We recently reviewed TechnologyOne (TNE) after the Company reported its results for the six months to 31 March 2019 (1H19). The share price had suffered a de-rating following the release of 1H19 results. This was because accounting changes caused a larger rebasing of earnings than original guidance, market expectations prior to the results release were very high, and the shares benefited from a rotation towards technology stocks.
The shares are currently trading at the upper end of the historical 1-year forward P/E multiple range over the last four years (from ~27x to ~43x). Despite this, we have been happy to purchase TNE in the last few weeks for clients. This is against a backdrop of the Company having a strong medium-to-long-term earnings growth profile and continued rotation into technology stocks.
TechnologyOne is Australia’s largest enterprise resource planning (ERP) Software as a Service (SaaS) provider. The Company is the only SaaS provider with a fully integrated ERP suite. Its entire enterprise suite is delivered on mobile devices. Customers use TNE’s SaaS solution as the benefits include cost savings, scalability, security, and anywhere-anytime access. It also allows agility and speed to market of new products. These customers have hundreds of thousands of users. It makes TNE the largest ERP SaaS offering in Australia.
The business model entails TNE developing, marketing, selling, implementing, supporting and running its preconfigured solutions for customers across eight markets. Those markets are: government, local government, financial services, education, health and community services, asset intensive, project intensive and corporate.
Accelerated Cloud Offering the Key Value Driver
A key highlight of the 1H19 result was the rapid growth in the Company’s cloud offering and outline of aggressive growth targets. This in turn is the key factor underpinning expectations of mid double-digit NPAT growth over the next three years for the group. In particular:
i. TNE has a target to reach ~1000 SaaS customers by FY22 (currently 389). A key part of this strategy is to focus on existing customers, in particular increasing the number of products used by the existing customer base (which is sticky with a 99% retention rate).
ii. Further, SaaS Annual Contracted Value (ACV) is growing very fast (up 45%) and the contribution of cloud revenue has now increased to 29% of group revenue. Importantly, all new business growth is currently driven by SaaS, which is offsetting the decline in revenue from on-premise initial licence fees and annual licence fees. This reflects the customer transition from on-premise to the cloud.
UK Business Turning Around
One of the market concerns about TNE over the last 12-18 months has been the challenges in generating consistent and meaningful profits from the UK consultancy business. These have been mitigated by the strong performance of the Company’s Asia Pacific Consulting business. While this business has always been a small contributor to overall earnings, losses over a period of 10+ years called into question management’s allocation of capital to the UK business. This is because it could have been redirected into other, high-growth areas of the Company’s operations (i.e. accelerating the cloud offering) and/or complimentary acquisitions.
In regards to the latter, TNE has a net cash position of $68.2m as at 31 March 2019. The Company has virtually no debt, which provides the Company with scope to pursue further small bolt-on acquisitions (which have generally been integrated well), undertake capital management and continue undertaking Research & Development (R&D), which is focussed on developing TNE’s product suite for the cloud.
The UK business reported reduced losses for 1H19 result, by implementing a strategy that entails slowing down the rate of sales growth in order to optimise its product and focus on meeting customer requirements. This strategy has now provided the UK business with a path to sustainable profitability, with the Company commenting that the UK business is approaching a critical mass in the next two years. Further, four new customers were signed in 1H19 and TNE have pointed to a strong pipeline of work.
While there are short-term headwinds (i.e. declining free cashflow, higher expense growth), the ongoing transition of customers to cloud, while impacting revenue growth in the short term, underpins the strong medium-to-long-term earnings growth profile for TNE. Further, we consider that market concerns about the performance of the UK business is abating.
On 28 May in our client research, we commented that TNE is showing signs that the decline was possibly over. Further buying down near $7 on strong volumes has made us more confident that TNE has found a low. Current levels still represent a buying opportunity and we still like the company fundamentals. We believe that TNE can go on to retest the old highs later this year.