currently markets 33 different models of gas generation and treatment plants.

In June 2023, ErreDue purchased an additional industrial building, which, following expansion and renovation, will become the main headquarters. The new production facility, which will be developed on a total area of 16,000 m2, will contain approximately 10,000 m2 for the production of generators and their components, including mechanical ones, storage warehouses, in addition to the technical, administrative and management offices. The flagship of the new facility will be an area specifically dedicated to the construction of larger generators, equipped with special means of lifting and moving materials. In July 2024, the municipality of Livorno finally granted the authorizations for the modifications and the expected date for the completion of the works is now the end of 2025, but the production of the large plants could probably start a few months earlier.

The overall costs of the new industrial site will be around EUR 12 million which will be financed by loans of EUR 9.3 million and non-repayable grants of EUR 2.3 million. In addition, the company can sell 2 “old” buildings no longer needed for around EUR 1.5 million. Thanks to the IPO in 2022, the company also still has around EUR 20 million in short-term available funds.

Its multi-decade in-depth knowledge in the field of hydrogen electrolysis has led in the past years to more than 2,000 generators and other equipment installed in over 50 different countries for more than 2,300 clients served since its foundation.

The fully internalised know-how and production footprint (every key component is designed and produced in-house) enables ErreDue to offer customised solutions according to the specifics required by clients, allowing for competitive differentiation.

The on-site generators from ErreDue allow customers to self-generate technical gases, replacing the purchase of the product stored in cylinders, thus preventing the risks and costs associated with the transport of such gases at high pressure. To avoid higher upfront costs for its customers, Erredue also offers to rent the generators. On-site gas generation plants offer several appreciable advantages for customers, in particular:

• independence from gas suppliers

• greater safety, as they do not require storage in high-pressure tanks

• no costs for transporting the cylinders, with the related reduction in environmental impact

• constant gas quality, without fluctuations due to different gas batches or contamination of the same

• no interruption in production operations for the replacement of gas cylinders

• no waste of gas due to the low residual pressure inside the cylinders

• immediate savings with the rental formula option

Technology & Products

Technology

The technology used by ErreDue for the production of gas generators is based on the development of electrolytic cells. Electrolysis is a process that uses an electrochemical device called an electrolytic cell to produce hydrogen gas by splitting water molecules as the raw material, releasing oxygen as the only waste product of the process.

Electrolyser generators are mainly made of five key parts:

• Electrolytic cell: the heart of the machine, ErreDue developed 7 cell models (5

  alkaline and 2 PEM) for different equipment models optimised for various end-

  applications. The alkaline cells feature polymeric components then stacked

  together, produced with proprietary molds, designed in-house. PEM cells feature

  membranes that are catalysed with internally researched and produced

  catalysers

• Electric system: Internally designed and assembled

• Software: Fully internally developed, both for process control, and remote control

  once installed allowing for constant performance monitoring and predictive

  maintenance

• Process components: Tanks, tubes, manifolds, generator sealing plates (both for H2 cells and N2 generators); produced internally in the Lavaiano “workshop” plant

• Metal shell: Component without any specific know-how, whose production is

  generally outsourced to clients in the metal cutting and treatment business renting ErreDue generators.

The electrolytic cells, based on the two different technologies, can be declined in different sizes, with different gas generation capacities, to meet the specific needs of the customers.

The PEM technology is more efficient and compatible with the intermittent power supply provided by renewable energy sources but it’s also more expensive as precious metals are needed. ErreDue will soon publish the results of a research project aimed at replacing precious metals with something less precious, which will Erredue enable to reduce the costs of the stacks and increase the margin. Additionally, Erredue is developing a new PEM cell with high current density for megawatt PEM electrolyzers.

On the other hand, alkaline technology is cheaper and the better choice if the main production line has a parallel production line that requires oxygen, which is a secondary product of alkaline electrolysis.

The management believes that in the medium-term alkaline will be better suited to meet the demand for 1 to 5 MW plants, as alkaline production costs, and therefore sales prices, are currently significantly lower and it is a mature technology with performance levels largely supported by data (e.g. electrolytic cell life, maintenance frequency, etc.). For the medium to long term, however, management believes that PEM will play a much more central role, given its promising performance levels in terms of energy consumption and operational efficiency and given that, through research into rare earth reduction, Erredue aims to reduce production costs without lowering performance.

Products

ErreDue produces the following families of products:

• Industry

• Laboratory

• Energy transition

Generators for industrial applications:

• Sirio: plug & play on-site hydrogen generator with very high levels of purity using the PEM technology used for heat treatment of metals or Biomethane production processes

• Mercury: alkaline hydrogen & oxygen generators for any industrial need with up to 1MW production

• Saturn: ultra-pure nitrogen generator with a purity of up to 99.9999%

• Venus: modular nitrogen generator with automatic regeneration so that maintenance work is minimized

• Nitrobox: simple and compact plug & play system for producing pressurized nitrogen directly where it is needed for laser cutting and other applications

• Mizar: oxygen generators using PSA technology with automatic regeneration so that maintenance work is minimized

• GN INOX: pure nitrogen generator (up to 99.9999%) for all those applications where special attention to hygiene is required in addition to gas quality

• Others: gas purifiers, electronic mixers, special applications

Generators for laboratory applications:

This is the miniaturized declination of the entire offer of ErreDue systems such as ultrapure hydrogen generators (Mars), nitrogen generators (Galileo), oxygen generators (Gemini), pure air generators (Orio P-Series), air purified from hydrocarbons (or pure air generators, Orio Z-Series). PEM technology is particularly useful for these machines due to the possibility of miniaturizing the system, thanks to the elimination of additional components to balance hydrogen and oxygen.

Generators for the energy transition:

The energy transition requires a trial period utilizing smaller MW-scale facilities. That’s why ErreDue will focus on the niche of 1-5 MWplants. During 2024, Erredue continued its development activities for the construction of plants for the hydrogen production with alkaline electrolysers of 1 MW and above. They have already received some important sales orders for modular plants with increasing capacity with the first delivery scheduled for the end of 2024. In addition, the first PEM Megawatt generator will be delivered in the first 6 months of 2025. In November 2024, Erredue signed another agreement for two 1 MW PEM generators to Agrobiofert as part of an “H2 Farm” project, worth EUR 3.4 million. The delivery is scheduled for December 2025.

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4. Business Model

R&D

ErreDue is a fully vertically integrated company. The deep-rooted know-how of every single process and component (manufactured internally) enables the company to efficiently control costs and at the same time offer innovative solutions tailored to customer specific needs, with a fast time-to-market. ErreDue can be considered a full electrolyser supply-chain in one company and this is a key competitive advantage in terms of:

1. possibility of customization

2. faster time to market (4 months on average from order specifications to installations)

3. more effective R&D thanks to an all-round knowledge of the final product

4. more reliable after-sales services, as every component and related underlying technology is under control

R&D is the beating heart of ErreDue. The management is strongly committed to the continuous research and testing of different materials, new technologies and product applications and they have already successfully launched several innovations in their industry. The company has decided not to patent any of its proprietary technologies due to the following reasons:

• as a producer of full generators and not just of a specific component, all the proprietary hardware and software in the generator are strictly interconnected and hard to reverse engineer effectively

• as the underlying technologies are quite complex and testing times to guarantee product safety are very time-consuming, product imitation has been slower than the company’s product innovation pace

• patenting exposes publicly the proprietary designs, without being able to enforce properly legal IP protection at the worldwide level

Therefore, ErreDue strategically prefers, at the moment, to protect know-how with non-competition agreements on key personnel, who also own company shares, and by avoiding the outsourcing of all components with relevant embedded technology. For the newer large-scale systems, ErreDue for example purchased a milling machine dedicated to special processes in order to not disclose the design drawings of these solutions to external suppliers.

Sales

The company manufactures based on clients’ demand and not to build inventory stocks. Once orders are confirmed, machines are delivered within an average period of 4 months. As already mentioned, ErreDue’s machines are offered either for sale or for rent:

Sale

If the customer decides to directly buy the machine, the contractual conditions typically include an advance payment upon order confirmation amounting to 30 % of the total contract value, which increases to 50% for machinery made with solutions that must need specific client requests. For sales within Italian territory, the balance of the payment, after deducting the aforementioned advance, is made in installments at 30, 60, and 90 days from delivery, while for foreign clients, the balance is usually settled before delivery. The machines enjoy a twelve-month warranty, which, however, does not cover components subject to wear and is typically provided ex-works from the Livorno plant.

Rental

The rental option is currently limited to the Italian territory, but could be expanded in the future. The rental of a machine allows customers to avoid upfront costs for equipment investments while it generates predictable and recurring revenues for ErreDue. Rental contracts are fully indexed to inflation and have an average duration of 65 months. At the end of the contract, machines still have a market value (even if fully depreciated), of approximately 60% of the initial one. They can be rented again to the same customer or sold to 3rd parties with a capital gain. The average payback time on these machines is around 2.6 years on average.

After-Sales

Generators can only and exclusively be maintained by ErreDue technicians, using only and exclusively components developed in-house. A highly specialised technical department takes care of clients along all the journey from plant design to installation and keeps following it in the after-market. After installation and testing, ErreDue performs continuous remote monitoring of each installed machinery, promptly performing both routine and extraordinary maintenance, avoiding sudden production stops.

After-sales services provide a steady flow of recurring revenues to ErreDue with very attractive margins, thanks to the fact that machinery's estimated useful life is around 15-20 years and the supply of spare parts typically entails nice operating margins.

In H1 2024, Erredue generated ~62 % of revenues with the sale of generators, ~15.6 % with the rental of generators and ~22 % with the sale of spare parts and services. So over 35 % of revenues have recurring characteristics.

Product-wise, the company generated ~62 % of revenues with hydrogen-related products, ~34 % with other gases (nitrogen, oxygen) and ~4 % with other products.

Around 59 % of revenues are generated in Italy, 12 % in the EU and 29 % in the Rest of the World.

5. Market, Customers & Competition

Market

Traditional business

In the traditional business, Erredue is active in all industrial verticals where technical gases are needed, which is the case for nearly all manufacturing companies. This means that Erredue is to some extent dependent on the general economic development. In Italy for example, there was a significant slowdown in the automotive and textile sectors in the first half of 2024, which have a big portion of the overall industry in Italy. And in economically uncertain times, companies tend to postpone larger investments (like for generators). Although ErreDue is counteracting this trend with its rental model and by showing the advantages of on-site gas generation, it is much more difficult to convince new customers of such a change in difficult times. For industrial applications, it can therefore be said that ErreDue is dependent on the cyclical nature of industrial development. ErreDue already generates 40% of its revenues outside of Italy, so the company is not purely reliant on the Italian market and the share outside the EU increased to around 29% H1 2024.

In the traditional business, ErreDue also diversified into laboratory applications. This market, on the other hand, tends to be counter-cyclical and kept growing in H1 2024 while the on-site industrial gas market struggled.

Green transition business

In the Green transition business, ErreDue is active in the hydrogen market for the global energy transition. The EU's hydrogen strategy and REPowerEU plan have put forward a comprehensive framework to support the uptake of renewable and low-carbon hydrogen to help decarbonise the EU. In 2022, hydrogen accounted for less than 2% of Europe’s energy consumption and was primarily used to produce chemical products, such as plastics and fertilisers. 96% of this hydrogen was produced with natural gas, resulting in significant amounts of CO2 emissions.

The priority for the EU is to develop renewable hydrogen. The REPowerEU Strategy of 2022 set out the aim of producing 10 million tonnes and importing 10 million tonnes by 2030. By 2050, renewable hydrogen is set to cover around 10% of the EU’s energy needs, significantly decarbonising energy-intensive industrial processes and the transport sector. Hydrogen stands as a key component in the EU's strategy to the energy transition, net-zero, and sustainable development.

To reach these ambitious goals, huge investments in the whole H2 industry are needed. The EU and several governments have committed large funds to support these initiatives like the REPowerEU plan, the NextGenerationEU (NGEU) plan or the National Recovery and Resilience Plan (NRRP) in Italy.

Only 5% of the cumulative clean Hydrogen production volume that has already been announced by 2030 has reached a Final Investment Decision, according to a BloomberNEF analysis, but the numbers are starting to improve.

The initial progress towards the 2030 targets has been slower than anticipated, which is a common occurrence in the early phase of such ambitious projects, especially when large governmental fundings are involved. But it seems like the numbers are starting to accelerate.

From a regional perspective, the current electrolysers’ capacity is dominated by China, although European markets will gradually rise in relevance.

To sum up, the global green hydrogen market is expected to grow a lot in the coming years. If all the countries actually stick to their targets, it is only a matter of time before the really big investments are made in infrastructure and the production of hydrogen. As we will see later, ErreDue's order intake is already showing a significant increase in this respect and this is probably just the beginning.

Customers

In the traditional business, ErreDue’s customer base is diversified with more than 2,300 customers in over 50 countries and 400 different customers on average per year. In the IPO document from 2022, one can see a detailed summary of the customer concentration. In 2021, the largest customer accounted for 4.8 % of revenues, the Top 3 for 11.5 %, Top 10 for 25.5 % and the Top 20 for 39 %. Of course with large orders/deliveries for bigger generators in one year, these numbers can vary from year to year, but ErreDue was able to continuously expand their customer base in the past.

In the Green transition business, ErreDue has two kinds of customers. The big energy companies that use ErreDue’s generators to start the pilot projects to test the hydrogen applied in several applications and the other companies that received funds from the multiple governmental/EU projects regarding H2 like for example Agrobiofert, an agricultural company that is part of the “H2 Farm” project, funded by the NRRP funds and who recently ordered 2 large electrolyzers from ErreDue.

Competition

ErreDue has a strong and consolidated presence in the sector of alkaline and PEM electrolysers, especially in the market of smaller laboratory or on-site generators. When looking for companies that offer on-site gas generators like ErreDue, you will most likely land on the website of one of the big industrial gas companies like Linde, Sol or Sapio. But these companies are actually customers of ErreDue as the logistics of transporting the gas to some of their customers is complicated so the gas companies prefer an on-site solution with electrolysers from ErreDue.

However, the market for large Megawatt electrolysers will rapidly evolve in the foreseeable future, with new emerging technologies for hydrogen production (like the Anion Exchange Membrane technology) or new entrants in the market, such as low-cost manufacturers from China that can build generators with mature alkaline technology at cheaper prices. Below you can see a compilation of some of the larger players active in the market of large electrolysers.

In this field of companies, ErreDue is a small player, but one with extensive experience in the business. That’s why they decided to focus on their niche with smaller 1-5 MW generators that are used for pilot plants of the energy companies or individual customers like Agrobiofert while other competitors are aiming for the largest generators needed once the pilot projects are approved. Nevertheless, ErreDue will have to stay ahead of the competition with its technological know-how. Especially when they are able to replace some of the precious metals that are needed for the PEM technology to reduce the costs and then increase the output of these generators, this could be a big advantage for the company.

6. Growth Drivers & Catalysts

Large megawatt plants for the generation of green hydrogen for the energy transition

The biggest growth opportunity is of course the emerging large megawatt electrolyser market for the green transition. ErreDue intends to become a recognised reliable partner for the supply of generators from 1 to 5MW capacity with their newly developed large-scale alkaline and PEM generators. Anticipating substantial demand for these types of application, ErreDue is already expanding production capacity to at least 60MW annual production, expected to be fully operational by end-2025. In the H1 2024 report, the management confirmed that 2025 will be the start-up of the first pilot plants. In the H1 2024 report, ErreDue reported an order backlog of EUR 24 million (compared to total revenues of EUR 16.5 million in FY ‘23) of which 65% or EUR 15.6 million refers to 2025. The major part of this backlog for 2025 is linked to the energy transition market, confirming the expected growth and the ability to acquire significant contracts in this market, despite the small size of the company.

