TechnologyOne (TNE) was one of Australia’s first tech start-ups, pioneering configurable software to meet enterprise and government needs. It has since grown to become one of Australia’s largest tech companies since publicly listing in 1999. TNE targets six key markets: Local Government, Federal Government, Education, Health & Community Services, Asset & Project Intensive Industries and Financial Services & Corporates.
Consistent growth. Revenue has grown from $164m in FY12 to over $368m in FY22, a CAGR of 8.4%. The majority of this growth has been organic, with only a handful of acquisitions in 2015, and one in 2021. TNE has historically focussed on profitable growth, and has paid a growing dividend each financial year, starting at 5.09cps in FY12, to 15.02cps in FY22, a CAGR of 11.4% (not including special dividends).
Operating leverage. Profit before tax has risen from $30m to $112m from FY12 to FY22, a CAGR of 14.0%. This has been driven by increased operational leverage through efficiency gains, with margins rising from 19% to 30%. We expect margins to continue to improve in the future, with guidance for 35%+ “in the next few years”. The market is only forecasting margins to reach 34% in FY26, providing upside risk to earnings.
Customer growth and retention. TNE targets a customer churn rate of below 1% and has only gone above this twice in the last 10 years. By having a significant customer centric focus, TNE is able to effectively service and retain its customers, ensuring its product meets client needs. Further, many customers continue to adopt more of TNE’s product suite, with customers averaging 4.9 products in FY16, to now average 6.2 in FY22. This has led to historic Net Revenue Retention (NRR) of over 100%, reaching 116% in FY22.
Investment View
TNE has an incredibly sticky customer base which are increasingly adopting more products, leading to higher retention rates and revenues for little incremental cost. Operational leverage is clearly evident through increasing margins, with scope for further increases with scale. Whilst the industry is competitive, as TNE focuses on just six key end markets, it is able to much better tailor its products to specific customers, rather than trying to provide a solution for all users, providing a key competitive advantage.
The key issue then becomes valuation and what an appropriate price is to pay for a high quality, net cash balance sheet, recurring revenue software business growing earnings at 10-15%pa for the foreseeable future. Trading on an EV/EBITDA of 24x, 1 standard deviation above its average and an acquisition to effectively integrate, we initiate with a Hold until valuations become more attractive, or there is increasing evidence of earnings upgrades.
Business Overview
TechnologyOne (TNE) is an Australian-based software company that provides enterprise resource planning (ERP) software solutions to businesses and government organizations. The company was founded in 1987 and has since grown to become one of the largest enterprise software providers in the Asia-Pacific region.
TNE targets six key markets: Local Government, Federal Government, Education, Health & Community Services, Asset & Project Intensive Industries and Financial Services & Corporates. TNE has an accountable business model where it develops, markets, sells, implements and supports its own internally developed software. This is a key differentiation where other enterprise software customers often rely on resellers, meaning the product manufacturer does not have full control over the customer experience (for example budget overruns, poor implementation etc).
The main products (roughly 80% of revenue) are Financials, Student Management, Asset Management and Corporate Performance Management. TNE is confident it has a superior product for its niche areas, and better customer service than larger vendors. The enterprise suite sits on a single global code line, resulting in efficient implementations, low friction of adoption of additional muddles and lower total cost of ownership. As of FY22, TNE has 16 licensable products (with over 350 licensable modules) as seen below:
Figure 1: TNE’s extensive product suite, which continues to grow
Cornerstone Questions
Can historic growth rates continue?
In all verticals other than local government in Australia (where TNE is a leader), TNE currently has low penetration, where it can grow both through winning new customers and from adding additional modules to existing customers. This increased product adoption is evident through a strong Net Revenue Retention (NRR) consistently being above 100%, with TNE calling out that the average products per customer has risen from 4.9 to 6.2 from FY16 to FY22. There is also a significant geographic expansion potential, with the recent acquisition of Scientia (timetabling and scheduling software) signalling its intent to expand in the UK market.
