Should you buy Prophecy International Holdings Limited?

Prophecy International Holdings Limited (ASX:PRO) latest acquisition looks good.

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I first wrote about Prophecy International Holdings Limited (ASX: PRO) back on 7 April 2015. On that day, its shares closed at 62 cents and last Friday they closed at $1.36.

On Wednesday last week, Prophecy's shares were placed in a trading halt pending an announcement relating to an acquisition and capital raising. Usually I am sceptical of acquisitions because all too often they result in a loss of shareholder value, however I was positive in this case because of the time taken by management to find a suitable target.

On Friday, the details were released and the deal looks promising. Prophecy will acquire eMite Pty Ltd for a combination of cash and shares. The upfront consideration is $4 million in cash and 6.3 million Prophecy shares. After earn outs, the total price is expected to be between $14.3 and $17.8 million depending on eMite's 2016 performance.

Prophecy are forecasting that eMite will deliver earnings before interest and tax (EBIT) of $3 million in 2016 which would trigger the maximum purchase price of $17.8 million, representing a price to EBIT multiple of 5.9x.

This is reasonable given eMite looks like a high growth business with world class technology. That is not just my opinion, in 2014 Gartner, the world's leading IT research and advisory company, awarded eMite one of the top two product scores for Infrastructure and Operations Business Value Dashboards. Furthermore, CIO Review Magazine selected eMite among the most promising technology companies in the US for 2014.

eMite appears to be a good fit with the existing Prophecy business. Prophecy's flagship product, Snare, has been growing quickly in recent years and boasts an extensive international client base which management will hope to use to help it increase eMite's sales.

The other piece of good news tucked away in the acquisition announcement was a new sales upgrade for Snare. Sales growth in 2015 was over 170%, which is an improvement on the 100% year-to-date growth figure that was most recently disclosed the last time I wrote about Prophecy.

Sales lead revenue and so profit growth in the existing Prophecy business is virtually guaranteed in 2016. Also, as software providers, Snare and eMite have low variable costs and receive payment upfront so most incremental revenue falls straight to the bottom line and cash flow generation is strong.

Perhaps the only negative last week was the dilution of existing shareholdings. In total, 8.6 million new shares will be issued increasing shares on issue by 15.5%. Of these shares, 2.3 million have been placed with new institutional investors at $1.09 per share, a 15% discount to the share price when the trading halt was announced last Wednesday. The remainder will be allocated to the eMite vendors as part payment for the company.

Overall, I am comfortable with the issue of both lots of shares despite the discount involved. The vendors have shown a commitment to the combined group in accepting a large equity stake as payment, whilst the institutional raising was very small and so the effect on existing holders is limited.

Earlier today, Prophecy was trading at $1.41 per share and net profit after tax (NPAT) is forecast to be $5.7 million in 2016 including the contribution from eMite. After adjusting for shares issued and other items related to the transaction including deferred consideration, Prophecy's enterprise value (EV) is $93.3 million. Therefore, it currently trades on a 2016 EV to NPAT ratio of 16.4x which appears to represent decent value.

Whilst there is no guarantee that the combined entity will hit management's profit targets, the eMite acquisition reinforces the view that Prophecy is a fast-growing company with heaps of potential.

Motley Fool contributor Matt Brazier owns shares of Prophecy International Holdings Ltd. You can find Matt on Twitter @MatthewBrazier1 The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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