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Gresham Technologies (LON: GHT) down 14% - this looks wrong, too much

Dropping a low value business segment should be positive, surely?

Update : 17 Nov 2023, 04:36 PM

Gresham Technologies (LON: GHT) shares are down 14% in London today. This looks to us wrong, too much of a reaction in fact. But then there’s another twist to the tale that makes it an understandable move. It depends upon what everyone thought was happening before to make sense of it.

The news itself: “Shares in Gresham Technologies plonked over 13 per cent on Friday morning after it told markets it is discontinuing its low-margin legacy service, costing it £8.5m. The software and services company said it has agreed with Australia and New Zealand Banking Group (ANZ), its largest customer by revenue, to “completely exit” the lower margin sub-contracting business, which provides IT freelancers to ANZ.”

In theory, if you drop low margin business then all of your revenue should be rated as high margin business. That should - could - lead to a rise, not a fall, in the share price. Think it through - a pe ratio is applied to earnings. That must be true. Rational investors will apply a higher ratio to better margin earnings. So, drop the lower stuff and then all of the remaining earnings should be higher rated.

Gresham Technologies share price from Google Finance

The corporate announcement: “In consultation with ANZ, the Company has agreed to completely exit the lower margin legacy sub-contracting business under which locally based freelance IT contractors are provided to the Bank on short-term agreements. The Company expects to recognise £8.5m in revenue from these agreements in FY23 with fixed margins of 13% and will discontinue the business from January 2024. The majority of the sub-contracting business has been reported as its own contracting services business segment, with a smaller proportion being reported within Clareti non-recurring revenue where a small number of contractors have been provided specifically as part of the Floe project. In line with the Group's strategy, these changes will accelerate the Group's transformation to a pure-play SaaS company and lead to an immediate improvement in gross and adjusted EBITDA margins.”

Which should be positive. Unless, unless….what if that £8.5 million wasn’t been broken out by investors? Instead, it was thought that that was similar high margin business like the SaaS work? Then losing that would indeed be negative. Not because losing the low margin business is a bad idea, but because it’s the realisation that it was low margin business.

If we think the first, that this should be a positive, then clearly this price movement is too much and in the wrong direction. So, which of the two possibilities do we believe?

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