Technology applications and kit get put through the ringer before they ever get near a business or consumer. Rugged testing makes sure they don't fizzle out, blow up or otherwise go pop when the 'on' switch is flicked. Cloud services, mobile devices and booming internet transaction volumes are just making the demands greater.


The market is huge, worth about $11.3 billion this year, according to researchers at Nelson Hall. Analysts at industry organisation TechNavio estimate an average 5.4% growth rate every year to 2016.


Here sits SQS (SQS:AIM), a specialist with over 30 years experience in supplying business customers with rugged testing and quality assurance for their IT systems and applications. The Cologne-based £108 million cap has been a favourite here at Shares; we flagged it as a Play of the Week (page 11 of PDF) back at the start of last year at 153.5p. The shares today stand at 388.5p, over 150% up.

SQS SFTWQUALITY SYS - Comparison Line Chart (Rebased to first)

Behind this re-rating story is an increasingly clever shift to managed services. Faced with intense competition and cost/pricing pressure, especially from the cohort of Indian rivals, SQS has banged its managed services drum hard, effectively getting customers to have rolling contracts where workloads can be adapted to suit client needs. This brings transparency for the business and offers SQS opportunities to up-sell extra services and tools, bolstering margins.


It's a shift that's paying off. While overall revenues rose just 5% in the six months to end June, sales in the field of managed services jumped 23.8%, and is today it's biggest single revenue contributor worth 40% of the overall income.


SQS has 'met or exceeded all the targets that the management team set out last September and it is clear that the company looks to the future, both short and medium term, with an appreciably higher degree of confidence than it did at this time last year', say Canaccord analysts.


As for the up-selling, managed services gross margins rose 300 basis points to 33.2% in the half, helping overall pre-tax profits and earnings to jump over 30% to €4.5 million and €0.12 respectively. Interestingly, average revenue per customer is up 15%, a trend also helped by carefully managing out smaller contracts/customers in favour of bigger ones with more testing workloads.


'As anticipated, managed services was the star once again,' claim Canaccord analysts. 'These results provide further evidence of the ongoing professionalisation of SQS since chief executive officer Diederik Vos took over a year ago.'


SQS has ambitions to be a £500 million company down the line and one of the ways it hopes to match that growth hope is with acquisitions, either adding scale or attacking niche markets.


Chief executive Diederik Vos highlights banking as one area SQS is watching closely. Pulling off such deals should be all the easier with net debt down to€10.3 million and likely to be close to zero come year end (assuming no acquisitions) and the share price on a less dilutive rating. Along the way we'd expect the re-rating story to keep going, especially having largely proven its managed services switch adds-up. A price/earnings (PE) multiple of 15 looks reasonable, which implies that the shares could hit 480p in the not too distant future.

Issue Date: 04 Sep 2013