Increasing market awareness of the advantages of on-site industrial gas generators

In the industrial market, on-site generators are not yet as widespread as cylinders. They represent less than 1% of the global hydrogen production and consumption. ErreDue intends to invest in marketing activities to educate potential customers, illustrating the advantages of on-site generators compared to traditional formulas for supplying technical gases via cylinders. ErreDue intends to continue to use the rental commercial proposal as an effective marketing lever, offering customers the opportunity to experience the advantages of on-site generation. In particular, this formula allows customers to avoid significant investments and allows them to enjoy immediate savings in terms of operating costs. Besides these cost savings, the on-site gas generation is also more sustainable which becomes more and more important for companies with ESG pressure. ErreDue posted a 17% revenue CAGR from 2016-2023 in its traditional business, showing that on-site gas generation is a growing market.

International Expansion

In the medium term, ErreDue intends to start a greater penetration in foreign markets, by opening branches in the main geographical areas, where it already sells its products, starting from the European countries for which it already holds all the required product certifications. The company has started an internal training program for future Country Managers, with skills in the production, maintenance and sales departments. Furthermore, the presence of local personnel with knowledge of the specific regulations of the country would allow to start proposing the rental formula also abroad, thus encouraging a further adoption of on-site, while at the moment the rental business is mainly limited to Italy. The share of revenues generated in Italy already dropped from over 65 % in H1 2023 to 59 % in H1 2024.

Expansion of the product portfolio and development of new applications

ErreDue is constantly committed to innovation and market development of its product portfolio, seeking new applications in sectors with high growth potential. With the development of their laboratory line, the company has shown that they are able to find new end markets and establish itself as a new player.

7. Management & Shareholders

Enrico D’Angelo is the founder, President & CEO of ErreDue. He has multiple years of experience in the technical gas sector and as a founder of companies. After graduating as electronic technician, D’Angelo founded several companies over the years, demonstrating his entrepreneurial spirit:

• GDF, Livorno (1974-99), focusing on customer-specific solutions and product sales

• Megabyete, Livorno (1981-85), exclusive IBM dealer for the Livorno area

• Tecnimat (1976-86), administrative, accounting, tax and financial management

• Idroenergy(1985-2000)

He was also managing partner at Bulleri Macchine Srl (1987-99).

Francesca Barontini is the company's CFO. She began working as a consultant in Livorno in 1997, focusing on legislation and technical finance facilitation for businesses. In 2001, she joined ErreDue as an employee in the Finance & Administration department and Head of HR. She was appointed Sole Administrator in 2010, a position she held until 2018, when she was appointed as the CFO.

The COO of Erredue is Emiliano Giacomelli. After obtaining his diploma as an electronic technician, Emiliano served in the Italian Army from 1993 to 1994 in the firefighting unit. In 1994, he joined Idroenergy with roles of increasing responsibility until 2000. In 2001, Emiliano became part of the newly founded ErreDue as the Chief Operating Officer, overseeing the Production, Procurement, and Logistics departments.

ErreDue’s shareholders structure is characterized by a significant degree of employee ownership, with ca. 25 employees collectively holding 70% of the Company's share capital. This ownership is distributed between the Green H2 Holding, which owns 54% of share capital, and individual direct shareholdings, making up 16%. This shareholding structure ensures that the employees are deeply invested and actively involved in the business operations of ErreDue. It should also be noted that the Green H2 Holding has multiple voting shares (2 votes per share), so even if the shareholding would be below 50% they could still control the company.

Additionally, the Company's share capital includes several institutional investors such as Arca Fondi (7%), Axon Partners (5.3%), First SICAP (3.2%), or Chelverton (2.6%), leaving a free float of only 11.9%. 

There haven’t been high related party transactions with major shareholders or the management in the past and the compensation is also not exceptionally high with around EUR 140.000 for the CEO per year. A conflict of interest is not recognizable.

8. Financials

Erredue has a long history of organic, profitable growth with a revenue CAGR of 17 % (2016-2023), high margins, and a good cash flow generation.

Nevertheless, the sales revenues in H1 2024 declined slightly by 2.2% yoy, while the value of production was flat yoy. The reduction in sales was primarily due to two factors:

1. the postponement of generator deliveries at the request of purchasing companies (turnover of EUR 1 million)

2. a sharp slowdown in domestic demand in the traditional on-site generator sector for industrial activities, especially from the Italian automotive & textile sector

The first factor is just a temporary issue, the deliveries have taken place in the second half of 2024. Including these orders, revenues in H1 2024 would have been up by 10 %. The situation regarding the domestic demand is more difficult. In July 2024, the domestic (Italian) production reached its lowest point since the post-pandemic period (according to ISTAT). According to the management, the distrust generated by the current industrial crisis led to a postponement in the conclusion of new contracts. Due to that, the revenues generated in Italy fell by 11.6 %, while the revenues generated in the Rest of the World increased by 27 %.

Despite this significant slowdown, the turnover achieved in the traditional sector remained at a good level due to 3 factors:

1. the sale of laboratory generators, which due to their use are intended for so-called "counter-cyclical" markets (+13% in the first half of 2024 compared to the first half of 2023)

2. the growth in rents, which is less affected by the crisis as it is based on multi-year contracts (+8.50% in the first half of the year compared to the same period of the previous year)

3. the Aftermarket (+10.8 % compared to the first half of 2023) which is not directly connected to the sales of the period, but rather to the generators sold at any time as long as they are still active

In the hydrogen sector, on the other hand, ErreDue had a significant increase that derived from the green transition business. Sales of hydrogen products increased by 40 % yoy to EUR 4.8 million. Compared to that, revenues generated by hydrogen products have only been at EUR 1.8 million in H1 2022 confirming the growth prospects in this sector. In addition to the good increase in turnover in the first half of the year, the company has recorded a significant increase in orders for generators to be delivered in the remainder of 2024 and even more in the next year.

The slowdown in the industrial demand was particularly significant in the nitrogen sector (-58 % yoy). As the nitrogen products of Erredue have the highest margins in the product portfolio, this slowdown also affected the margins of the company.

The EBITDA was down by 30 % yoy (EUR 2 million vs. 2.8 million) with an EBITDA margin of EUR 25.7 % (vs. 35.9 %). The decrease in EBITDA can be mostly explained by three (temporary) factors:

1. postponement of large orders (amounting to EUR 1 million) where the costs for the production of these generators are fully included in the P&L of H1 2024, while the corresponding revenues are recorded in the second half

2. high R&D costs for the first prototypes of Megawatt hydrolysers which are fully expensed in the P&L

3. increase in the number of employees in view of the developments expected for the next few years

The EBIT decreased by 43 % (EUR 1.1 million vs. 1.9 million) with an EBIT margin of 14.3 % (vs. 24.4 %) while the net profit decreased by 32.8 % (EUR 1 million vs. 1.5 million) with a net profit margin of 11.5 & (vs. 17 %).

The management’s optimism for the coming years is underlined by the total backlog of EUR 24 million (compared to revenues of EUR 16.5 million in 2023). Approximately 35 % of the backlog refers to H2 2024 (EUR 8.4 million) and 65 % to 2025 (EUR 15.6 million). According to the management, the green transition business is able to fill the gap of the temporary slowdown in the traditional business to be in line with the analyst’s targets for 2024. In January 2025, the management indicated that they have the perception that the manufacturing industry has restarted by looking at the current backlog and that they are confident for 2025.

The operating cash flow on the other hand increased from EUR 1 million to EUR 2.2 million yoy (+113 %), showing the strong cash generation capabilities of the business. The net financial position of the company increased by EUR 1 million to EUR 17.3 million (37 % of the current market cap).

The ROIC decreased to 17 % (annualized) in H1 2024, compared to 28 % in 2023.

9. Valuation

ErreDue has a market cap of EUR 44 million and an enterprise value of around EUR 26 million thanks to its net financial position of EUR 17.3 million.

Despite the slowdown in the traditional business, the management is confident to reach the analyst’s targets for 2024, thanks to the acceleration in the green transition business. The robust order backlog could even mean that they could beat the analysts' targets for 2025. The analysts (consensus of 2 analysts) are expecting revenues of around EUR 18.1 million (-6.3 % yoy), EBITDA of EUR 5 million (-15 %), EBIT of EUR 2.5 million (-38 %) and net income of EUR 2 million (-41 %) reflecting the continues slowdown in the traditional business in H2 2024 hitting the profitability even more as these generators have higher margins compared to the large electrolysers as explained in the previous section.

Based on these forecasts, ErreDue currently trades at an EV/EBITDA multiple of 5.2x, EV/EBIT of 10.4x and EV/E of 13x. As it is likely that the company will spend most of its current cash position in the development/production facilities of large electrolysers, one could argue that a valuation excluding the cash position would make more sense as this cash will not be distributed to the shareholders and the returns on this invested capital could not materialize in the short(er) term. Based on the market cap, ErreDue currently trades at a P/EBITDA of 8.8x, P/EBIT of 17.6x and P/E of 22x.

Based on first recovery signs of the traditional business and strong backlog in the green transition business (EUR 15.6 million for 2025 at H1 2024), analysts are expecting revenues of EUR 27.7 million for 2025, an increase of 53 % compared to 2024. Since the publication of the H1 report, ErreDue has announced new contracts worth EUR 3.7 million, so around 70 % of the expected revenues for 2025 are already secured by the backlog at the beginning of the year. This jump in revenues is mainly related to the sale of large generators for the green transition. This combined with a return of sales for high-margin nitrogen generators, could lead to significant earnings growth in 2025, compared to the (depressed) earnings in 2024. Analysts expect an EBITDA of EUR 7.7 million (56 %), EBIT of EUR 4.8 million (+94 %) and net income of EUR 3.8 million (+92 %). For 2026, expectations are even higher, with growth expected at a similar pace, but due to the political nature of the green transition and the corresponding uncertainties, it makes more sense to evaluate the business prospects from year to year.

Based on these estimates for 2025, ErreDue trades on the following multiples:

• EV/ EBITDA of 3.4x and P/EBITDA of 5.7x

• EV/EBIT of 5.4x and P/EBIT of 9.2x

• EV/E of 6.8x and P/E of 11.6x

A peer group comparison with these multiples to most of the listed companies active in the hydrogen electrolyser market like ITM Power, Nel ASA, Plug Power, Enapter or McPhy Energy wouldn’t make much sense, as they are not even profitable on an EBITDA level yet. As the high profitability of ErreDue is mainly attributable to the more mature on-site gas generator business, it makes more sense to also compare the multiples with other (more mature) companies that are active in a comparable branch.

Even compared to these more mature & profitable companies, ErreDue stands out in terms of valuation, margin and expected growth.

10. Risks

Uncertain development of the green hydrogen market

Growth in the green hydrogen production and electrolysis and electrolyzer solutions sector is highly dependent on increased renewable energy production, continued political and industrial commitment and the development of an adequate global outlet market for green hydrogen, with the risk that the latter will not be able to establish itself as a competitive alternative, in terms of costs, to fossil fuel-based hydrogen and other energy carriers or will not be able to do so in the timeframe envisaged by the management. The development of the market is highly dependent on subsidies granted by governments or organizations like the EU to incentivize companies to make these large investments needed for a green hydrogen infrastructure. While many institutions and companies have already committed to invest in the market, it remains a highly political decision. And as we all know, political decisions can be revoked or at least the realization of the projects take much longer than initially anticipated. Donald Trump for example announced that he will stop the Green Deal and favors fossil fuels instead of (green) hydrogen. This is likely to hamper the investments in the USA in new hydrogen electrolysers and similar could happen in the EU or member countries in the EU. Erredue plans to invest a lot in a new “Gigafactory” for large electrolyzers. If the expectations of the management don’t materialize, the company will have large overcapacities.

Technological risks / Absence of patents

The green hydrogen market is exposed to competition from other technologies that provide decarbonisation solutions not necessarily derived from currently consolidated electrolysis technologies, such as, for example, the development of “blue hydrogen” solutions based on the reforming of natural gas and subsequent capture of the carbon dioxide produced (whose production technology is supported by companies in the Oil & Gas sector). Technological development may stimulate the adoption of a number of new technologies or improve existing technologies.

ErreDue is also working on new electrolyzation technology such as the AEM (Anione Exchange Membrane) electrolysis and improvements for the alkaline and PEM methods. In the past, ErreDue has shown, that its R&D department is able to deliver disruptive developments. However, the company has decided to not secure this know-how with patents. The absence of patents could lead ErreDue’s trade secrets to be copied or replicated by competitors. However, the company does not exclude to patent specific breakthrough components, e.g. new PEM catalysers, in the future.

Competitive pressure

Competition will likely intensify on the back of the sound investments expected to be channeled into hydrogen. Some players with deeper pockets than a small company like ErreDue may adopt aggressive commercial strategies leading to pricing pressure in the electrolysers manufacturing market. Moreover, the mature alkaline process, with relatively simple manufacturing and low capital costs, may allow new entrants to carry out Manufacturing and EPC services, therefore crowding the competitive arena. International competitors from countries with lower wages like China or India could probably offer large alkaline electrolysers at a fraction ErreDue’s costs. We have seen a similar development for example in the solar market, where initially European countries have been market-leading in producing PV modules, but over time, Chinese modules became so cheap that the whole industry in Europe died as they were not able to compete against these prices. The management of ErreDue is currently seeing at least three obstacles for Chines player to penetrate the European market:

• technological: Chinese electrolysers are not yet ready to be used on a production line that operates 24 hours a day, 360 day a year making them less reliable

• political: The EU Commission has set a cap of 25% of extra-EU technology to recognise incentives for projects

• economical: Exporting raw materials like iridium or palladium (needed for PEM electrolysers) is easier and more profitable for China now as these precious metals are very present in Chinese territory

Weak demand in the traditional business

A big part of the investment thesis for ErreDue is, that they have a traditional business, that was historically able to grow at a steady pace with high margins and cash generation. This significantly reduces the overall risks associated with the green transition market as described above. As we have seen in the results for H1 2024, part of this traditional business is cyclical and dependent on the economic situation in the industrial markets. If the industrial crisis, especially in the domestic Italian market continues, the sale of new generators will likely weaken further. On the other hand, ErreDue also has the counter-cyclical laboratory segment, and recurring revenues from the rental & after-service business. Especially the expansion of the rental business could become more interesting for customers during a longer economic trough as this allows them to directly save costs.

11. Summary

ErreDue is one of the very few companies able to capitalise on the huge H2 opportunity while remaining highly profitable. The traditional business grew steadily with double digits in the past and the various advantages of on-site gas generation will remain a tailwind in the coming years and continue to generate excess cash. This high-quality traditional business will act as downside protection for the risks that come with the high opportunities in the green transition business. There are political, technological, timing or execution risks. And some of these risks are beyond ErreDue's control, which makes them even more serious. Investing in a company that is solely reliant on a successful ramp-up in green hydrogen demand while generating huge losses in the meantime is a bet. For ErreDue, success in the green transition business is basically a free option as the downside is protected by the highly profitable traditional business and cheap valuation. The backlog already shows initial success in the new business and if ErreDue is able to reduce the costs for PEM generators by replacing rare metals with cheaper alternatives, the company would have significant advantages in their competitive positioning in the medium term. The mainly temporary hurdles in 2024 could present a good opportunity to profit from the potentially pivotal year 2025 for ErreDue.

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Welcome,

in this issue of Under-Followed-Stocks, I will present you Arcure S.A. ($ALCUR).

