Pinnacle Telecom Group plc (formerly Glen Group plc) is an acquisitive AIM listed provider of integrated telecommunications solutions, specifically focused upon the huge UK SME market.

The company is currently over half way through its strategic repositioning, as outlined when CEO Alan Bonner reversed Pinnacle Telecom into Glen Group in June 2007. The group has now been stabilised, returned to growth, and reported a maiden operating profit* for the six months ended 31 March 2010 (*clean of exceptional items).

Whilst the market for hosted business-to-business telephony is still embryonic, Pinnacle's service offering has been steadily strengthened and the Company is leading the market with its hosted voice (VoIP) solution, which has been fully endorsed and used extensively by the BBC, most recently for this year's General Election coverage. In addition, the company has provided similar virtual communications networks to some of the UK's biggest outdoor festivals, such as the Chelsea Flower Show, Donington Download, Glastonbury and T in the Park, to name only a few.

Results for the six months ended 31 March 2010 confirm that the group has turned the corner, all KPI's point toward a sustainable return to profitability and cash generation. The company now boasts 94% of its revenues are recurring.

We have valued Pinnacle Telecom using an Enterprise Value/Sales (‘EV/Sales') methodology, which we believe conservatively values the growth potential as the group moves into sustainable profitability and cash generation. Therefore, with the shares trading at 0.27p, the 2009 financial year Enterprise Value was GBP3.263 million, which is 1.02 times reported 2009 Sales of GBP3.192 million. We estimate that by the end of the 2011 financial year, the group will be profitable and increasingly cash generative, such that (in the highly unlikely event of no further acquisitions) Pinnacle will close the year with net cash of GBP0.581 million. Therefore, if the shares were to trade on a similar EV/Sales multiple, then, based on our conservative 2011 forecasts, the shares should be 0.53p and with the shares currently trading at 0.27p we recommend the shares as a buy.

Source: Company and Growth Equities & Company Research

Group History

The company was established in 2002 and floated on the AIM market on 1 December 2004 as Glen Group plc (‘Glen') following a placing of 25 million shares at 3p each, raising GBP0.75 million and valuing the company at GBP1.5 million. The company started its quoted life as an IT and communications integration business, focussed on providing a wide range of communications and IT services to SMEs throughout the UK.

On 20 January 2006, Glen acquired Eclectic Holdings Limited ('Eclectic') for an initial consideration of GBP2.2125 million, of which GBP1.95 million was cash and the balance in shares; there was an additional consideration of up to GBP787,500 dependent on adjusted results of Eclectic for their year ended 31st July 2006. The cash element of the acquisition was funded through a placing of 250 million shares that raised GBP2.5 million before expenses. Eclectic, based in Glasgow and London, was a project based reseller of IT services operating in the corporate market.

On 5 September 2006, the group acquired Edinburgh based Explore IT Limited ('Explore') for a cash consideration of GBP115,000.

Pinnacle Telecom plc was founded in March 1998 by Alan Bonner; the business grew rapidly posting turnover of GBP6m in 2004. In the same year, Pinnacle sold its customers to AdEPT Telecom plc for a seven figure sum and then set about rebuilding the business, with a focus on converged telephony and IT. On 6 June 2007, Glen acquired Pinnacle and its associated companies for a consideration of GBP700,000, which was satisfied by the issue to Alan Bonner of 122,727,273 ordinary shares at 0.55p per share and cash of GBP25,000. The Pinnacle management team led by Alan Bonner assumed management control of Glen and initiated a five-year transformation strategy.

Following the introduction of Pinnacle, substantial changes were made to the business and operations of Glen to increase the focus of its product set on the provision of IT services and solutions, including the provision of voice services over a broadband connection (VoIP). The intention was to start to convert its revenue streams to recurring, rather than project-based, income.

On 9 August 2007, Glen acquired the London based IG Software Limited, a corporate performance management IT services and consultancy business, through its subsidiary Eclectic, for a total consideration of GBP1.35 million, which was satisfied by the issue of 200 million shares at 0.55p per share and GBP250,000 in cash.