As TNE converts on-premise customers to Software-as-a-Service (SaaS), this shifts the business model to an annual recurring revenue (ARR) stream, compared to a typical legacy one-off perpetual license. Further, SaaS customers purchase on average 1.0x-1.5x more modules versus on-premise customers, providing strong cross-selling opportunities. TNE detailed its strategy in 2018, where the legacy license fees were ~$70m, to now being close to $0 in FY22, allowing it to bring an end to the legacy arrangement. TNE is one of the only ERP companies that has successfully made the transition without impact its customers or its growth profile. With there only being a handful of adoptions to go, TNE can focus the entirety of its efforts to now growing the SaaS business.
Figure 2: NRR has been driven by increased product adoption
Earnings growth is also set to improve with operating leverage benefits. This is evidenced through the growth rate in the profit before tax margin, which has grown consistently over time from 18.5% in FY12, to 30.5% in FY22. EPS growth is forecast to grow at ~14.5%pa from FY22-FY25e. Margins in FY22 were impacted by the integration of the Scientia acquisition (which is lower margin), where organic margins would have been 32%. TNE has stated its target for 35%+ ‘in the next few years’. Consensus has not forecasted margins above 35% by FY26 (~33.9%), providing potential upside risk to earnings if higher margins are achieved earlier. We believe these are achievable driven by the significant economies of scale as well as from extracting synergies from the acquisition.
Figure 3: Profit before tax margin has been consistently improving, target of 35%+
Is the competitive advantage sustainable?
TNE’s niche focus on six key verticals allows it to develop deeper understandings and product offerings of those end markets, providing a key competitive advantage. Further, TNE encompasses the ‘power of one’ where it takes responsibility to build, market, sell, implement and support the software, compared to key competitors SAP and Oracle which often use partners such as Accenture to implement the software. This removes key friction points for customers which need to deal with several parties, compared to the ease of dealing with just the one. Implementation partners can often be costly with budget overruns and there is less accountability for product quality as the manufacturer does not have full control over the customer experience. TNE’s competitive advantage is largely evidenced by a churn rate that is largely <1% over the last decade. As customers adopt more products and transition to more cloud-based applications, TNE expect the churn rate to remain incredibly low, given the accountable business model and long-term relationships with customers.
Figure 4: Customer churn rate has been consistently low
The product suite continues to expand, having grown from 11 products in 2012 to 16 in 2022. TNE have significantly increased its investment in R&D from ~18% of revenue in FY18, to now ~25% in FY22, and this stepped-up level is expected to remain. This increase in R&D expenditure is expected to underpin its competitive advantage, spending above smaller peers to offer the best-in-class products. Whilst it’s not official guidance, TNE have indicated it will increase the product offerings to ~21 by 2031. Each module is expected to considerably increase the total addressable market, as well as provide incentive for existing customers to adopt more products. TNE also illustrate its forecasts for customers to average 8.9 products in 2031, up from the current 6.2. New products relating to the Digital Experience Platform (DXP), focussing on the customer-centric experience and the App Builder, allowing customers to create applications within the ecosystem with little training are key focus areas for product development and the main drivers of the increase in R&D spending. Whilst there is scope for the R&D spend as a % of revenue to fall lower as the company continues to scale, TNE have not provided any meaningful numerical guidance around this.
Figure 5: R&D investment has steadily increased over the years, underpinning growth
Are the target ambitions too conservative?
At the FY22 result, TNE reiterated its ambitions for FY26 ARR to be $500m+. We expect this is too conservative. TNE had originally set this target at the FY19 result for the $500m+ to be achieved in FY24. Covid had a significant impact on the growth of the business, before TNE announced in FY21 the FY26 target. Despite significant ARR growth in FY22, TNE still reiterated the guidance. The market is currently forecasting ~$535m revenue for FY25, which is well above the FY26 target. As a result, we largely expect TNE to either increase its ARR target or bring forward the goal to FY25 especially given the increased visibility TNE management have on revenue given the migration to annual recurring revenue SaaS contracts.
TNE have stated its ambition to ‘double in size every 5 years’ which implies a CAGR growth rate of ~15%. The significant R&D program is expected to underpin growth, extending functionality and capabilities of the product suite. The introduction of ‘Solution as a Service’ is also expected to drive growth through its bundling of implementation cost and delivery as a recurring subscription fee. The market is only forecasting a 13.0% revenue CAGR from FY23-26, which is below the ~15% required to double over the next 5 years. We view this growth rate as potentially at risk as TNE’s product offering has expanded, with growth underpinned by strong NRR and increased contract wins in new geographies such as the UK, however it remains to be seen what the true organic growth rate will look like until the FY23 results.