Investment Summary:

• pioneer in embedded AI for industrial vehicles

• benchmark solution for industrial safety and productivity

• named as one of Europe’s long-term growth champions

• huge untapped market potential

• 39 of the Fortune Global 500 are customers

• revenue CAGR of over 33 % since 2013

• high potential of further increasing margins

• H1 revenues +24.5 % & profit up >9x

• EV/ EBIT ‘25 of 9.7x

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1. Introduction

Arcure is an industrial pioneer in artificial intelligence (AI) solutions for enhancing the safety, productivity and autonomy of machinery. Its flagship product, Blaxtair®, sold more than 22,000 units in more than 50 countries and is today a standard in its markets, offering a cutting-edge pedestrian detection solution to improve safety around industrial vehicles used by world industrial leaders and gradually adopted by machine manufacturers. 39 of the Top 500 global companies are end customers of Arcure. This expertise is crucial for the robotics of the future, constantly striving to be more autonomous and synergistic.

With this in mind, the company’s development is based on three pillars: UNDERSTAND customer needs, INNOVATE to maintain a leading position and ESTABLISH A STANDARD for perimeter protection around machinery.

Arcure is listed on the Euronext Growth Exchange in Paris since 2019 under the ticker $ALCUR.PA. The current market cap is EUR 30 million (USD 32 million).

2. The Company

Brief History:

• founded in 2009 by Franck Gayraud and Patrick Mansuy, two engineers from the aerospace and defense industry, born out of a major need identified by industrial players and machine manufacturers: safety around vehicles.

• set up of a joint R&D laboratory in 2009 in the fields of vision & video recognition technologies with the CEA (French Alternative Energies and Atomic Energy Commission), the INRS and manufacturers

• after having the first Proof of Concept (POC) models with customers such as Alcan and Eurovia the series production of the first generation of Blaxtair started in 2012

• In September 2014, Arcure signed its first OEM partnership with SICK, one of the world leaders in industrial sensors and automation for the development and production of Visionary-B, a 3D vision solution for the outdoor automation segment. At this time, Arcure was already active in 15 countries.

• In 2016, the Blaxtair solution was validated and integrated by Jungheinrich, the world’s 3rd largest manufacturer of forklifts.

• Continuous R&D resulted in a third generation of Blaxtair in 2017, which was more robust and compact and had significantly lower production costs. At this time, Arcure was already active in 30 countries.

• After the IPO in 2019, the company expanded to North America with a new subsidiary in Chicago. This strategic location in the United States represented a strong development potential for the company, as more than one in ten forklifts are involved in an accident every year in this territory.

• In November 2020, Arcure expanded its product range with Blaxtair Connect. The Blaxtair Connect dashboard allows users to quantify and locate accident risks so that action can be taken before they happen. In 2023, Arcure released further additional features like Blaxtair Zoning & Checklist

• In May 2024, Arcure presented the fifth generation of Blaxtair with onboard AI that allows the easy addition of numerous functionalities, à la carte, by simple download. The Blaxtair offering now includes a broad portfolio of software solutions to improve safety and productivity in the industry

Nowadays, Arcure is a global company, active in over 50 countries via local distributors and an internal sales force (Europe & North America). 81 % of Arcures revenues are generated outside of France.

Among its customers are world-leading companies like Arcelor Mittal, Linde, Jungheinirch, Still, Liebherr and many more. Over time, the Blaxtair solution has become the standard solution in its market. The management estimates Blaxtair’s market share at around 80 %.

Multiple awards have already been given to the company in recognition of its technological leadership. The professional association for the construction industry in Germany (BG BAU) for example, has published an information sheet regarding the requirements to get subsidies when a company aims to implement a camera-based pedestrian detection system. The only mentioned solution in this sheet is Blaxtair.

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3. Technology & Products

Technology

The company has developed cutting-edge technology, the result of nearly 10 years of development, designed for the extremely harsh environments that equipment on board of industrial vehicles operating in the most demanding conditions may encounter. The first generation of Blaxtair was based on a machine-learning algorithm (developed in partnership with the CEA) and a robust stereoscopic camera, whose performance remained limited (detection distance of 5 meters maximum, basis of several tens of thousands of data).

Over time, the exploitation of the database from Blaxtair's fleet in operation with customers (more than 22,000 currently) and the improvement of its proprietary algorithms in the field of AI have made it possible to considerably improve the performance of products over generations, to raise barriers to entry and to distance themselves from competitors whose offerings struggle to be relevant. The barriers to entry that protect the Group reside in the construction of the learning database, the iterations that exploit it and the programming of the neural network. Especially the large database that neural networks can be trained on, represents a unique asset. Data mining work (construction of the learning database) requires strong expertise, which is fundamental to constitute a sufficiently diversified and non-redundant database so that the algorithm can extract generalizable criteria and avoid it being oriented towards overly specific criteria, which would distort the analysis and constitute "overfitting".

Arcure has gathered data for nearly 15 years from private industrial sites worldwide. This is completely different from data that you can openly access. The typical “AI” that we currently use like ChatGPT, is mostly trained on open information from the Internet. The algorithms for autonomous vehicles like Waymo are based on data gathered on the open street, which everyone can access. This makes it easier for potential competitors to gather a similar database. Getting a similar database from private industrial sites is much more difficult for potential competitors of Arcure. And that’s also the reason why Arcure focuses on its “industrial niche” and will not try to develop solutions for “normal vehicles”.

In 2022, Arcure moved from “Machine Learning + Stereovision” to “Deep Learning + Monoscopic Vision”, with very extensive performances (up to 15 meters distance) and at the same time massively reduced production costs. This AI camera can detect and precisely locate pedestrians in real-time, in any posture (standing, crouching, or hidden) and in all the most demanding work environments. The latest Blaxtair version has been released in April 2024. This fifth generation of Blaxtair has onboard AI, the true technological heart of the vehicle, allowing the easy addition of numerous functionalities, à la carte, by simple download. The Blaxtair offering now includes a broad portfolio of software solutions to improve safety and productivity in the industry.

Products

Blaxtair Pedestrian Detection

This is the core solution that Arcure offers. They developed the Blaxtair technology and AI cameras to save lives, with the goal of zero accidents at industrial sites. The solution has the following features:

• Improves safety, working conditions and productivity

• Prevents collisions between industrial machinery (reverse and forward) and pedestrians

• Avoids unnecessary alerts that tire the driver

• Control & reduction of accident risks thanks to the integrated Blaxtair Connect

• Future-proofed: online maintenance & remote software updates

• Scalable: ready for future additional features or cloud services

In the video below, you can see how the solution works (the video is based on an older Blaxtair version).

Around this core solution, Arcure has developed additional features that complement the aim of zero accidents and simultaneaously increase the revenue per customer with optional recurring revenues.

Blaxtair Connect

The Blaxtair Connect dashboard provides access to relevant metrics and hot-spot mapping to enable occupational health and safety managers to take proactive action every day to drastically reduce the risk of machine/pedestrian collisions. The solution allows you to manage a fleet of Blaxtair systems, identify danger zones and actively prevent accidents. It helps to decrease the machinery/pedestrian coactivity on sites by at least a factor of three and measures the effectiveness of the preventive actions implemented.

Blaxtair Checklist

The 'Blaxtair Checklist' solution allows the operators to create a checklist on a tablet before starting their vehicle. It strengthens personal safety, improves the availability rate of machines, and optimizes maintenance. Upon start-up, the Blaxtair Checklist ensures the safety and proper functioning of the machine through a series of questions. The responses are stored directly in the cloud, and in the event of noncompliance or malfunction of the machine, maintenance is notified, and the start-up of the machine can be limited or prevented. This functionality is sometimes mandatory, particularly in North America because it is imposed by the Occupational Safety and Health Administration (OSHA).

Blaxtair Zoning

The Blaxtair Zoning technology automatically reduces the speed of vehicles entering high-risk areas, such as:

• areas with high vehicle/pedestrian co-activity

• narrow aisles

• dangerous intersections

• doors

When a vehicle leaves these risk zones, normal speed is automatically applied again, guaranteeing optimal fluidity of operations. By integrating Blaxtair Zoning, businesses can not only create a safer work environment, they can also optimize their operations for better overall efficiency.

Blaxtair Vehicle & Obstacle Detection

By going beyond pedestrian detection, Blaxtair detects and localizes vehicles & specific obstacles around one another, thus guaranteeing more complete collision prevention.

Blaxtair Shock Detection

The ‘Blaxtair Shock Detection’ solution makes impacts visible and traceable. Equipped with an inertial sensor, it detects and localizes impacts in real time and transmits critical data to Blaxtair Connect. It allows each impact to be tracked, specifying their exact location, detection times, vehicles involved and the severity of the impacts. Additionally, visual evidence such as photos and video footage of the incidents are provided for in-depth analysis. By cataloging and evaluating every impact, even the most minor ones, companies can prevent more serious problems, significantly reduce the risk of equipment damage, and improve overall safety. Blaxtair Shock Detection provides unprecedented visibility and indicators to optimize operations and enhance the safety and reliability of vehicles and facilities. It also enables proactive management of any impact as soon as it occurs, providing increased peace of mind.

4. Business Model

Arcure is selling its products via dealers and distributors (62 % of revenues), direct sales to end users (14 % of revenues) and OEMs (24 % of turnover).

Arcure offers its “After-market” Blaxtair solutions to the end users and dealers/distributors. This is a range of tailor-made solutions to be installed on-board equipment. This means that the customer already has a certain industrial vehicle like a forklift and now wants to equip the fleet with a pedestrian detection system, for example. On the other side, Arcure has developed a range of tailor-made software bricks for the technological roadmap of manufacturers. This allows, for example, the forklift manufacturers to directly embed Blaxtair software into their newest forklifts. For example, when ordering a forklift from Jungheinrich, you can choose Blaxtair as a factory option.

The innovative nature of Blaxtair leads to a relatively long sales process despite its limited price in relation to the value proposition in terms of safety and productivity, which is often explained by the complex organisation of these large groups that are Arcure's customers.

While the initial sales cycle is quite long, Arcure on the other side has very low visibility on the final orders. Delivery plans are based on oral commitments made by customers and on probability approaches. The order book typically has a low level (around 6 weeks) and relatively short delivery times (2–3 weeks after receipt of the order). The average effective selling price of a Blaxtair is around EUR 3,600, which ultimately weighs little in the overall cost of the machine (EUR 15,000–20,000 for small forklifts and up to EUR 1 million for the largest). The product life cycle is mainly linked to the operating duration of the equipped machines. For a typical forklift, this is probably around 6-7 years.

The manufacturing of the hardware components of Blaxtair is subcontracted to third-party suppliers as Arcure wants to focus on the development of the technology. The company significantly reduced the hardware components needed from generation to generation, resulting in higher gross margins.

5. Market, Customers & Competition

Market

Arcure’s technology addresses the risks associated with industrial vehicles. Thus, various industrial sectors globally like logistics, transport, mining, defense, energy, chemistry, metallurgy, construction and many more are their potential end markets. According to the management, the company is not heavily dependent on one of these sectors alone.

Historically, the primary end market was the construction sector, as the initial products were mostly installed in construction vehicles. However, over time the forklift market has grown considerably and is now the primary market for Blaxtair. Forklifts of all types are used in nearly every industrial company, so the potential end market is high.

According to Statista, the global forklift truck market size is expected to grow with a CAGR of ~7 % from 2022-2030.

According to the company, around 1.4 million forklifts (excluding China) and 0.9 million construction vehicles (excluding China & India) are produced every year and can potentially be equipped with intelligent perception systems like Blaxtair. The management is estimating that currently only ~0.5 % of this fleet is equipped with such a system, leaving a high potential for further growth and achieving more security for the staff.

But why should companies invest in such systems at all?

According to the OSHA (Occupational Safety and Health Administration) forklift accident statistics, approximately 11 % of forklifts are involved in some kind of accident each year and 25% of workplace transport injuries are the direct result of forklift truck accidents. In the US alone, there are around 35,000 to 62,000 injuries every year related to forklifts and 85-100 workers even die as a result of such an accident. The average cost of workers’ compensation claims is USD 41,003 and the average cost per OSHA safety violation is USD 13,494. So each prevented accident saves the company money.

Customers

As already mentioned, 39 of the Top 500 global companies are end customers of Arcure. But many more large companies across mutiple industrial verticals are trusting Arcure’s solutions. You can see some of the largest end customers in the picture below like Coca-Cola, Nestlé, Renault, Arcelor Mittal, Nippon Steel, Vinci and many more. Besides these large end customers, some of the largest OEM’s are also trusting Arcure like Jungheinrich, Liebherr, Manitou, SICK, Kalmar or Still.

Competitors

As a specialist in artificial intelligence applied to image processing to increase the safety around industrial vehicles, Arcure is active in a relatively niche but emerging market. With over 22,000 installed systems, the company sees itself as the clear market leader in its niche, with an estimated market share of around 80%. According to the management, the competitive landscape is emerging, but they are (yet) not reaching the same level of performance. The company mainly observes local distributors of cheap Asian solutions on the market. In addition, some OEMs are also trying to develop proprietary solutions, so far without success.

Most of the “cheap” solutions are based on devices, that every worker/pedestrian has to wear, like wristbands/tags that communicate with the vehicle as soon as both are close to each other. Then either the vehicle stops or the device is alerting the worker. This is a simple way, but not comparable with “real machine vision” that Arcure offers. Once a worker forgets to wear his device, the solution doesn’t work anymore. Below you can see different technologies that are used to avoid collisions ranging from device/badge detection to a “normal” camera or microwave/laser detectors that can’t distinguish between humans and obstacles.

But of course, competitors exist that are offering similar technological solutions like Blaxtair. For example DotNetix with its Safeye & Argos solution. The Safeye solution looks like one of the first generations of Blaxtair, while the Argos solution more looks like the newest monoscopic Blaxtair generation, but offers reduced capabilities like a lower detection range. In addition, it seems like DotNetix is more focused on the mining vehicle market. Other pedestrian detection systems based on “AI cameras” for forklifts can for example be found from FTC safety soltions or AiVA but the informations that can be found on these products also indicate that the capabilities are lower compared to Blaxtair.

Nevertheless, there is definitely competition and Arcure will have to further invest in R&D to stay ahead of the competition by increasing the accuracy of their system, reducing the costs & offering additional features and functionalities. As soon as the adoption of advanced pedestrian systems increases competition will heat up.

6. Growth Drivers & Catalysts

Expanding the (international) customer base

Although Arcure is already generating 81 % of its revenues outside of France, the company is still seeing a lot of opportunities in the expansion of its international customer base. As part of their efforts to increase their international presence, Arcure opened a new office in Barcelona, Spain with a sales, marketing and R&D department. With 53 % of revenues, Europe (excluding France) is the largest market for Arcure (especially Germany/Austria with 29 %). The second largest market is North America with 21 %, but the market is currently growing faster with 34 % yoy and Asia has a share of 7 %. So especially in North America, there is a lot of potential for further growth.

What helps Arcure is also that most of its customers are multinational companies. Once they have tested and equipped their fleet with the Blaxtair solution in one country and see its benefits, there is the potential that this customer will roll out the solution on its global fleet. Such a partnership has recently been signed with Arcelor Mittal France. Initially, Arcelor Mittal equipped several hundred industrial machines in North America and Europe with Blaxtair’s pedestrian detection solution. Arcelor Mittal was happy with the results, especially the exceptional performance, including its ability to detect pedestrians in difficult conditions, as well as its connected solution Blaxtair Connect and thus decided to extend the use of Blaxtair to its entire fleet. The final equipment of this fleet of vehicles is in the hands of each subsidiary and each site in the world, so Arcure hasn’t published any exact numbers, but the potential is immense. At the Florange site of Arcellor alone, there will be 200 forklifts equipped by the end of the year and they will also equip multiple Canadian sites this year.