However, given the group's new focus was on converting its revenue streams away from project based revenues, and onto recurring revenues, on 19 December 2007, the company agreed to sell both Eclectic and IG Software, for a cash consideration of GBP2.72 million, to Maxima Holdings plc.

On 30 June 2008, Glen acquired the Paisley based Colloquium, a public telecommunications operator (“PTO”) and Internet Service Provider ('ISP'), through its subsidiary Pinnacle for a total cash consideration of GBP100,000.

Glen Group plc changed its name to Pinnacle Telecom Group plc following the 5 March 2009 AGM to better reflect the future direction of the group, which is to be a provider of high quality, hosted telephony and value added IP/IT services to the UK SME market.

On 11 June 2009, the group, through Pinnacle, acquired the Northampton based Accent Telecom UK Limited ('Accent') for a total consideration of GBP661,450 that was satisfied by the issue of 508,807,826 shares at 0.13p per share.

On 13 January 2010, the group acquired Hinckley, Leicestershire based Solwise Telephony Limited (‘Solwise') and its wholly owned subsidiary, Sipswitch Limited (‘Sipswitch') for a maximum all share consideration of up to GBP0.5 million, at a minimum share price of 0.57p per share, which is in part based on an earn-out.

Management

William (Bill) Allan is the Group's Non-Executive Chairman. Prior to joining Pinnacle he was Chief Executive of THUS Group plc from February 1999 until December 2008. In that time THUS grew its annual turnover to GBP576m. He has more than 25 years' experience in the telecoms industry. In previous years, he has also been Chief Executive of Cable & Wireless Regional Businesses, and a director on the boards of Telecommunications of Jamaica, Entel Panama, the Barbados Telephone Company, and the Barbados External Telecommunications Company. Between 1995 and 1997, he was Regional Director for Cable & Wireless North East Asia Region, President and Representative Director of Cable & Wireless Japan, and Chairman of Cable & Wireless Communication Services Limited (Japan). He was also a Director on the boards of International Digital Communications of Japan), Sakhalin Electrosvyaz, Sakhalin Telecom, Sakhalin Telecom Mobile and Nakhodka Telecom.

Alan Bonner is the group's Chief Executive Officer. He founded Pinnacle Telecom PLC in 1998. The business, including Pinnacle Mobile Limited and Sports Club Telecom Limited, was brought into Glen Group plc (later renamed Pinnacle Telecom Group plc) in June 2007. Pinnacle, based in Scotland, grew very rapidly as a provider of solutions based telecoms services to the SME market. The company has received numerous awards for its growth profile, and the entrepreneurial nature of the way it helped businesses by taking a solutions based approach to their telecoms requirements. He assumed management control of Glen and initiated a five-year transformation strategy in 2007.

John Anderson is a Non-Executive Director. A Chartered Accountant and a former partner at Grant Thornton, he has worked with many of Scotland's most exciting growth companies. He is the CEO of The Entrepreneurial Exchange, Scotland's leading members' organisation for ambitious, growth-orientated entrepreneurs. Formed in 1994, it has 450 members, representing over GBP22 billion of turnover and 290,000 employees. Mr. Anderson is also an Honorary Senior Lecturer at the Hunter Centre for Entrepreneurship at the University of Strathclyde; a founding GlobalScot member; a Saltire Foundation Fellowship advisory board member and sits on the boards of PSYBT and Stirling University Innovation Park.


Significant Shareholders

There are 1,738,857,630 ordinary shares of 0.1p each in issue and those owning more than 3%, as at 17 February 2010, are:

Source: Company

Notes:
1 - Includes interests of his wife, N. Patel
2 - Inludes the interests of R. Alexander


Overview of Operations

Pinnacle Telecom Group plc is an integrated value added, solutions based provider of converged telecommunications services, to the UK SME market of 1.4 million companies that employ less than 250 people. The company provides a wide range of customer solutions including telecommunications calls and access, consultancy, IT support, mobile solutions both voice and data and hosted broadband voice services.