Historical revenue growth from FY17-FY22 was impacted by the migration of old legacy licenses to recurring subscription licenses. The majority of existing customers are now on the new subscription offerings, and TNE have guided that FY23 contribution will be negligible. Around ~80% of contracts are inflation linked, providing a valuable source of revenue growth.
Figure 6: Forecast revenue CAGR of 13% is below required rate to double every 5 years
Founder Adrian di Marco has left the building, are the current team capable?
The founder Adrian Di Marco officially retired from Chairman in June 2022, after being with the company for 35 years. Adrian remains a major shareholder of TNE with ~4.4% holding. The transition has been in progress for a while, with Edward Chung being appointed CEO in 2017 (taking the role from Adrian) after spending more than 10 years in senior executive roles at TNE. Edward has overseen a rapid period of growth for the company and has been instrumental in the transition into a fully SaaS-based organisation. The new Chairman Pat O’Sullivan has over 40 years’ experience and is currently chairman of Carsales.com and Siteminder. Another major shareholder is John Mactaggart (~8.3%), who has been on the board since 1999 and was instrumental in the funding and creation of TNE.
Valuation Considerations
TNE’s PER has expanded considerably as the company has scaled and transitioned into a SaaS business, however its earnings growth rate has not materially improved. The SaaS business model usually commands a premium to the market given its high-quality recurring revenue, however without earnings upgrades, the recently elevated PER becomes difficult to justify. Given the balance sheet is net cash, EV/EBITDA valuation may be more appropriate. Even on this metric, at 24x, it is trading 1 SD above its longer term average. The stock price has been heavily correlated with the EPS, and strong deviations from the line provide opportunities (both for buying and selling), whereas currently it sits in inline with the trajectory, indicating relatively fair value.
Figure 7: TNE expensive compared to most global peers, but with solid EPS growth and margin
Figure 8: Implied growth rate below current PER
Figure 9: Strong share price correlation with EPS
Figure 10: 10 year historical forward PER
Figure 11: 10 year historical forward EV/EBITDA
TNE is a highly cash generative business, evidenced by a strong correlation of NPAT and Cash Flow Generation (cash flow from operations less capitalised development costs) over its history. The recent deviation has been driven by occasional large legacy license transitions invoiced at the end of the year, but collected in the new year, leading to timing discrepancies. The high cash realisation indicates a quality company, where many companies often attempt to hide differences between profit and cash through creative accounting policies. We expect this correlation to continue, however significant deviations may need to be investigated.
Figure 12: Strong cash flow generation correlation with NPAT
Investment Thesis
TNE is a high quality business with recurring revenue and sticky customers. The migration of existing customers to the SaaS platform is largely complete, with revenue streams becoming more predictable. The customer churn rate has largely been below <1% over the last decade, indicating strong customer retention and deep relationships, especially in the government and education sectors. This is also evidenced through NRR consistently exceeding 100%, with customers increasing their average products from 4.9 in FY12 to 621 in FY22. TNE expect this to increase to 8.9 by 2031.
We believe TNE should be a company on everyone’s investment radar, however our main concern is on the right multiple to pay for the business. The current PER multiple of ~45x is looking stretched and above the 3 year average of ~40x. With a net cash balance sheet, TNE may be more appropriately valued on an EV/EBITDA ratio, where it is still expensive, currently trading at ~24x, compared to its 3 year average of ~23x. Further, companies which have just entered the ASX100 can often struggle for a short period as many small-midcap fund managers must sell the stock, and some large cap managers may see the stock as too small to purchase.
Whilst there is scope for earnings upgrades and a guidance improvement, there is also potential acquisition integration risk and a slowing of customer growth given macroeconomic concerns. We would like a lower multiple for the business, however note that the company has the ability to deliver consistent 10-15% eps growth for the foreseeable future. We initiate on TNE with a Hold recommendation, waiting on market weakness or clear upgrades to become more positive.
Risks to Investment View