Increase revenue per customer

After building a larger customer base and building a market leading position, Arcure has expanded its offering with new functionalities around its core Blaxtair product. Some of these high-added value solutions, like “Checklist” are even mandatory in certain countries. Once a vehicle is equipped with Blaxtair, Arcure can easily expand the functions of the system without high initial integration costs for the customer. The share of sales for services increased by 45 % in 2023. As these additional features don’t need further hardware, these sales also have a higher margin profile compared to the initial hardware-based Blaxtair sale which contributes to the structural improvement of the companies profitability profile.

Regulations & ESG

As already mentioned, there is a legal requirement for the “Checklist” solution in the US. Other countries may introduce similar regulations or even additional ones to increase the safety of the people. But even when it is not mandatory, there is an inherent interest for the companies to avoid accidents at their industrial sites. Every accident costs the company real money as the workers are absent for some time after an accident. In addition, ESG (Environmental, Social, Governance) criteria become more and more important for companies. Part of the “Social” goal (8.8) is also to promote safe and secure working environments for all workers.

Improved Margin

Thanks to the continuous innovation and development of Blaxtair, Arcure was able to significantly reduce the hardware costs and ultimately improve its gross margins. Since 2021, the gross margin increased from 49 % to 58 % in H1 2024 as the newer versions of Blaxtair became the main growth driver. In H1 2024, the company still delivered a substantial volume of older Blaxtair 3 orders as a large European customer ordered them in advance for their needs and spare parts for 2024-2025 before Arcure will end the product life of this old version in H2 2024. In contrast, the newest Blaxtair generation will start selling during the second half of 2024. So one can expect that the share of newer (high-margin) generations will be even higher in H2 which should positively impact the overall gross margin.

Besides the improved gross margin, the new generation of Blaxtair has another advantage for the companies margins. The older versions were still based on “older” algorithms that were initially co-developed with the CEA in 2009 and Arcure has to pay royalties to CEA based on the product volumes sold that use this technology. In 2023, Arcure paid EUR 328,000 to CEA as license costs while only generating an operating profit of EUR 957,000 (excluding CIR tax credits). So when Arcure would not have to pay these royalties, the operating profit would have been over 30 % higher in 2023.

The good thing is that the new Blaxtair generations no longer use the old machine-learning algorithms that are covered by the license agreement with CEA. Arcure has developed proprietary deep learning algorithms, and thus the new versions are based on purely Arcure technology. The end of the sale of versions Arcure has to pay royalties on is planned for 2025. So the licensing costs should significantly decrease in 2025, and then finally end in 2026 which will further contribute to the companies margins.

But the biggest impact on improved future margins is a bigger share of OEM software sales. The company has developed a tailor-made software bricks portfolio for OEMs and as you can imagine, these software sales have a much higher margin compared to hardware sales. In the past, Arcure was already able to significantly increase its OEM sales. In 2023, 20 % of revenues have been directly to manufacturers (growing by 26 %).

But these sales are still based on old agreements, where the manufacturers offer Blaxtair equipment in its factory setting on new vehicles. So in the end, Arcure is still delivering the hardware components to the manufacturer, who is then equipping the vehicle. In the medium term, it is planned that the hardware (camera etc.) is already implemented by the manufacturer (as part of their technological roadmap) and Arcure will only grant software licenses to use their technologies. Discussions and calls for tenders are underway with the main manufacturers, according to the company. In the report for the H1 results, the management stated that:

“Discussions of agreements with builders (OEM) and partners stepped up. These discussions will be our main growth drivers for volumes in 2025 and beyond.”

Digitalization of industrial sites

Vehicles & industrial machines are no longer “dumb”. As with everything nowadays, they also become connected and smart. The trend is clear that industrial machinery will be increasingly equipped with smarter features and functions to ensure greater safety, autonomy and productivity. With the recent hype in AI solutions, this trend has even accelerated.

This trend will probably not stop with “intelligent vehicles & machines”. Similar to Smart Home solutions, where you start with automating some basic things like automatically switching the lights off or closing the shutters and then you go on with window sensors, power measuring, etc. And ultimately you can manage that your dryer should only start when your solar system produces excess power. So you developed from smart gadgets to a real smart home. The same will probably happen at industrial sites, where we are now digitalizing vehicles, but in the end we want a fully digitalized industrial site. Thanks to Blaxtairs embedded AI, Blaxtair can produce digital twins from the industrial site thanks to the forklifts that are driving at the site and capturing real-time dynamic 3D recordings.

Takeover / Partnership with major industrial player

With ChatGPT, the AI hype has started and everyone realized how powerful real artificial intelligence can be. Since then, many “AI companies” have been acquired by larger companies. And of course, AI is also an important factor for industrial companies and manufacturers. So Arcure could be a logical target for an industrialist in this sector. According to the management, they are always in discussions with industrial groups that wish to strengthen their position in these areas. However since Arcure was still reliant on CEA technology in the past, an acquisition was not that interesting for these players. As this will change in the future, this topic could become more interesting. The management is recently often talking about partnerships with major industrial players. So it could also be possible that, for example, a large OEM could buy a bigger stake in Arcure or establish a joint venture.

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7. Management & Shareholders

Franck Gayraud is the Co-Founder, Chairman and CEO of Arcure. He began his career at Arianespace as a Project Manager, then became Program Manager at Sagem Défense Sécurité in 2001 before heading the Strategic Planning department until 2007. At that time, he became director of Airborne Optronics programs before co-founding Arcure in 2009 and leads the business development, international growth, communication and finance operations.

Jean-Gabriel Pointeau is the Deputy CEO & Director of Strategic Partnerships. He began his career in the aeronautics industry as a systems engineer and project manager at Thales and Sagem (Safran Group). He joined Arcure in 2013 to create and lead the Sales Department until 2022. He graduated from EMLyon’s Executive MBA program in 2018 and joined Arcure’s Executive Board in 2020.

Sabri Bayoudh is the Chief Innovation Officer. After his first job at CEA, he joined Arcure in 2010 and became Technical Director in 2012. After a decade of technical experience, he completed his education with an Executive MBA at HEC in 2020. With these technical and business skills, he created the Innovation Department, which he now heads.

The other Co-Founder of Arcure, Patrick Mansuy, is a non-executive Member of the Board of Directors. Together with his wife, he is also the largest shareholder of Arcure with a combined 13.04 % of the company. He no longer exercises any operational responsibility in the company since September 2023. It should be mentioned that he recently sold around 44,000 of his shares (around 5 % of his shares).

The second largest shareholder is Co-Founder Franck Gayraud with 8,19 % and other Arcure employees own around 2.34 % of the outstanding shares. CEA ( (French Alternative Energies and Atomic Energy Commission) who initially researched on the algorithms with Arcure, still owns 2.59 % of the company.

Other shareholders are A.T.I. SA with 5.36 %, Seven Canyons Advisors with 4.39 % and Odyssey Venture with 3.82 %. The free float is around 57.5 %.

8. Financials

Since its foundation in 2009, Arcure was able to organically grow its top line to EUR 18.2 million in 2023. The company grew with a CAGR of over 33 % from EUR 1 million in 2023 to EUR 18.2 millon in 2023. Arcure is named as one of the European long-term growth champions, a ranking published by the Financial Times that lists the 300 companies in Europe (private & publicly listed) with the highest disclosed CAGR over the 10 years to 2023. Arcure ranked 123rd in the overall ranking and 20th in the IT sector.

Especially since 2021, the turnover increased significantly and the company finally turned profitable in 2023.

In H1 2024, revenues increased by 24.5%, and EBIT turned positive from EUR -140,000 in H1 2023 to EUR +809,000 in H1 2024 with an EBIT margin of 8%. The net result benefitted from Research Tax Credits (CIR, subsidy for R&D costs) of EUR 465,000 in H1 2024 and EUR 371,000 in H1 2023. In previous years, this subsidy was included in the operating result (EBIT), but since 2024, the company has to include it in the income tax line of the P&L. That’s why you can see below the 2023 numbers as pro forma to compare them on a like-for-like basis. On a like-for-like basis, the net income increased by >9x in H1 2024.

It should also be mentioned that the H1 results are burdened by an increase in provisions for warranties of EUR 426,000. The increase in this provision is particularly related to the impact of a one-off customer service issue encountered with certain equipment from two suppliers on certain batches of equipment, totaling €426k. This provision covers the estimated retrofit and after-sales service costs. Although this type of event is part of the life of an industrial company, one could ideally assume that these should not be recurring costs. So if no additional events happen in the next year, one should expect margins to be even higher going forward, just by excluding these non-recurring costs. Excluding these additional (one-off) costs, the EBIT margins would have been around 12 %.

Self-financing capabilities net of fixed assets amounted to €1.1 million over the half-year. To be noted, the company has continued investing in R&D (-€1.2 million), which is necessary to maintain its technological leadership.

The contribution to the change in cash from the change in working capital amounted to -€1,5 million, related to an increase in trade receivables (-€0.8 million), in Research Tax Credit (CIR, -€0.5 million), inventories (-€0.8 million) and trade payables (+€0.6 million). The impact of financial expenses paid amounted to -0.1 million. The Company has also continued to decrease its debt steadily and viably (-€0.5 million). Therefore, cash declined by €1 million over the half-year. As of 30 June 2024, gross cash amounted to €2.7 million and financial debt totaled €7.3 million, which comprised a majority of long-maturity convertible bonds (2027). Post-closing, Arcure has secured two additional credit lines for €1.75 million to be cashed in the second half of the year.

Arcure has tax loss carryforwards of EUR 17 million in France and EUR 1.6 million in the US. So Arcure will not have to pay a lot of taxes in the near term on its profits as these can be offset by the tax loss carryforwards. Due to that, Arcure has capitalized deferred taxes of EUR 2 million, corresponding to an amount that has a high likelihood of being recovered over the short term.

The management expects that their working capital needs will be reduced as they will only have one product line starting in 2025 (with reduced hardware costs). They are currently not planning any financial operations on the market in the short term to raise money. However, they remain open to opportunities (like the already mentioned strategic partnerships with major industrial players) that would allow them to increase their operational capacities for future growth.

9. Valuation

Arcure has a market cap of EUR 30 million and enterprise valuation of around EUR 35.75 million (including new debt after H1 2024).

The management has recently confirmed its previous guidance of achieving (at least) EUR 20 million in revenues in 2024. As Arcure already generated EUR 10.1 million in revenues in the first half, this would leave (only) EUR 9.9 million for the second half. As already mentioned in the Financials section, the H1 results were burdened by one-off costs and that the adj. EBIT margin excluding these one-off costs would have been around 12%. As the share of revenues of the new Blaxtair generation with a higher gross margin should increase in the second half of 2024, it is likely that the margin will continue to improve in H2. Estimating that the margin will increase to 14 % in the second half, Arcure could generate around EUR 1.39 million in EBIT in H2 ‘24, just by achieving the minimum of the revenue guidance. Totalling H1 & H2, Arcure could achieve a normalized EBIT of EUR 2.62 million for the full year 2024. Based on this number, the company trades at an P/EBIT multiple of 11.4x and an EV/EBIT multiple of 13.6x. A multiple based on the net profit of the company would be even lower as the research tax credits are added at the tax level of the P&L since 2024. But as such subsidies are based on political decisions that may change, valuing a company without these additional (external) profits is more conservative.

Given the various growth drivers described in chapter 6 of this write-up, it is likely that Arcure will continue its growth path in the coming years. Although industrial companies will probably invest more in new technologies for the safety of their employees in the future, the current economic environment could hampen their willingness to increase these investments in the short term. To be conservative, one can calculate with (just) 15 % revenue growth in 2025 year-over-year, which is well below the historical growth rate. In 2025, the margin profile should continue to improve, as the newest version Blaxtair will be the primary product. Besides the better gross margin profile, Arcure will also not have to pay royalties for these new products. This aspect, combined with some scale effects could lead to an improved EBIT margin of 16 % in 2025, resulting in an EBIT of around EUR 3.68 million in 2025. Based on these estimates, Arcure trades at a P/EBIT of 8.2x and EV/EBIT of 9.7x for 2025.

Considering the huge untapped market potential, Arcure has the chance to continue to grow its top line with double digits for a long time, even if they lose some market share to emerging competitors. On top of that, there is the huge potential for the margin profile, if Arcure is able to sell its software products to the OEMs. In the IPO document of Arcure, they said that they could achieve EBIT margins of 25 % at revenues of around EUR 60 million, just by the new products with higher gross margins and some scale effects. Software revenues with even higher margins weren’t even included in these estimates. So a long-term EBIT margin profile of around 25% seems to be achievable for Arcure. One could start to make some estimates based on these numbers for the years after 2025, but the multiples one can calculate with conservative assumptions for 2025 already indicate, that the current valuation is not too demanding given the revenue & margin potential.

Arcure is active in a very small niche and the management is claiming, that they have around 80 % market share in this niche. So it’s not easy to find a suitable peer group and it would have been easy to pick some hyped AI stocks and compare them to the valuation of Arcure. This would probably not have been that helpful. But as the technology of Arcure allow the industrial vehicles to “see” obstacles, a comparison to some publicly listed companies in the field of “machine vision” could be helpful.

Even compared to this “not so hyped” group, the valuation of Arcure still looks attractive.

10. Risks

Low visibility of orders

As already mentioned, Arcure has a relatively short order book of just around 6 weeks. This makes it difficult for management to predict revenues and recognize orders' slowdown. Especially as the economic development in many European countries is currently uncertain and many industrial companies had to publish declining revenues, this could become a problem for Arcure. In uncertain economic environments, companies will not likely start new investments. So the business of Arcure is sensible for the current industrial situation, but due to the short order book, they will recognize this later, making it more difficult to react.

Competition

The competition in Arcure’s emerging niche will heat up. Manufacturers of industrial vehicles will further invest in digitalizing the vehicles they sell. In the world of artificial intelligence, data is the new gold and everyone wants to collect data to analyze & use it. For a small company like Arcure it will not be easy to always stay ahead of the competition, especially when competitors are large industrial players with much deeper pockets.

New technologies

The cheaper (Asian) solutions for pedestrian detection are mainly based on tags, that the workers have to wear, which is clearly a disadvantageous solution. But over time, these cheaper solutions could become better and if the results can be nearly as good as the Blaxtair solutions, customers could decide to safe some real dollars instead of getting a slightly better product.

Dilution

The company is not planning to raise money in the short term. But as previously explained, the current economic environment is uncertain and if some of Arcures major customers start to struggle, this will also affect Arcure. At the same time, Arcure will have to further invest in its R&D to technologically stay ahead of the competition. If Arcure is not able to increase its cash flow to cover its costs, the company will have to raise more money, as there is not much more room for additional debt. And if they have to raise cash during an economic downturn, this could result in heavy dilution for its shareholders.

Co-Founder selling shares

As mentioned, one of the co-founders (and currently the largest shareholder) has recently sold some of his shares (around 5 % of his holding). In September 2023 he left the active management of Arcure and is now just a non-executive member of the Board of Directors. Arcure is a microcap company with a market cap of around USD 30 million and very low liquidity. So if a major shareholder would continue to sell his shares, this would probably have a bigger impact on the share price. But it is good to see, that the other co-founder who serves as the CEO, hasn’t sold any shares. As always, there can be multiple reasons for selling shares.