Chart: Group Divisional Reporting Structure

Source: Company

Pinnacle is a fully licensed Public Telephone Operator with its own telephone network, it has interconnects with BT, Virgin Media and THUS. In addition to traditional telephony (‘landline), the group has its own hosted VoIP (Voice over Internet Protocol) platforms and engineers.

Pinnacle is Scotland's oldest ISP as well as a founder member of Nominet, which operates from the group's Glasgow data centre to service it clients, which include leading companies such as Loganair, Flybe, Sally Salon Services and Holiday Inn Express. It also has connected data centres in Brighton and London.

The group has direct agreements with Vodafone and 02 as well as indirect agreements with Orange and T-Mobile.

In summary, Pinnacle is one of Scotland's leading providers of hosted converged telecom solutions, that brings together next generation fixed and mobile telephony, VoIP, broadband, and IT/IP solutions.


Strategy for Growth

The management team led by CEO Alan Bonner, outlined the group's long term strategy following the reversal of Pinnacle Telecom into Glen in June 2007, which was to establish a SME focused, value added, solutions based provider of next generation, hosted, converged communications services. Obvious, the emergence of the cloud has now strengthened that earlier vision.

Chart: Strategic Vision



Source: Company


However, the team's immediate priority when laying out the original five year plan was to stabilise, rationalise and return to sustainable profitability the existing group, whilst not missing strategic opportunities that strengthen the service offering. This phase has been successfully completed as confirmed by the recent interim results that are commented upon later. The company is now positioned to drive itself forward through a combination of organic and acquisition led growth.

Table: Revenue and Gross Profit GBP million

Source: Company

Pinnacle determined that the large UK SME market for converged next generation, hosted, communications services was, and remains, poorly addressed and highly fragmented (e.g., 600 – 1,000 UK resellers). There are some 1.4 million SME's in the UK each employing less than 250 people and generating sales revenues of GBP1.5 trillion per annum or 51% of UK GDP; of which 33% are situated in London and the South East.

In a recent analysis, BT estimated that UK SME's spend GBP20.3 billion per annum on ICT and we believe that about GBP14 billion of that spend is an immediately addressable opportunity for Pinnacle (highlighted in red in the following Chart).

Chart: UK SME ICT Purchases, GBP million



Source: BT market studies, April 2010

The BT analysis indicated that the annual growth rates for those segments that Pinnacle is addressing ranges from 24% - 40% (see following Table).

Table: UK SME ICT Growth Rate for Pinnacle's Offering

Source: BT market studies, April 2010

We believe that Pinnacle's underlying organic growth rate, based upon BT's analysis, should be 27% pa if it maintains market share or considerably higher if its offering is acquiring market share. However, Pinnacle has stated that, within the next five years, it expects to grow revenues to between GBP100 million and GBP200 million. It is obvious that this cannot be achieved through organic growth alone. The sales revenue gap will be plugged through targeted strategic acquisitions for which there appear two approaches:

•             Strengthen the technical service offering; and
•             Deepen the customer pool.

The former will be achieved through the acquisition of companies in EBITDA multiple range of 2 – 6 times, while the latter on the basis of buying customer base acquisitions on monthly gross profit multiples of 15 – 24 times depending upon circumstances. All acquisitions should present additional group up selling opportunities.

Moreover, the company is confident that acquisitions can be quickly integrated (i.e., typically within 90 days) and that there will be good synergy opportunities, which will enable the elimination duplicated centralised functions, e.g., finance, customer care and billing.


Recent Results

Pinnacle began a five year strategic repositioning in 2007, with the early years focused upon stabilising and turning around the business, whilst at the same time strengthening and positioning the service offering, in line with the long term strategy of creating an integrated SME focused, hosted, converged communications group. We believe the interim results indicate that the final phase of the five year plan is about to commence in earnest, i.e., delivery of sustainable profit growth and cash generative.

Group sales revenues for the six months ended 31 March 2010 increased 188% from GBP1.077 million to GBP3.102 million, benefiting for a full six months contribution from Accent Telecom (acquired June 2009) and an initial three months from Solwise Telephony (acquired January 2010). Nevertheless, as can be seen from the following table, the group has continued to build upon the earlier second half period's progress.

