Is K3 Business Technology Group Plc a falling knife to catch after dropping 40% today?

As I write, shares of K3 Business Technology Group (LSE: KBT) are down just over 39% today on the release of a trading update containing a profit warning.

One-day falls like this can be a shocking event for a firm’s shareholders, but they also raise the possibility of increased value, particularly if it later proves that a share-price correction like this is overdone.

Is K3 Business Technology a falling knife to catch, or should we steer clear of the firm now it has run into operational problems?

Deal slippage

The software company provides end-to-end business technology solutions to the retail, manufacturing and distribution sectors. Back in March with the interim results statement, the directors reported some operational progress but warned that the results had suffered from deal slippage and overhead investment.

In today’s update, the directors are blunt, saying they now believe that the results for the year to 30 June 2017 will be “significantly below current market expectations.” That’s the opposite of what I want to hear from the firms I’ve invested in, but let’s dig deeper.

Although some major deals closed, the directors say, certain large enterprise contracts have not been secured as they expected. What we don’t know, and what the update doesn’t tell us, is why.

The wording in the update suggests that the work has been lost, perhaps in a competitive tendering situation or for some other reason, so I’m not counting on those contracts coming in during a later period.

Refocusing strategy

Yet there are reasons to be optimistic from this new share-price level. The update also reveals that operations elsewhere in the business are showing progress and decent cash flows. What the company describes as ‘pilot customers’ have been secured for the firm’s new cloud-based modular technologies, which the directors predict “will generate opportunities for both new and existing customers.”

However, there seems no doubt that this outcome is acting as a wake-up call for the firm and the directors tell us they’ve started a review of resources with the aim of refocusing the growth strategy around the firm’s cash-generating business units and the large installed customer base. 

To me, that sounds encouraging. Restructuring, change, and an overhaul and re-examination of strategy can all be positives within a business leading to new growth, and that could happen with K3 Business Technology Group.

Awaiting full-year figures

It’s hard to value the firm when we don’t know what full-year earnings will be, but as a reference, with a share price of 151p, the historical price-to-earnings ratio is just over six for the year to June 2016. The forward P/E rating will be higher, but we’ll have to wait for full-year earnings figures or the directors’ estimates to find out how much higher.

Meanwhile, there’s no mention, yet, of cutting the dividend, and last year’s payout comes out at a historical yield of almost 1.2%. That sounds low, but last year’s earnings covered the payout more than 13 times. The directors are clearly focused on growing the company rather paying out all the cash inflow with the dividend.

Overall, I reckon K3 Business Technology has a good chance of turning itself around and going on to grow from here. It could be one to watch.