11. Summary

Arcure combines nearly all aspects of a hidden champion with multibagger potential. It is a market-leading microcap in an emerging niche with a lot of growth potential, high-profile customers and increasing margins at a low valuation. As always, these high (potential) rewards are inherently connected with some risks. Europe is still the biggest market for Arcure and the economic development there is more than uncertain. This combined with the low visibility of orders can become a serious problem for Arcure and once the growth story is broken, it could be more difficult for Arcure to continue to fund their necessary R&D to keep the increasing competition at a distance. But Arcure is not a young AI startup funded by some VCs who wanted to participate in a new hype. Arcure’s developers have been able to adapt new technologies and significantly improve hardware for 15 years. The management has shown, that they are able to deliver consistent organic growth since 2009, even in economically difficult times. There is no reason why they should stop now.

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Welcome,

in this issue of Under-Followed-Stocks, I will present you Powersoft SpA ($PWS). ,

Investment Summary:

• high-quality hidden champion with a market-leading position in its niche

• patented technology that creates superior immersive experiences e.g. in the “Las Vegas Sphere”

• the biggest venues and most famous artists are among their customers like Taylor Swift, Lady Gaga, Coachella, Tomorrowland or the Wembley Stadium and Ferrari chose them for a partnership

• long history of sustainable organic growth as a result of continuous innovation

• a clean balance sheet with net cash and no long-term debt

• founders still own 75 % of the company

• Revenue growth of 44 % & EBIT growth of 68 % in 2023

• EV/EBIT of 9.3x & P/E of 13.8x

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1. Introduction

Powersoft is a global leader in the design and manufacturing of professional audio amplification technologies, advanced signal processing, unique transducer systems and software for the professional audio sector. Their products are used in fixed audio systems of venues like the Las Vegas Sphere or the Wembley Stadium and also in transportable audio systems for the most famous artists and festivals like Taylor Swift or Coachella. Powersoft is the creator of the world’s finest audio technology.

In recent years, the company has transitioned from a product company to a solution provider, expanding into vertical markets segment within the install sector and increasing its portfolio of offerings. This change allowed the company to grow fast and expand its margins. The company’s mission is to make inspiring, reliable and innovative products that shape audio frontiers while helping customers succeed.

Powersoft is listed on the Euronext Growth Exchange in Milan since 2018 under the ticker $PWS.MI. The current market cap is EUR 164 million (USD 181 million).

2. The Company

Powersoft was founded in 1995 by Luca Lastrucci, Claudio Lastrucci, and Antonio Peruch in a small garage in Florence, Italy - and since then the company hasn’t stopped innovating.

Powersoft is a pioneer in switched-mode technology. They mastered the design and development of a new Class-D amplifier that was able to deliver consistently reliable high power levels – something that had never been achieved before. The development of fixed frequency switching mode technology for professional amplifiers delivered many benefits to its professional products, including unprecedented low noise leakage, low crosstalk, and performance suitable for any power levels. This helped correct the overall industry perception that switched-mode power supplies were unreliable. Now, the technology is considered an industry standard. Using its own-patented technologies, Powersoft’s switching mode power supplies were also able to greatly reduce heat dissipation, and deliver back EMF (active recycling of the reactive energy from the loudspeakers), while easily handling heavy impedance loads.

As these examples demonstrate, Powersoft is constantly breaking new ground in terms of what is possible: it holds 44 patents, has meaningful manufacturing partners around the world, and also holds the keys to what will be possible in the next generation of audio.

Powersoft operates globally, with over 90 % of its sales originating in markets outside Italy. It maintains a direct and indirect presence in 110 countries across the globe.

Production activities are primarily conducted at company-owned plants in Scandicci, which employ approximately 140 resources. Additionally, partnerships with leading industry players in Bologna, Cortona, Gorizia, Modena, and Vicenza involve over 100 resources. The products are “Made in Italy”. The main activities involving R&D, technical support, marketing, sales, logistics, warehouse and corporate are all carried out in Italy.

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3. Products

Powersoft’s core products are amplifiers. As probably not everyone knows what an amplifier is and why it is necessary in a professional audio system, let’s first clarify this.

An audio system processes (transports, changes and/or stores) audio signals coming from a sound source (human voice, musical instrument or any phenomenon that generates an audio signal) and sends the output to human ears. The amplifier is at the heart of a professional audio system. It is needed to increase an audio signal voltage to a higher level at a low impedance to drive energy into loudspeakers.

A professional audio system differs from a home (consumer) system in many ways. A professional audio system is composed of different basic components:

• Microphone: It converts the acoustic signal coming from an acoustic source into electric analogue signals

• Head amp (HA): It is a microphone pre-amplifier, which amplifies signals generated by microphones before entering further electronic circuits

• A/D converter: It converts electrical (analogue) signals to digital data for further processing in digital audio systems

• LAN (Distribution Network): It is a collection of components used to transfer data from and to all physical locations in the audio system

• DSP (Digital Signal Processors): They are used to perform real-time change and mixing of different audio signals

• D/A converter: It converts digital audio data to electrical (analogue) signals to be sent to power amplifiers

• Amplifier: It increases an audio signal voltage to a higher level at a low impedance to drive energy into loudspeakers. Modern power amplifiers use high-frequency switching output stages to directly drive loudspeakers (class-D). Some power amplifiers have distribution interfaces, DSP (for speaker processing) and D/A converters built-in. There are two main types of amplifiers: rack and module. Rack amplifiers are stand-alone and usually mounted on a rack. Module amplifiers are integrated with loudspeakers in one product

• Loudspeaker: It converts electric signals into acoustic signals. High-quality loudspeaker systems use multiple transducers to generate a combined acoustic output, each delivering a separate frequency range. Loudspeakers integrated with module amplifiers in one product are called active speakers and differ from passive (non-integrated) speakers

Powersoft offers a broad range of different amplifier modules for active loudspeakers and rack amplifiers for passive loudspeakers. Over the years, Powersoft’s engineers have added multiple new innovative features to the products.

Their latest development is the cloud-based amplifier platform Unica. Unica represents the next-generation amplifier platform designed to deliver unmatched performance and flexibility. It combines high-quality amplification with advanced DSP capabilities, providing users with exceptional sound reproduction and control. The cloud-native connectivity allows remote monitoring of the amplifier status from any device, anywhere in the world, via Powersoft’s Cloud Platform MyUniverso.

Besides the different amplifiers, the company also offers different controllers for the amplifiers, a gateway, a safety multimedia device (a high-powered speaker with a camera and multiple sensors) and transducers.

Especially the new “Mover” Transducer is a highly interesting product. The Mover is a patented low-frequency direct-drive/tactile transducer designed to kick the listener’s butt. Mover lets audiences feel the sound through haptic perception by vibrating the surrounding environment, which the human body picks up and, through bone conduction, stimulates the inner ear, translating the vibrations into perceivable frequencies.

A key component of The Las Vegas Sphere Experience that makes audiences feel like they’ve been transported to another world are Sphere’s 10,000 haptic seats that are integrated with Powersoft’s Mover technology. Powersoft’s patented moving-magnet technology is more durable, accurate, and efficient, relying on an audio signal with ultra-low-frequency reproduction to make the chairs vibrate and shake as desired for each performance. These immersive experiences are currently getting traction, but more on this topic in the “Growth Driver” section of this write-up.

4. Business Model

Powersoft has a flexible business model that mixes internalized and outsourced manufacturing. All the research, design and development is done in-house.

The group's internal production activity consists of the assembly of components and semi-finished products at its factory located in Scandicci (Florence) following the “lean” methodology. Once the assembly phase is completed, the products go through quality control. It consists of testing the finished product carried out by qualified operators, through the use of measuring equipment designed by the Group. The production process is managed internally by the Group for higher-added value products to protect the company know-how.

In parallel, the Group makes use of strategic partners for the production of both semi-finished and finished products, which allows mitigation of the production risk, as well as the possibility to adjust the overall production volume according to the market needs. In particular, for the production of components and for the production of finished products, modules and multimedia units, the group makes use of partners specialized in EMS (Electronic Manufacturing Services). Roughly 60% of finished products are assembled by themselves, while the remaining 40% is assembled by specialized partners.1

Most of the revenues are generated via direct sales. This includes sales generated by the 100% owned distribution company in the US, by key accounts (large clients served with Powersoft’s branded products) and by OEM’s (mainly related to white label module amplifiers sold to active loudspeaker makers) and also via E-Commerce. In addition, the group makes use of an articulated network, coordinated by area managers, of authorized distributors, to sell its branded products in a specific geographical area.

5. Market, Customers & Competition

Powersoft is active in the high-end professional audio market. In this niche, they are globally recognized as a market setter of cutting-edge products.

With these high-quality solutions, Powersoft is targeting a variety of end markets like stadiums & arenas, theme parks, hotels & resorts, malls, cruise ships, houses of worship, cinemas and many more.

Looking at the list of customers, we can see that Powersoft already serves the “who is who” of the audio industry. We have artists like AC/DC, Beyoncé, David Guetta, Ed, Sheeran, Drake, Elton John, Eminem, Jay-Z and Taylor Swift. We also have the biggest festivals in the world like Tomorrowland, Burning Man, Coachella, Eurovision Song Contest, and Lollapalooza. But also in the fixed installations segment, the biggest venues & companies are their customers like McDonald’s, Burberry, The Sphere, Allianz Arena, Staples Center, Wembley Stadium, Google Campus, Dortmund Stadium or Domino’s Pizza. And that's just the tip of the iceberg.

The overall global professional AV (Audio Visual) Market is expected to reach a market size of 8 billion USD by 2032, growing with a CAGR of 8.2 % between 2022 and 2032.2

This of course includes segments where Powersoft is not active. The company expects that their targeted end-markets for installed applications will reach 1 billion Euro by 2030.

Powersoft is active in a highly fragmented industry. With an estimated market share of 7 % in their core market of rack amplifiers, they are one of the market leaders.

The German IcePower group and Danish player Pascal are mainly producers of professional module amplifiers. Other competitive brands are part of larger multi-brand conglomerates, including the Swedish Lab.Gruppen (acquired in 2015 by the Philippian group Music Tribe) and Crown (part of the US group Harman, acquired by Samsung in 2016). Other competitors are large mono-brand integrated groups, including Bose Professional, Panasonic, Yamaha, Ashly and QSC. Below you can see a summary of the competitive landscape:

Some of the market companions are competitors and clients of Powersoft at the same time, which is often an indicator that a company has a unique positioning in the market. Recently, Powersoft has for example signed a partnership with Bose Professional to develop the new Bose Professional PowerShareX series of amplifiers.

In February, Powersoft has signed another very interesting partnership with Ferrari, bringing together Italian excellence in acoustic innovation and automotive engineering. The partnership aims to develop solutions enhancing the Ferrari brand's audio experience while minimizing energy consumption and offering benefits in efficiency, reliability, and sound quality. That such a well-known and high-quality brand like Ferrari has chosen Powersoft is another sign for their unique & qualitative products & innovations. One of the reasons why Ferrari has chosen Powersoft is that their technologies stand out for their significant reduction of heat dissipation, recycling of reactive energy from speakers, and installation flexibility, thanks to the remarkable weight/power ratio. Powersoft products will likely be implemented in the new fully electric Ferrari models, which will have an “authentic sound” according to Ferrari executives. This is why they created an intricate system of auditory feedback devices that use the genuine sounds of the vehicle's motors and aero to create its roar. Powersoft’s expertise certainly plays an important role in the development process of this unique system.

6. Growth Driver

International Expansion: Although Powersoft is already a global company, they still see huge opportunities in geographical expansion, especially in the US, China, Japan and Middle East. China and US are expected to account to over 40 % of the professional rack amplifier market by 2025.

In January 2023, Powersoft has strengthened its US organization by appointing Thomas Howie as a new Business Development Manager who is a highly regarded professional, and brings over 15 years of experience in developing and managing vertical markets within the large sports installation and theme park industry for top-tier brands.

In July 2023, Powersoft opened a representative office in Tokyo to accelerate business penetration in Japan.

In August 2023, Powersoft announced the reinforcement of its team in China by appointing Miao Wang as Solution Engineer and relocating to the new offices in Beijing. Moving the representative office from Shenzhen to Beijing confirms the Group's strategic decision to strengthen its presence in the People's Republic of China, offering a more extensive and timely response to market needs.

In August 2024, Powersoft strengthened its global presence with 2 new business development managers for the Chinese and Southeast Asia markets and 3 solution engineers for the Chinese, UK & US market.

We can see that Powersoft is currently working on improving its international presence. This geographical expansion is strategically tailored to encompass markets experiencing rapid growth in the demand for advanced technology solutions.

New technologies: Powersoft became a global leader in professional audio amplification thanks to strong R&D and continuous innovation. Since the three founders started with their first innovation in a small garage in 1995, they continuously added new technologies and products. They haven’t stopped at amplifiers, they also developed completely new products like the “DEVA” multimedia device or transducers and their own software (Armonia Plus) and cloud solution (MyUniverso).

The R&D Director Claudio Lastrucci has international recognition as winner of the Innovation Awards in the Industry Influencer category. Several company products have received sector awards. Powersoft also launched its own growth incubator/accelerator Ideofarm dedicated to supporting new creative projects, and future development of innovative technologies. With Powersoft’s focus on developing extremely energy-efficient products, they also meet current expectations of more eco-friendly companies.

Now that Powersoft has transformed from a product company to a solution provider, they are more directly in exchange with their partners & customers. They will know even faster what their customers need to create even better (audio) experiences. So after nearly 20 years of continuous innovation, one can expect Powersoft to continue to innovate the industry.

New verticals/partnerships: Powersoft hasn’t just changed from a product company to a solution provider, they also expanded their addressable market from large installation to small(er) commercial installations. The company launched Dynamic Music Distribution, a suite of hardware (“Mezzo” series amplifiers), software (Armonia Plus, mobile app for remote control) and additional tools (internally developed wall mounted remote touch controls) designed to offer system integrators and installers an integrated solution for smaller venues in 4 identified verticals (hospitality, retail, higher education, places of worship) and other corporates verticals. This platform offers system integrators key advantages like (i) reduced installation time, (ii) reduced cable runs, (iii) less equipment, (iv) simple setup and less time to learn and configure the system. Powersoft can leverage on its current distribution network to push the new solution.

Since introducing this solution in 2021, Powersoft has already been able to sign contracts within a variety of verticals and they continue to find new ones where they can implement their products. For example, the partnership with Ferarri opens the automotive sector as a new vertical for Powersoft, which they hadn’t even thought about when they introduced this series. Another example is the agreement they signed with Vega Global, a leading name in Digital Workplace solutions in audiovisual, video conferencing, and collaboration technologies, to supply professional amplifiers to expand and strengthen the audio solutions it offers to end customers. Every location where people hear music via loudspeakers is a potential vertical for Powersoft.

More Software & Cloud services: Powersoft has already developed proprietary software solutions like Armonia Plus, Pro Manager Plus, and the Sys Control App for audio engineers to easily design and configure their audio system. With the MyUniverso Cloud solution, the audio engineer can upload their audio projects into the cloud, allowing Powersoft to carry predictive maintenance and remote diagnostics activities. This is key to have more visibility on the installed base of amplifiers, to develop potential direct to customer upselling and cross-selling activities, and for the development of aftersales and warranty extension business. Powersoft plans to increase their offering of cloud-native IOT products and software-based services in the future.

(Immersive) Experience Economy: Millenials are more interested in experiences rather than goods. According to an Eventbride Study, 78 % of (US) millennials would choose to spend money on a desirable experience or event over buying something desirable, and 55% of millennials say they’re spending more on events and live experiences than ever before. Nearly 7 in 10 (69%) millennials experience FOMO. In a world where life experiences are broadcasted across social media, the fear of missing out drives millennials to show up, share and engage.

