Recurring Service Models And Microsoft Partnerships Will Secure IT Transformation

Key Takeaways

• Accelerating shift to subscriptions, security offerings, and top-tier vendor partnerships support more stable, higher-margin recurring revenue and net profit expansion.
  
• Enhanced demand from digital transformation, operational efficiency improvements, and strong device refresh cycles continue to fuel above-market growth and growing profitability.
  
• Heavy dependence on key partners, intensifying competition, IT commoditization, public sector in-sourcing, and talent shortages threaten revenue growth, margins, and long-term profitability.

Catalysts

Engages in the provision of information technology (IT) solutions and services in Australia, Fiji, and the Pacific Islands.

• The accelerating shift by customers to multiyear subscription and as-a-service models (evidenced by recurring revenue increasing to 69% and rapid expansion in Device-as-a-Service), positions Data#3 for higher, more stable, and predictable revenue and margin growth over time as the mix continues to improve.
  
• Enterprise and government digital transformation is driving robust demand for IT infrastructure upgrades, devices, cloud integration, and AI deployment-areas where Data#3 consistently grows ahead of the market, supported by record device refresh cycles and increasing public and education sector spend, boosting topline revenue and gross profit.
  
• Rising cybersecurity threats and stricter regulatory requirements have made security solutions a must-have for all customers; Data#3's expanded investments (e.g. security operations centre, new managed Microsoft security services), position it to continue benefiting from premium, higher-margin projects and increased contract values.
  
• Deep partnerships with major vendors (Microsoft, HP, Cisco, Adobe, etc.) and ongoing recognition as a leading partner provide exclusive/preferred supplier status and grant access to select incentive programs and implementations (e.g., Copilot, Azure AI, ECIF), supporting both existing recurring revenue streams and new high-value growth areas, thereby protecting and expanding net profit.
  
• Investment in automation, AI integration, and operational efficiency (internal use and customer consultancy) is reducing the company's cost ratio, improving operating leverage, and enabling margin expansion, thus supporting future earnings growth even as top-line revenue grows.

Data#3 Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Data#3's revenue will grow by 63.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 5.6% today to 1.7% in 3 years time.
• Analysts expect earnings to reach A$62.8 million (and earnings per share of A$0.4) by about September 2028, up from A$48.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 27.5x on those 2028 earnings, down from 29.3x today. This future PE is lower than the current PE for the AU IT industry at 37.6x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.26%, as per the Simply Wall St company report.

Data#3 Future Earnings Per Share Growth

Risks

• Heavy reliance on key vendor partnerships, especially Microsoft, exposes Data#3 to concentration risk; changes in Microsoft incentive structures (decreased channel incentives, reduced enterprise agreement rebates, and push to cloud programs) are already causing headwinds, particularly for the Software segment, and may lead to lower revenue growth and compressed margins if not offset by growth in other areas.
  
• Increased market competition and the growing strength of global IT providers and hyperscalers (Amazon, Microsoft, Google) could marginalize local system integrators like Data#3, making it more difficult to differentiate offerings, exerting downward pressure on pricing, and potentially shrinking the addressable market-impacting long-term revenue and earnings stability.
  
• Public sector in-sourcing, particularly in key regions such as Queensland and Canberra, reduces external consulting and contingent labor opportunities for Data#3's People Solutions and BA consulting businesses, directly impacting the services revenue stream and potentially lowering overall earnings growth in periods of increased government preference for internal delivery.
  
• Potential commoditization of IT services, especially with the rapid transition to as-a-service and subscription-based models, risks margin compression: as recurring revenue increases, a greater portion may come from lower-margin software and Device-as-a-Service contracts, challenging net margin expansion and reducing the predictability of earnings if cost structures are not continually optimized.
  
• Persistent IT skills shortages and rising wage inflation (noted at 5–6% staff cost increases), combined with the need to continually invest in technical certification and internal platforms, could limit Data#3's ability to scale high-value services profitably and erode EBITDA margins if talent acquisition or retention becomes more difficult in the face of global competition.

Valuation

• The analysts have a consensus price target of A$8.853 for Data#3 based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$9.76, and the most bearish reporting a price target of just A$8.3.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be A$3.7 billion, earnings will come to A$62.8 million, and it would be trading on a PE ratio of 27.5x, assuming you use a discount rate of 8.3%.
• Given the current share price of A$9.11, the analyst price target of A$8.85 is 2.9% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.