When a company loads up its balance sheet to make an acquisition, that new business better deliver — and soon. Unfortunately for Legacy Holding DH Corp. (TSX: DH, OTC: DHIFF), the macro picture hasn’t cooperated.

In late October, the C$1.7 billion financial-technology firm announced third-quarter results that missed analyst estimates by 20.7%, while falling short on sales by 2.6%.

Adjusted earnings per share (EPS) dropped 21% year over year, to C$0.49, though sales managed to tick up by 1%, to C$417.7 million.

Adding insult to injury, management also issued guidance for full-year 2016 that was significantly worse than had been expected, leaving analysts racing to lower their forecasts.

Prior to DH’s earnings release, analysts had been expecting adjusted EPS to decline 8.2% year over year, to C$2.35, on sales growth of 12.4%, to C$1.72 billion. Not great, but not horrible either.

Now, adjusted EPS are projected to drop 21%, to C$2.03, on sales growth of 10%, to C$1.68 billion.

Beyond that, analysts lowered their estimates for adjusted EPS in 2017 and 2018 by 13.4% and 22.5%, respectively. While adjusted EPS are still expected to grow 10% annually over the next two fiscal years, previously they had been forecast to grow 16% annually.

Although projections that are more than a year out have a considerable degree of uncertainty, at the very least it looks like DH will experience a slower growth trajectory after earnings bottom out this year.

The market responded to these numbers with an absolutely punishing selloff: Shares of DH dropped 43.4% in a single day on 10 times the stock’s usual trading volume.

Cautious Customers

Management primarily attributes the company’s performance to a slowdown in technology spending among global banks in response to uncertain economic conditions.

That hit sales in DH’s Global Transaction Banking Solutions (GTBS) segment (22% of revenue), whose main contributor is FundTech, which the company acquired in April 2015 for US$1.3 billion.

This business provides global financial institutions with software that creates a payment hub to facilitate the flow of customer funds across products and currencies around the world.

In the past, FundTech has generated growth in the mid-teens, but more recently that growth has decelerated to the mid- to high-single digits, as banks defer spending.

And DH is hardly alone in this experience. Many of its peers have also reported that banks are dragging their heels on certain types of tech spending, such as payments and account management, to focus on compliance instead.

The other factor in the company’s performance was a faster-than-expected decline in a business that dates back to the company’s founding in the 19^th century: printing checks for Canadian banks.

This was originally the company’s main business and one that it dominates in its domestic market. However, DH has spent the past decade aggressively diversifying into financial technology (FinTech) via strategic acquisitions, and this legacy business now accounts for just 20% of revenue.

The managed decline of DH’s check-printing business had been expected to occur at a rate in the mid- to high-single digits. More ominously, however, check volumes dropped by 12% during the third quarter.

Hang On

The question for longtime shareholders is whether to hold or fold. Despite the alarming plunge in the share price, we think it’s worth taking a wait-and-see approach.

While DH’s third-quarter performance and full-year outlook were disappointing, they weren’t so bad that they warranted a selloff of such magnitude.

Part of the reason for the sharp drop in the stock may be due to the fact that DH’s investor base is dominated by retail investors, who hold more than two-thirds of the company’s shares outstanding.

Retail investors, particularly income investors, tend to spook much more easily than institutional investors, especially when poor earnings are followed by a slew of analyst downgrades.

Prior to its earnings release, DH had six “buys,” three “holds,” and one “sell.” Now it has three “buys,” seven “holds,” and zero “sells,” which means analyst sentiment has shifted to neutral.

However, it should be noted that three analysts who had been bearish or neutral on the stock upgraded their ratings. We’d be much more concerned if these analysts still didn’t like what they see even after the share price plummeted. Instead, they see opportunity.

Assuming things return to normal in the financial sector, DH could see delayed spending show up again at some point in the next few quarters, boosting earnings for those periods beyond what they’d usually be.

In the big picture, DH is striving to be a global FinTech powerhouse. It has a market-leading position in a number of areas, with significant room for future growth. And the fact that nearly 80% of its revenue is recurring (thanks to long-term contracts) means that it has a solid foundation upon which to build.

In the near term, however, leverage is a big concern.

DH took on substantial debt to acquire FundTech. The firm’s leverage had been expected to quickly decline as the new business boosted cash flows.

But while EBITDA (earnings before interest, taxation, depreciation and amortization) jumped 35% last year, it’s expected to decline by 7% this year. Even if the operating environment improves, it will take longer for leverage to go down than analysts had anticipated.

Although DH’s debt is unrated, which means it doesn’t have a credit rating to defend, it does have to abide by its lenders’ covenants. At the end of the third quarter, DH had a net debt to EBITDA ratio of 3.071x, which is well below the 3.50x specified by its covenants. However, leverage allowed by covenants will decline to 3.25x for the fourth quarter and to 3.0x thereafter.

It should be noted that the calculation for net debt to EBITDA for DH’s covenants is much more forgiving than the one we’d calculate normally. Mainly, it excludes the firm’s two convertible debentures, which total $460 million.

Assuming average cash and debt retirement, then based on EBITDA forecasts, DH is on track to have a net debt to EBITDA ratio of around 3.25x for the fourth quarter and 3.15x for the first quarter. Clearly, that’s a problem.

During the recent earnings call, management said it would be addressing the progressive step-downs in its covenant ratios with its lenders. So we would expect these covenants to be revised higher to give DH a bit more flexibility in the near to medium term. Here, it should be noted that many of DH’s lenders are also its customers.

Although management said supporting the dividend is one of its three main areas of focus right now, risk to the dividend is certainly elevated since lenders could pressure the firm to cut its payout.

For now, we think the selloff is overdone and would expect the share price to recover over the next 12 months. For their part, analysts have a consensus 12-month target price of C$23.06, which is nearly 50% higher than current levels. DH is now a Hold.