And this Forbes article suggests, that the GenZ will continue with this trend:

Of the people surveyed, 93% plan to visit attractions at the same or greater level in 2024 when compared to 2023. Of note is that 50% of Gen Z and affluent visitors plan to go to even more attractions than they did this past year, making them the two groups with the most positive sentiment heading into next year.

The gigantic hype around Taylor Swifts “Eras Tour” is another indication. And the audio experience is a crucial part of any experience, so Powersoft will probably benefit from this trend.

The immersive entertainment markets is a submarket of the experience economy market, but it is one of the fastest growing. According to this study the market is expected to grow with a CAGR of 22.3 % from 2022 - 2032.

The market is still in its infancy. But with examples like “The Sphere” where people can now actually feel what real immersive entertainment is, it has the potential to emerge from its current niche market status. MSG is already in talks for other Sphere venues around the world and they will probably not be the only one. Below you can see an interesting video with Erik Hockman, the Mastermind and acoustic engineer of “The Sphere”. There he talks about the unique experience when you can actually feel the sound via bone conduction and why immersive sound and haptic seating is the next generation of entertainment. He also explains that they chose the Powersoft “Mover” over other solutions as it allows very very low frequencies which others can’t. This makes it possible, for example, to feel the swaying of a boat very well. On the other hand, very high frequencies are also possible, so that the spectrum is very large.

For true virtual realities, the user must be fully immersed in the new world. Ultimately, this will only be possible if they can actually feel what they are experiencing on their bodies. Immersive sounds bring the fourth dimension to this experience. For now this only an application for large venues and theme parks. But with a wider adoption of virtual reality glasses, this could become more and more relevant for the masses.

M&A: The sector of professional audio equipment is quite active in terms of M&A, with deals finalised by PE and industrial players. Below you can see selected M&A deals in the professional AV sector since 2010.

One of the reasons for the IPO of Powersoft was to use the proceeds for potential M&A targets. But since then the company hasn’t finalized any significant M&A deal. When large industrial conglomerates and PE funds are also bidding for potential targets, valuations are often not a steal. In addition, large acquisitions are often not that easy to integrate and often don’t have the synergies initially expected. The Powersoft management is long enough in this industry to know when they found a target that fits to them and can be acquired at a fair price. They are continuously scanning the market and acquisitions to gain market share or to diversify their product range is still an option.

On the other hand, Powersoft could also become a target of a large multi-brand conglomerate. However, as the founders still own over 75 % of the company, this would only be possible with their consent.

7. Management & Shareholders

Carlo Lastrucci is the Chairman of the Board of Directors. He has over forty years of experience as a top manager in the telecommunications industry. In 1998, persuaded by his sons to join the newly founded startup Powersoft, he embraced the challenge of becoming its President. Focusing on foreign business development, he immediately brought his vast experience and strategic vision, significantly contributing to Powersoft’s growth and international expansion.

The three founders of Powersoft are still active in the company. Luca Lastrucci is the CEO. With a degree in Electronic Engineering, a PhD in Artificial Intelligence applied to voice recognition and an MBA, Luca Lastrucci began his career as a researcher at Berkeley. As a co-founder of Powersoft in 1995, he led the software development until 2001, and then took on the role of CEO in 2011, focusing on the company’s expansion and organization.

Claudio Lastrucci is the R&D Director. He has been the Director of the R&D department from the start, showcasing his ingenuity in the fields of power electronics, audio amplification, signal processing, acoustics, and transducer design. His work propelled the evolution of the entire audio industry, his extensive patent activity underscores his constant dedication to research and development, and numerous international awards and recognitions attest to his broad impact in the professional audio industry, reinforcing Powersoft’s reputation as a high-value brand and hotbed for technological development.

Antonio Peruch is the Cost Assessment & Production Engineering Director. He has applied his skills in hardware design and the development of switching power supplies, significantly contributing to the engineering of the first Class-D amplifiers. His vision, integrating engineering innovation with economic acumen, reflects a commitment to efficiency and sustainability that enhances Powersoft’s competitiveness by producing technically superior and financially accessible audio solutions.

The major shareholder is Evolve S.r.L. with 75.65 %. Evolve S.r.L. is is controlled by the three founders Claudio Lastrucci (45%), Luca Lastrucci (45%) and Antonio Peruch (10%). So Powersoft is still founder-led and has management with high skin in the game. In Addition, Lorenzo Lepri, a non-executive director owns 3.11 %, leaving a free float of 21.24 %.

8. Financials

Between 2017 and 2023, Powersoft grew its top line with a CAGR of 13.7 % and its EBITDA with a CAGR of 26.5 %. Due to operational leverage, the EBITDA margin nearly doubled from 14.7 % to 28 %.

The most recent financial numbers available are the numbers for FY 2023:

• Total revenue +44.2 % (EUR 70.3 million)

• EBITDA +59.7 % (EUR 19.7 million)

  • EBITDA-Margin of 28.5 % (vs. 25.6 %)

• EBIT +68.1 % (EUR 16.6 million)

  • EBIT-Margin of 24 % (vs. 20.5 %)

• Net Profit +90 % (EUR 12.1 million)

  • Net Profit-Margin of 17.2 % (vs. 12.9 %)

As you can see below, over 50 % of revenues in 2023 were made in Europe as Powersoft was able to grow by over 70 % there. With 25 %, the North American market (NAM) is the second largest. In 2023, revenues decreased by 4 %. I could imagine, that the North American revenues have been influenced by the construction of the Las Vegas Sphere, which is probably one of the biggest venues equipped with Powersoft equipment. The Sphere has been completed in 2023. I could imagine that most of the deliveries of the audio equipment were already made in 2022 which would explain the consolidation in 2023 on a high level. The North American region is expected to grow again in 2024. With 18 %, Asia and Pacific (APAC) is also an important market for Powersoft, which grew strongly by over 70 % in 2023. The Middle East and Africa market (MEA) and the Caribbean and South American market (CALA) are significantly smaller with a share of 2.7 % and 2 % respectively, but both are growing fast with 70 % and 158 %.

In 2023, the operating cash flow decreased by 22.7 % from EUR 8.2 million to 6.3 million, mainly as a result of higher working capital needs due to the high growth. Powersoft has relatively low Capex needs, resulting in a good free cash flow conversion. There is no need for external capital fo fund further growth. Powersoft has a sound balance sheet with a net cash position of EUR 17.8 million and no long-term debt. In addition, the company is paying a dividend. In 2023, they paid EUR 0.82 per share, resulting in a dividend yield of around 6 %.

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9. Valuation

For 2024, it is expected that the company will grow its sales by 13 % while the EBIT is expected to stay nearly flat due to an expected additional personnel expansion to support higher expected business volume. For 2025, sales are expected to continue to grow by 13 % and EBIT will return to grow by around 16 %.

Powersoft’s management doesn’t publish specific guidance for 2024. In the annual report it is only noted, that the year 2024 began on a positive note, marked by the prestigious partnership with Ferrari and the launch of the new “Verso” gateway device. On September 25, Powersoft will publish its H1 2024 results an we can see how the company performed so far this year.

Based on the results for FY 2023, Powersoft is currently valued at the following multiples:3

• EV/EBITDA of 8.8 x

• EV/EBIT of 9.3x

• P/E of 13.8x

This is below the mean valuation of 12.6x EV/EBIT and 20.4x P/E since the IPO, but it is also far away from its low.

As already outlined in the “Competition” section, Powersoft has no direct peers that are publicly listed. Other companies active in the professional amplifier market, are part of large conglomerates or private companies. This makes a peer comparison more difficult, but below you can see some companies that are also active in the professional audio sector. Although these groups are not involved in the same products as Powersoft, they are exposed to similar end markets.

I think the most comparable company is B&C Speakers. B&C is also a pure player in the professional audio market (but more with transducers instead of amplifiers), has a similar size and is also listed in Italy. Powersoft and B&C are valued at a similar level and both are expected to grow at a similar pace in 2024, but Powersoft (currently) has a slightly better margin profile. Moreover, Powersoft has attained its entire historical expansion by organic means, whereas the growth of B&C was also driven by acquisitions. Powersoft’s management has already successfully shown that they can expand in new verticals and product categories. B&C is more dependent on the touring market, while Powersoft is also successful in the fixed installations market. The valuations of both companies are currently not demanding with a single-digit EV/EBIT multiple, but I think Powersoft offers better optionality for future growth.

Looking outside of Italy, the valuations are significantly higher, margins are lower and except for Audinate, the companies are not expected to grow this year.

Assuming that Powersoft can grow by 12-13 % in 2024 & 2025 and that it can maintain an EBIT-Margin of around 20 %, the company can reach around EUR 20 million in EBIT in 2025, resulting in an EV/EBIT multiple of ~7.5x. Putting this multiple into the context of a high-quality business with a market-leading position, showing consistent double-digit organic growth for a long time, the valuation seems to be attractive.

10. Risks

Related party transactions: As seen in the “Shareholder” section of this write-up, Powersoft is controlled by its founders via their investment vehicle Evolve S.r.L who still own over 75 % of the company and who are still actively engaged in the company. While it is generally a positive sign when the managers/founders have a lot of skin in the game, they can also take advantage of their majority ownership. They can agree on excessive salaries or make other agreements to the detriment of minority shareholders. As you can see below, the salaries for the key management don’t seem to be exaggerated.

But that’s not all. Powersoft is leasing business property from Bluesky Immobiliare S.r.l and Bluesky is owned by Evolve S.r.l. To put it more simply, Powersoft leases buildings from its founders. There is still nothing wrong with this as long as these transactions are carried out at normal market conditions. In the annual report it is noted that all business dealings with Bluesky are concluded at normal market conditions and looking at the reported related party transactions, the numbers don’t seem to be exaggerated.

In March 2024, Powersoft announced plans for a new headquarters, the “Human Audio Experience Center”. The new headquarters, covering more than 9,200m² across four floors, is purpose-built to accommodate a projected increase in the size of the company’s workforce, as outlined in its development plan for the coming years. By centralising all corporate functions, enhancing departmental potential, improving cross-team collaboration, and delivering significant operational cost savings while boosting energy efficiency. Construction is anticipated to conclude in the latter part of 2026, after which production lines and all company departments will relocate from the existing premises to the new HQ.

This new headquarters will also be owned by Bluesky Immobiliare (or the founders of Powersoft) and then leased by Powersoft. As you can see in the picture below, the new building is much bigger and was planned by an internationally acclaimed architectural firm. The leasing costs will be much higher here and they could possibly be structured abusively and to the disadvantage of minority shareholders. But Powersoft has already released a 26-page information document regarding the preliminary lease agreement with Bluesky where they openly explain how they calculated the leasing rate and other potential costs. In addition, the Board of Directors of Powersoft has appointed KROLL Advisory SpA, an independent expert firm to determine the market rent for the New Complex. The annual rent for the building will be EUR 1.75 million.

I think with this detailed information document and the appointment of an independent advisory firm, the major shareholders have shown that they are not trying to hide something or betray the minority shareholders. Nevertheless, the related party transactions will be something to have a close look at in the coming years.

Economic cycle: Many industries were severely impacted by the COVID-19 measurements. However, the travel and (live) entertainment/event industries have arguably been impacted the hardest. This is of course also reflected in the numbers of Powersoft, as it is (at least partially) dependent on the live entertainment industry. Revenues in 2020 and 2021 have been 15-20 % lower than 2019.

After months in their homes, people wanted to catch up on everything they had missed during Covid. In the travel industry, they were talking about “revenge traveling”. A similar effect has happened in the live entertainment industry. Festivals and concerts were what people longing for, no matter what it cost. After two years of being closed, all the arenas, stadiums & venues may had to renovate their acoustic installations. At least the revenues of Powersoft more than doubled since the end of COVID-19 and partially this could be explained by a similar “revenge partying” effect which Powersoft benefited from.

Any industry that benefited during COVID-19, has been hit hard once the restrictions were lifted. And a similar effect likely happens to the industries that strongly benefited from the end of COVID-19. You can already find many articles that the end of revenge travel has arrived. At least one can assume that the growth rate of the live entertainment market will not continue to be in a similar range as it was in 2022 & 2023. This is underpinned by the market expectations for music events. The growth rate will substantially decrease in the coming years.

So one should not expect that Powersoft can continue to grow by over 40 % like 2022 & 2023. This growth was at least partially due to the effect described above. It is possible that Powersoft is currently overearning. But historically, Powersoft was able to grow with low double digits for many years and with the different “Growth Driver” described before, they should be able to continue to return to such growth rates in the coming years.

Dependence on key individuals / Selling shareholders: The three founders of Powersoft have played, and continue to play, instrumental roles in the company's success. If these key individuals were to leave the Group Management, there is no assurance that the Group could swiftly find equally capable and fitting replacements, at least in the short run.

After the IPO in 2018, the controlling shareholders owned 87 % of the company. That means they have already sold around 12 % since then. They may continue to sell their shares which would of course have an impact on the share price.

Competitors with deeper pockets: As already described, there are a lot of M&A activities in the professional AV market. Many large conglomerates emerged and also big PE funds invested. These competitors often have deeper pockets than a small company like Powersoft. They can invest much more money in R&D and Powersoft would definitely lose a price war against them. Powersoft has found a niche as an independent product specialist where even competitors are customers of them. But Powersoft enters more and more verticals and launches new product categories. Eventually, the rivals may consider this as a threat and launch an offensive instead of cooperating.

11. Summary

While looking at Powersoft's list of customers and partnerships, you wonder who in the professional audio sector is not one of their customers. This is no coincidence. Thanks to continuous innovation, Powersoft has built up an excellent reputation in its niche over the years. Powersoft is constantly expanding its addressable market thanks to the introduction of new innovative products like the patented “Mover” technology for the fast-growing immersive experience market. It remains to be seen if the company was over-earning in the last two years. However, the three founders are still passionate about the future opportunities of the company like the successful international expansion. Even if 2024 would be a year of “consolidation, the current valuation for such a high-quality company, with a clean balance sheet & net cash is not really demanding. If they can continue to profit from the various growth drivers described and return to sustainable double-digit growth, the valuation is even more attractive right now.

Welcome,

in this issue of Under-Followed-Stocks I will present you Toyokumo Inc. ($4058).

Investment Summary:

• sticky Software-as-a-Service business with churn rates < 1 %

• Revenue CAGR of 38 % and EBIT CAGR of 45 % from 2018 - 2023

• Revenue growth of 25 %, EBIT growth of 37 % with an EBIT-Margin of 36 % in 2023 & ROIC of 37 %

• a clean balance sheet with net cash and no long-term debt

• CEO owns 49 % of the company

• LTM EV/EBIT of 15.8x & NTM EV/EBIT of 13.8x

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Let’s go!

1. Introduction

Toyokumo is a SaaS company that provides cloud services like a safety confirmation service & cloud services that are linked to the low / no-code platform “kintone” as well as a group scheduler that makes it easy to adjust daily schedules.

The company’s mission is “Freeing all people from inefficient work”. By keeping ahead of the constantly changing times, it intends to anticipate products and services that customers will wish for and prepare them in advance. With an unprecedented focus on service, ease of operation, simple functions, and self-explanatory user interfaces, Toyokumo hopes to provide services that those new to the world of IT, who do not use PCs and smartphones on a day-to-day basis, can use with confidence, assisting business in their first steps toward computerization.

Toyokumo is listed on the Tokyo Stock Exchange Growth Market (TSE) since 2020 under the code $4058. The current market cap is 16.483 ¥ million (USD 106 million).

2. The company

The company was established as Cybozu StartUps Inc. in August 2010 as a wholly-owned subsidiary of Cybozu Inc., to develop new cloud services. Cybozu is Japan’s leading groupware provider. Its products like Cybozu Office or Kintone are used by over 115,000 companies worldwide including SoftBank, Nissan, Ricoh, Volvo, Gojek or WholeFoods.