Table: 6-monthly Divisional Sales GBP000

Source: Company

Cost of sales increased 173.6% from GBP0.753 million to GBP2.059 million, which was 14.4% points less than sales growth due to higher recurring income (94% of income is recurring) together with a progressive shift towards the newer higher margin services.  Consequently, gross profit increased 221.5% from GBP0.324 million to GBP1.042 million and the margin increased 3.5% points to 33.6%.

Pinnacle maintained a firm grip on administrative expenses, which increased a relatively modest 35.7% year on year to GBP1.002 million and there remains scope for further expenses to be driven out as Accent is further assimilated and Solwise integrated. Resulting in operating profit (before amortisation, impairment of goodwill and exceptional items) swung from a comparative loss of GBP0.414 million to a GBP0.041 million profit.

Table: Profit & Loss Account (continuing operations), GBP000

Source: Company

Notes::
1 Operating profit/(loss) before amortisation, impairment of goodwill and exceptional items

Headline or reported pre-tax loss fell from GBP0.510 million to GBP0.136 million despite higher amortisation charges (GBP0.153 million v GBP0.096 million), exceptional charges ((0.18 million v GBP0.0 million) and finance charges (GBP10.6 million v GBP0.4 million) as an initial GBP0.005 million contribution from a related company. This resulted in a loss per share for the six month period of 0.01p against 0.04p for the comparable period.

Importantly, Pinnacle has proven its technology is robust, and during February 2010, Pinnacle successfully tested its hosted voice (VoIP) and data application for the BBC, which was later used for the complete TV coverage of the BBC Election Special on 6th and 7th of May; this bespoke network comprised of 550 voice and data circuits connecting 198 locations within the UK. This contract win and endorsement has resulted in Pinnacle providing similar bespoke virtual networks for some of the UK's biggest outdoor festivals, including The Chelsea Flower Show, Donington Download, Evolution, Big Chill, V Festivals, Leeds Festival, Glastonbury, T-in-the-Park, Lattitude, Hyde Park Festival, T4 on the Beach and Shambala. All of these higher margin contracts will have contributed during the current year's second half ending 30 September 2010; we guesstimate that these contracts may add at least GBP1 million to sales revenues and on a very healthy double digit operating margin, even allowing for setup costs that will benefit future years as the contracts are renewed.

Table: Forecasts GBP000

Source: Company and Growth Equities & Company Research

In addition, the earlier momentum established across the group has been maintained, which augurs well for the full year outcome with further strong growth expected in the following year. However, gross margins may be modestly and temporarily constrained (see following Table) due to additional costs to support initial infrastructure demands for the rapidly expanding bespoke virtual communications contracts. Nonetheless, the group will continue to move further into the black on an underlying pre-tax profit basis.

The group's balance sheet remains robust net cash of GBP0.419 million as at 30 September 2009 and which we estimate, in the absence of acquisitions, will increase to GBP0.581 million by the end of the 2011 financial year as the company becomes sustainably cash generative. The balance sheet appears light in fixed assets terms but this is not unusual for an increasingly software-based, acquisition driven and IP rich company.

Table: Balance Sheet GBP000

Source: Company and Growth Equities & Company Research

Valuation

We have valued Pinnacle Telecom using an Enterprise Value/Sales (‘EV/Sales') methodology, which we believe conservatively values the growth potential as the group moves into sustainable profitability and cash generation. Therefore, with the shares trading at 0.27p, the 2009 financial year Enterprise Value was GBP3.263 million, which is 1.02 times reported 2009 Sales of GBP3.192 million. We estimate that by the end of the 2011 financial year, the group will be profitable and increasingly cash generative, such that Pinnacle will close the year with net cash of GBP0.581 million in the highly unlikely event of no further acquisitions. Therefore, if the shares were to trade on a similar EV/Sales multiple, then, based on our conservative 2011 forecasts, the shares should be 0.53p and with the shares trading at 0.27p we recommend the shares as a buy.

Source: Company and Growth Equities & Company Research

This research note cannot be regarded as impartial as GE&CR has been commissioned to produce it by Pinnacle Telecom Group, it should be regarded as a marketing communication.

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