In 2014 it was judged that shifting the company to an independent management structure would be beneficial for both companies and a management buyout (MBO) was agreed upon. Yuji Yamamoto (the current CEO & president director of the company before the MBO) acquired 70 % of Cybozu StartUps. Afterwards he conducted a third-party allocation to raise capital which was mainly allocated to the management.

In July 2019, to clarify the independence of Cybozu, the company changed its name to Toyokumo. The origin of the company name expresses the companies desire to spread cloud computing all over the world, just as the Japanese god Toyokumononokami is said to have created clouds and brought rain to the land at the time of creation, thereby enabling agriculture.

In September 2020, the company was listed on the mothers market of the Tokyo Stock Exchange.

Toyokumo’s aim is the “popularization of IT”. They have a corporate philosophy of contributing to the development of affluent social life around the world through information services. To realize this corporate philosophy, they are actively working with the following in mind:

Toyokumo’s services are available to try free of charge for 30 days before entering into a contract. During this short period, they strive to ensure that users become familiar with how the service works, and experience operational improvements through the service operations and settings. To secure high profitability, they are highly focused on working efficiently by keeping their per-contract acquisition costs low. They do not send out sales personnel to visit prospective clients and propose services for them. Instead, they employ inside sales via e-mail and telephone, and use marketing automation tools to automate some parts of the process. This waste-free operational approach is how they ensure high profitability.

Talented people are essential to maintain efficiency and continue to ensure high profitability in an ever-changing environment. To encourage talented people to choose Toyokumo over the competition, they are focused on affording individual employees a high degree of freedom so that they can fulfill their potential, and paying them generous salaries commensurate with the results they produce. Paying a generous salary is not just corporate babble. Between 2018 to 2023 the average annual salary at Toyokumo has increased by 57.3 %. Despite being a small company, the salaries at Toyokumo are at the 58th rank of the “Top 500 companies in Japan”. Recently, they have introduced a completely new personnel system which aims to create an environment where employees can demonstrate their performance through an in-house system that allows for fair evaluation of each other's achievements. They set two goals for each person: long-term goals to achieve future growth (growth goals) and guidelines for working towards the goals (achievement goals). Toyokumo believes that this will lead to continuous growth and improvement, making it easier for employees to plan their own careers. They have also established a stock ownership plan where employees can buy shares of Toyokumo with a 50 % discount for up to 10% of their salary. To maintain high profitability while increasing salaries, Toyokumo must grow its revenues and profits accordingly. We will see in the Financials section if they achieved this in the past and in the Growth Driver section if they can continue to do so.

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3. Products & Business segments

Toyokumo is reporting in two business segments, the safety confirmation service and kintone-related services that contain multiple products. Both segments have been growing consistently for many years.

Safety confirmation service (34 % of revenues)

In Japan, companies are required to provide countermeasures to minimize confusion in the event of a natural disaster like earthquakes or tsunamis. As Japan is situated in an area where several tectonic plates meet, it is vulnerable to natural disasters. Therefore, the Japanese government invests in disaster prevention systems such as earthquake alert systems. Furthermore, participation in natural disaster drills is common in Japan.

In 2011, Toyokumo released its safety confirmation service, a cloud service for confirming the safety of employees and others when disasters occur. In the event of a disaster within Japan, automatic safety confirmation notifications are sent to cell phones, smartphones, and PCs to help organizations accurately assess any damage, confirm that their employees and their families are safe, and communicate with suppliers. The countermeasure instruction function for example enables users to engage in three different communication functions:

• a message function for discussing countermeasures with the most suitable team member

• a message board function for notifying transitional processes

• a bulk notification function for communicating the results

Toyokumo uses data centers of Amazon Web Services (AWS) for its safety confirmation service. The data centers are mainly located in Singapore as there have been no earthquakes or damages by Tsunamis observed in Singapore in the last 100 years, it has a stable electricity situation and is close to Japan. Other internationally distributed data centers are also available. The server capacity can be expanded flexibly and the system can respond automatically to an increase in access during disasters. For instance, based on early reports of earthquakes by the Japan Meteorological Agency, the function can automatically expand servers before opening access to users to ensure that the system can operate stable even when access to the service increases rapidly. On the other hand, there is little need for use during normal times. Toyokumo enters therefore server contracts according to the status of access that allows them to be always able to operate with an appropriate cost burden, enabling them to provide the service at a competitive price.

Every year, Toyokumo conducts a nationwide simultaneous training for all its current contract users. In this training, they place a load on the system that is close to or even larger than an actual disaster, allowing customers to see for themselves whether the system will actually be able to operate in the event of a disaster. In addition, participating companies will be provided with a free training report, summarizing for example the average response time for the entire training, which can also be used to raise disaster prevention awareness.

Over 3,500 companies have implemented the service, which has been ranked No. 1 in customer satisfaction for six consecutive years by ITreview, one of Japan’s largest IT product and SaaS review sites.

The churn rate for the safety confirmation service is around 0.2 %, which makes it a very sticky, profitable & growing SaaS business.

Kintone-related services (66 % of revenues)

Before going into detail about what services Toyokumo offers in this segment, let’s have a closer look at what kintone actually is. Kintone is a customizable workplace platform that organizes your data, workflows and conversations in one centralized place for a more streamlined work experience. The no-code drag-and-drop interface allows you to create your own custom database application whether it’s sales leads, customer quotes or inventory management.

Kintone is a fast-growing solution that is used by over 30,000 companies across multiple industries like Volvo, SoftBank, Whole Foods, Ricoh or Japan Airlines.

A comparable, but bigger company with a larger offering in the US is Appian. Appian for example is mentioned as a “leader” in the Gartner Magic Quadrant for Enterprise Low-Code Application Platforms, while Kintone is mentioned as a “niche player”. Kintone is owned by Cybozu, the company that spun out Toyokumo and that still owns about 7.3 % of Toykumo.

Kintone’s sometimes limited capabilities can be expanded by a wide variety of extensions and third-party API integrations. These let you build out your kintone environment the way you want without waiting on traditional software development methods or IT support.

Toyokumo is offering such extensions in its Kintone-linked services segment like FormBridge, kViewer, kMailer, PrintCreator, DataCollect, kBackup or the Toyokumo Scheduler.

After a 30-day free trial, the customer is billed a monthly fee that is determined by usage. For instance, the monthly expenses for the FormBridge extension are displayed below.

Currently, there are 267 different extensions available in the kintone extensions store, so there is a lot of competition for Toyokumo. To find the best extensions more easily, Cybozu has developed a partner evaluation standard that ranks all available extensions (from 1 star to 3 stars). In the latest Cybozu Partner Network Report (CyPN Report), Toyokumo has received the highest ranking for 3 of its products (Foam bridge, kViewer, Print Creator), 2 stars for kMailer & Data Collection and 1 star for kBackup. Toyokumo is the only company that received a star rating for 6 products. In addition, Toyokumo has won the “Extensions Category Award” for the second consecutive year at the Cybozu Awards 2024.

These recognitions are helping Toyokumo to be more visible with its products. When searching for an extension on kintone, the preset order is the “Evaluation order”. With this order, the user will see four Toyokumo products among the first 9 extensions.

From my impression, Toykumos FormBridge and kViewer extensions are the most successful. With FormBridge, the user can create web forms where even people who don’t have kintone (like customers) can enter data that automatically will be saved in kintone. kViewer on the other side, allows you to publish information from kintone to people who don’t have a kintone account. So Toyokumos service works here as a bridge between kintone users and non-kintone users.

One reason for the huge success of FormBridge and kViewer is that Toykumo added a new user management function called “Toyokumo kintoneApp Authentication” to these two services in February 2022. Previously in kintone user management, employees with accounts conducted operations as kintone users and suppliers and collaboration partners conducted operations as guest users. When using Toyokumo kintoneApp Authentication, it is possible to easily share information with others who could not be communicated with online previously. Toyokumo kintoneApp Authentication is expected to enable the evolution of kintone into an external information-sharing platform.

Recently, Toyokumo kintone App Authentication exceeded 400,000 users, showing rapid growth since its introduction. The graphic below is from the end of 2023 when the kintone App Authentication reached 300,000 users. Just 5 months later, they have added 100,000 additional users. It took them nearly a year to reach their first 100,000 users.

The services of Toyokumo are mainly used by SMBs, but also increasingly by local governments and larger enterprises as you can see below.

In November 2021, the company also released the Toyokumo Scheduler. The scheduler has a new concept of enabling schedule arrangements with people outside the company. It can be used by companies of any industry or scale, offering a wide range of user base. Additionally, the company has earmarked this service for overseas expansion.

4. Growth Driver

Toyokumo Cloud Connect: In November 2023, Toyokumo & Cybozu have established a new company that is called “Toyokumo Cloud Connect”. Toyokumo owns 85 % of the company, while Cybozu owns 15 %. The new company will provide packaged solutions made up of multiple cloud services (primarily the companies own services) and then release them as one service. While typically Toyokumo is aiming at SME’s with its products, these packaged solutions target larger companies and especially local governments. Over 400 local governments are already using solutions by Toyokumo, including Osaka Prefecture, Kobe City, Kanagawa Prefecture, Kakogawa City, Ichikawa City, Aichi Prefecture, Takayama City, and Gifu City. Toyokumo products are used by local governments because they are easy to use when communicating with residents which has been very helpful. Especially during the coronavirus, when many local governments searched for solutions to easily communicate with residents. Once employees were accustomed to the ease of use of kintone, the services continued to be used after the pandemic and their usage options were expanded. One of Kintone’s strengths is that it can be created by people in the field who know the business and don’t have to be IT professionals. On the other hand, there are also dangers involved, as these people are not as aware of potential IT security risks. Especially when several different cloud services are used, this risk can increase, which can be a major problem for sensitive information from local governments. Additionally, when used in large-scale projects, the limits of the Kintone product are becoming apparent.

Toyokumo Cloud Connect was established to solve these issues. They offer for example packaged services that can handle personal information of citizens or support services that are expected to be accessed on a large scale.

The new company will still be in its start-up phase in 2024. But management already aims to achieve sales of 100 million Yen in 2024.

Increasing Lifetime Value (LTV): LTV is a measure of how much revenue a customer can bring to the company after entering into a contract through to the termination of the contract. To generate profits, Toyokumo is focusing on the quality of sales. They do not force sales growth but rather invest in products that will ensure profits. That’s why the LTV is an important indicator for the company and they are continuously working on improving the LVT. By encouraging users to upgrade to a higher-end service (upselling) and to sign up for another service (cross-selling) the company was able to increase the LTV in the past.

Growing end markets: The expansion from cloud service solutions is expected to grow in Japan, especially compared to traditional on-premise solutions.

In addition, the worldwide low-code development platform market (including complementing services) is expected to grow even faster in the coming years.

The prevention-related information systems and services market in Japan is expected to grow from 105 billion Yen in 2021 to 153.3 billion Yen in 2027, an annual growth rate of 6.5 %.

5. Management & Shareholders

Yuji Yamamoto is the CEO and main shareholder of the company. He currently owns about 49 % of the company (personally and via his asset management firm KK Nano Bank). He served as the president of the company since 2010 (when it was still Cybozu Startup) and then organized the management buyout in 2014.

The second largest shareholder is still Cybozu with 7.25 % of the company, followed by Tomohiko Tasato with 5.57 % who is a Board Member of Toyokumo.

6. Financials

From 2018, the company has increased its sales from 482 million Yen to 2,434 million in 2023, resulting in a CAGR of over 38 %. At the same time, EBIT increased from 137 million Yen to 875 million, implying a CAGR of 44.9 % and the net profit increased from 91 million Yen to 631 million (CAGR of 47 %). So highly impressive historical results.

This consistent growth can be achieved by a growing number of paid contracts with recurring SaaS revenues, combined with a low churn rate. As you can see below, the number of contracts for both segments have increased rapidly since 2019 while prices have remained relatively stable.

At the same time, the company was able to keep the churn rate at a level that is rarely seen in SaaS businesses. In 2023 the churn rate for the safety confirmation service hs been at 0.2 % and for the kintone-related services at 1 %, resulting in a combined churn rate of 0.68 % which indicates that the Toyokumo services are very sticky.

Let’s have a look at the 2023 results:

• Revenues +25.7 %

• EBIT +37 %

• EBIT-Margin of 35.9 % (vs. 32.9 %)

• Net Profit +47.9 %

• Net Profit-Margin of 25.9 % (vs. 22 %)

• Return of invested Capital (ROIC) of 37 %

You can see that the only costs that Toyokumo has are personnel & advertising expenses. Especially the advertising costs can fluctuate strongly during a year that can have a bigger impact on quarterly earnings. For example in Q1 2024 there has been a bigger eartquake in Japan. Toyokumo has increased is advertising spend significantly afterwards for its safety confirmation service (compared to previous year) with the result that EBIT decreased in Q1 ‘24 by 3 % yoy while revenues increased by 26 %. This is not unusual and in the end, Toyokumo has often exceeded its guidances for the fiscal year. More on Toyokumo’s guidance for 2024 in the valuation segment.

Toyokumo has a solid balance sheet with an equity ratio of 67 %, no long-term debt and net cash of 3,086 million Yen (vs. market cap of 16,757 million Yen).

They also pay a dividend since 2021 which they continuously increased (14 yen per share expected for 2024: +40 % yoy).

The company is also releasing monthly sales data. Based on the recent monthly sales trends of ~25 % growth in April 2024, the company is already on a good way to achieve its targets for 2024. You can also see that the growth rate accelerated slightly in April 2024, which hasn’t been the case for some time.

In the grafic below you can see the monthly increasing recurring revenues. I think this steady growth in recurring revenues speaks for the great quality of the company.

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7. Valuation

For 2024, the company is expecting sales growth of 23.2 %, EBIT growth of 14.3 % and Net Profit growth of 9.3 %. The lower growth in profit is mainly a result of higher expected personnel expenses as the company plans to increase the number of employees from 57 in 2023 to 72 in 2024. The company is targeting an EBIT-Margin of (at least) 30 % in the medium-term while maintaining high sales growth by investments in personnel and advertisement.

The management of Toyokumo is known to be conservative in its guidance. In the last two years, they had to announce upward revisions of their guidance at the time of its Q3 earnings announcements. Based on the current guidance for 2024, Toykumo is currently valued at the following mutiples:

• EV/EBIT of 13.8x

• EV/E of 20x

Considering the quality of revenue Toyokumo generates (recurring, low churn rate, highly profitable) and the long history of profitable growth, I don't think this valuation is expensive.

The company was listed in Sepemtber 2020 at an insane EV/EBIT multiple of over 200x. No wonder that the share price has decreased by over 65 % since. Maybe this share price development is one reason why the stock hasn’t reveiveid a lot of love from investors since then, although the business itself delivered continued revenue and profit growth since its listing.

Leaving the insane valuation multiples of 2020 & 2021 aside, the company was valued at a NTM EV/EBIT of 18.4x in the mean since January 2022. So currently it is valued well below its mean, but also not at its lowest valuation of 11x.

Everbridge , a US company that also offers some kind of safety confirmation services like Toyokumo recently announced that it will be acquired by Thoma Bravo, a leading software investment firm. Everbridge will be valued at approximately USD 1.8 billion which equals to a EV/EBIT multiple of 24. But of course Everbridge is a significantly bigger company that offers more services than just a confirmation service and it is a US company. So comparing this multiple with Toyokumo is probably not that meaningful.

The only listed company from Japan I found that offers a safety confirmation service like Toyokumo is Secom ($9735). Secom trades at a NTM EV/EBIT of 12, but the safety confirmation service is just a very small part of Secom. Secom is not a pure software company like Toyokumo, which is also reflected in substantially lower margins and it is also expected to grow by only 3 % in 2024.

For the kintone-related segment it is even more difficult to find comparable companies. One of the closest competitors here is probably R3 institute, that also offers mutiple extensions for kintone and that also receive high ratings. Unfortunately this is not a listed company and other companies in this segment are even smaller and also not listed. I came to the conclusion that a comparison to Cybozu itself could also be ineteresting. Cybozu currently trades at a NTM EV/EBIT of 19, but its also has significantly lower margins (13 %) and is expected to grow by 14 % in 2024.

8. Risks

Dependence on kintone (Cybozu): Although Toyokumo was separated from Cybozu in 2014, there is still a high dependence on the services that Cybozu offers. 66 % of Toyokumo’s sales are based on kintone, a product that Toyokumo has no influence on. Every failure in the kintone product can have a big impact on Toyokumo’s sales. Additionally, Cybozu could decide to implement extensions that Toyokumo offers, itself in its kintone product. Although Cybozu still owns a part of Toyokumo and they have recently established a Joint Venture, the odds are not zero.

Product failure: Especially in the safety confirmation segment, a product failure would have dramatic effects. When a natural disaster occurs, and the products of Toyokumo are not working as they are expected to do, the churn rate of these products would increase dramatically.

Ability to continue to grow: For a long time, Toyokumo was able to grow its monthly sales by over 40 %. But since February 2022 the sales growth rates declined to “only” about 25 % in 2023 and for 2024 it is expected to continue to decline to only 23 %.

Looking at the product development, one can also see that the company hasn’t released a new service since 2022.

Questionable is, if Toyokumo is able to continue to grow in the future without developing new services. Although one could argue that with the offering of Toyokumo Cloud Connect, they essentially started new services in 2024. But it remains to be seen whether they will actually be successful.

9. Summary

Toyokumo ticks a lot of boxes when you are searching for a high-quality investment. First of all the highly predictable, recurring & sticky revenues. But also the high profitability, high insider ownership, history of rapid growth, high equity ratio & high returns on the invested capital. Despite this high quality, an investment in Toyokumo shares was not particularly successful, with a loss of 65% since the IPO. This is mainly due to the exaggerated valuation at the time of the IPO. But now the valuation has come down to a more than reasonable level for such a quality company. If Toyokumo is able to expand its reach in its growing end markets while keeping the churn rate as low as it has been the chances are good that the future will be much better than the past as a shareholder of Toyokumo.

Disclaimer: The following write-up is no investment advice. The author may own, buy and sell securities mentioned in this post. Please always do your own due diligence! This company is a micro-cap. Keep in mind that even a small investment from your side can move the share price due to the low liquidity of shares. It's not easy to liquidate if you want to get out.

Welcome,

in this issue of Under-Followed-Stocks I will present you Civitanavi Systems SpA ($CNS.MI).

Investment Summary:

• Civitanavi is a pure player in Inertial Navigation Systems (INS)

• INS represents the only way to autonomously detect the position of any device and the direction of its motion when GPS signals are not available

• CNS products are used for space launch systems, military vehicles on land, air & sea and in the mining, oil & gas industry

• CNS benefits from increasing military budgets, higher demand for space launchers and trends in the eVTOL & fully autonomous driving sector

• Clients are multinational companies like BAE Systems, Leonardo, Rheinmetall, Honeywell or Teledyne

• founder-led with high insider ownership of 66.2 %

• profitable growth since foundation with a CAGR of 63 % from 2012 - 2022

• Growing by over 30 % with EBIT-Margins over 20 % and valued at an NTM EV/EBIT of 10.2x

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1. Introduction

Civitanavi Systems (CNS) is a vertically integrated provider of high-accuracy inertial navigation systems (INS), designed and manufactured using proprietary methods and techniques based on both Fiber Optic Gyroscope (FOG) and Micro Electro Mechanical Systems (MEMS) technology, integrated with satellite navigation devices (GPS). These are a lot of terms and abbreviations. I will try to explain exactly what this means in more detail later on.

Thanks to the founders Andrea Pizzarulli and Michael Perlmutter's years of experience in the field, the Company quickly became a major player in the global market for both aerospace and defense applications as well as commercial applications.

CNS has a unique positioning as a supplier of high-end inertial systems that are ITAR-free (exempt from US export regulation), have true solid-state (safety critical applications) and provide both stabilisation and navigation functions. This makes CNS well-placed to capture growth in the defence market globally, driven by rising military spending and growing demand for ITAR-free procurement, especially in Europe.

CNS is listed on the Euronext Growth Exchange in Milan since 2022 under the ticker $CNS. The current market cap is EUR 137 million (USD 148 million).

2. The company

CNS was founded in 2012 by Andrea Pizzarulli (CEO) and Michael Perlmutter (executive VP) with first sales in the oil & gas sector through a partnership with a leading US company. In 2015 they started their first airborne project for Piaggio Aerospace and two years later they secured the first contract with Leanardo in the helicopter business and a leading Turkish Aerospace & Defence company. In 2020 they entered the space business with Sener/Avio and in 2021 they secured a long-term partnership with Honeywell.

The headquarter and main industrial plant is in Pedaso (FM). Besides the commercial structure and the main research centre, production activities carried out in Pedaso include the manufacturing of fiber optic coils (coil shape can be tailored to customers’ specifications, a unique capability of the company that is hard for competitors to replicate), assembly of the inertial measurement system (IMU), and calibration of the IMU to ensure measurements are accurate. A new headquarter is currently built in Porto Sant’ Elpidio.

The company operates some other smaller sites in Italy and is also currently building up a new subsidiary in UK with additional production capacity.

What are Inertial Navigation Systems?

The Inertial Navigation System (INS) is based on gyroscopes (rotational assessment and angular rotation gauges) and accelerometers (motion sensing and linear acceleration gauges), which provide data on angular and linear motion and together constitute the Inertial Measurement Unit (IMU). Thanks to mathematical algorithms that translate raw data into orientation, attitude and positioning, INS is the only way to autonomously detect the position of any device on which it is installed and the direction of its motion.1

In particular, the INS allows for an accurate calculation of the speed and direction of the device in which it is installed without the need for external data input (i.e. a satellite signal for GNSS/GPS data), making the system intrinsically cyber secure; the inertial stabilisation system, on the other hand, provides the fundamental measurements for trim control. The Inertial System does not require external sensors, so can provide uninterrupted navigation support while allowing autonomous stabilisation. Conversely, GNSS/GPS relies on a clear signal from a satellite to establish navigation and position, cannot produce gyro data for automatic stabilisation, and is prone to jamming and/or spoofing.2

So to put it in easy words: INS are necessary for secure navigation and stabilisation of vehicles & objects when external signals are not available.

Thanks to the application of in-house developed fiber-optics gyroscope (FOG) and Micro Electro Mechanical Systems (MEMS) technologies, INS from Civitanavi allow

1. autonomous (without GNSS/GPS) and high precision inertial navigation

2. stabilization as well as

3. the precise orientation of the mobile device on which it is applied

Full ownership of the know-how developed in-house guarantees Civitanavi a higher quality and reliability of its systems, making it highly competitive compared to much larger international market players.

3. Market & Competitors

The total addressable market for high-end Inertial Systems is expected to reach USD 3.8 billion in 2025, implying a CAGR of 6 % from 2020 - 2025. This is some data the company published in its IPO prosepctus from a study made in 2020. In this study, it is expected that the defence & military market would grow with only 3.3 % during the 5 years. But when the study was made, the situation was completely different given the fact that (especially European) countries will now spent much more money again in this sector since Russia started a war in Ukraine. With its ITAR-free products (more on that later), CNS has a good position to participate from this development so that the TAM for CNS should grow faster than the study suggests.

CNS operates in a global market, dominated by a few big players. The company’s main competitors are US companies Honeywell (approx. 38 % of the global INS market), Northrop Grumman (approx. 21.2 % of the market) and the French company Safran (9.4%). The remaining part of the market (equal to approximately 31%) is divided among the remaining smaller operators. According to the IPO Prospectus CNS’ market share in 2019 was estimated at 0.4 %. Although CNS more than doubled its revenues since 2019, one can imagine that the market share is still very low.

So tough competition for a small company like CNS. But that the dominant market leader (Honeywell) started a cooperation with this niche player could probably mean that the products from CNS have some competitive advantages:

“At Honeywell, we have a long history of delivering high-precision inertial products for use in commercial, military and industrial platforms, and this collaboration with Civitanavi Systems will expand our expertise. The HG2800 IMU will come in multiple variants, utilizing Honeywell nextgeneration MEMS Accelerometer technology, coupled with Civitanavi Systems’ low-cost, highperformance FOG sensors to provide a new suite of products.” - Matthew Picchetti, vice president and general manager, Navigation & Sensors, Honeywell Aerospace

Competitive Advantages

CNS is the only operator able to develop and produce high-performance ITAR-free inertial systems, with technology suitable for both navigation and aircraft stabilisation.

ITAR-Free: ITAR is a regulatory regime imposed by the US government to limit and control the export of military and defense technologies to safeguard the national security of the United States. Binding a product to this regulation means facing various limitations and restrictions on the freedom of circulation of the product. Civitanavi's strategy is precisely aimed at avoiding the use of ITAR components within its systems that certainly make them easier to place on the market.

True solid state: high performance, non-mechanical gyros for safety critical applications (Systems whose failure to function can cause serious and often irreversible damage)

Stabilisation suitability: technology is suitable for both stabilisation and navigation

In 2019, Civitanavi was selected by BAE Systems Plc as a supplier of inertial systems for the flight control of a sixth-generation combat aircraft within the TEMPEST technological demonstration program ("Demonstration Program"), as the only one capable of offering an ITAR-free and certifiable solution from a safety-critical point of view. The TEMPEST program, which could follow the current Demonstration program, has a potential value of EUR 500 million for the entire duration of the program itself.

CNS has won some additional major projects against its much bigger competitors:

Additional advantages of their products are:

Proprietary FOG & MEMS Technology: CNS has in-house developed FOG & MEMS technology and the proprietary related integration into intertial measurement systems (IMS). The proprietary technology refers to multiple patents, but also to non-patentable industrial secrets, software and reprogrammable hardware. Thanks to the application of FOG and MEMS technologies, Civitanavi sensors are particularly effective, as they allow autonomous and high-precision inertial navigation, stabilisation and precise orientation.

Competitive final price: CNS uses a technology that is based on components coming from industries with a very high level of scalability (including telecommunications and automotive) compared to those of the sector in which it operates. These commercially available off -the-shelf components (COTS) have a competitive cost compared to specialist components typically used to design and produce INS.

Customization: CNS offers a high degree of product customization, with reduced delivery times compared to competitors which is possible due to a high level of vertical integration in the production process. In addition, the products have small dimensions, low consumption and high longevity.

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4. Product portfolio & Business Segments

CNS has developed several products for the various applications for which they are used and has divided its business into segments according to the end markets (Aerospace & Defence and Industrial). I used the revenue split from the last published quarter (Q3 2023), but keep in mind that the split can deviate strongly from quarter to quarter.

Aerospace and Defence (79 % of revenues)

Space (26 % of revenues): Launch vehicle guidance systems used in flight guidance control of space launchers and aboard space transportation systems. Customers are Sener & Avio who are responsible for the navigation units of the Vega rocket, developed by the European Space Agency (ESA).

Aeronautics (11 % of revenues): Products are used for flight stabilization control as well as replacing GNSS/GPS when unavailable in the defence and civil fields (helicopters, jets, eVTOL). Inertial systems are essential for stabilisation, especially when the aircraft is inherently unstable as is the case for eVTOL. Customers are for example Leonardo or BAE Systems.

Naval, Submarine & Guidance (36 % of revenues): These are systems used for the stabilization of ships and for naval navigation. Such systems, with the highest accuracy, are in particular demand for submarines, for which it is not possible to rely on satellite navigation systems. Teledyne Technologies is a customer in this segment.

Land (5 % of revenues): Stabilization and terrestrial navigation systems that are used in the presence or absence of satellite navigation systems (GNSS/GPS) for the stabilisation of moving equipment such as radars and cameras in military vehicles. Rheinmetall is a customers in this segment.

Industrial (19 % of revenues)

Mining, Oil & Gas: Used for tunnelling and horizontal drilling in the mining and oil & gas sectors. Customers are Teledyne, Scientific Drilling or Reflex.

The remaining 2 % are other revenues like grants, insurance and claims recoveries.

5. Growth Driver

Increasing Military Budgets: World military spending grew for the eighth consecutive year in 2022 to an all-time high of USD 2240 billion. By far the sharpest rise in spending (+13 per cent) was seen in Europe.3 Military aid to Ukraine and concerns about a heightened threat from Russia strongly influenced many other states’ spending decisions, as did tensions in East Asia. The order backlogs of the 15 largest defence companies in Europe increased already significantly and multiple of them are customers from CNS.

Moreover, Europe is slowly realizing that it cannot rely entirely on the US for its own defence. Europe must become more independent from the USA in this respect. As a result, further significant European military spending is unlikely to be affected by US regulations such as ITAR, which is a major advantage for European companies offering ITAR-free products.

In modern warfare, GNSS/GPS jamming is a common strategy to impede enemy operations. Russia is now developing a rocket capable of shooting down satellites, according to recent reports.4 So it becomes more and more important that military vehicles are not reliant on GNSS/GPS data and need an alternative such as INS.

Space launches: Since SpaceX has revolutionized the space launch market with its rockets, the number of launches is rapidly increasing and also the market for space launches itself. The demand for satellite launches is driven by a range of applications, including communication, navigation, earth observation, and scientific research. The military sector is also a significant driver of growth in the space launch services industry, with a growing demand for military satellites for communication, surveillance, and intelligence gathering. The space launch services market is expected to grow with a CAGR of 15.1 % from 2022-2027. With its launch vehicle guidance system, CNS can benefit from this trend.

Urban Air Mobility: Electronic vertical take-off and landing aircraft (eVTOLs) that can be flown by a pilot or self-driven, represent a great opportunity for manufacturers of high-end inertial sensors. The eVTOL market is expected to grow with a CAGR of 35.6 % from 2025-2035.

CNS aims to consolidate its compelling positioning by developing new technologies and components and aims to take on the role of a Tier-1 player in the Urban Air Mobility market. They have developed ONEBOX, an integrated vehicle management system based on inertial sensing with disruptive features in terms of weight, volume and price.

Fully autonomous vehicles: There are 5 different levels of vehicle autonomy. Currently, we are at level 2 - partial automation. The vehicle can perform steering and acceleration, but the human still monitors all tasks and can take control at any time. The higher the level of automation, the more important the accuracy and reliability of the systems and sensors on board are. The autopilot must always know the car's exact position, even when there are no external signals like GNSS/GPS.

While the step to fully autonomous driving will still take time, CNS is well-positioned to benefit from this trend in the future.

Establish partnerships / M&A: CNS growth strategy includes the creation of partnerships to allow them to enter new markets & new geographical areas and benefit from the licensing of technological property or products to partners. As already mentioned, CNS has signed such a partnership with the market leader Honeywell to co-develop a new inertial measurement unit where CNS can benefit from Honeywell’s worldwide distribution network.

In September 2023, CNS also signed a Memorandum of Understanding (MoU) with Hanwha Systems, a Korean manufacturer of Electric Optics Systems for airborne, naval & ground platforms, to develop cutting-edge products that integrate Civitanavis GNSS and Intertial Systems expertise with Hanwha’s products. Hanwha is a listed company and has a market cap of USD 2.25 billion.