Shares in Technology One (ASX:TNE) started to recover in late 2022 after a challenging period for tech shares. While an uncertain outlook for global growth weighed on the shares, easing macro concerns as well as meaningful progress by the Company on its SaaS transition have supported a recent re-rating. Accordingly, we recently researched TNE to consider whether there is scope for further upside.
Overview of Technology One
Technology One (TNE) 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 and its entire enterprise suite is delivered on mobile devices. There are currently 15 products onto the new cloud native Ci Anywhere (CiA) SaaS platform. 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, making TNE’s 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. They are: government, local government, financial services, education, health and community services, asset intensive, project intensive and corporate.
Around 85% of revenue is generated from the government, education and health sectors (or ‘verticals’), which are highly defensive. The Company has a customer retention rate of +99% and very low customer churn rate.
In September 2021, the Company announced the acquisition of leading higher education software provider Scientia. The acquisition is part of TNE’s strategy to deliver a student-centric, end-to-end ERP SaaS solution for the Higher Education sector.
Key Fundamental Drivers
Upside Risk to Annual Recurring Revenue Target
Total Annual Recurring Revenue (ARR) for the 12 months to 30 September 2022 (FY22) increased by 25% to $320.7m. Of this amount, ARR from the SaaS offering was A$274.2m (+43% vs FY21) and was driven by an acceleration in the number of SaaS customers to 810 (+27% vs FY21). In addition, the Company’s deadline for the end of on-premise support on 24 October 2022 incentivised customers to shift to SaaS.
The Company remains well placed to meet its A$500m FY26 ARR target through a combination of further uplift from customers transitioning to SaaS, an increase in the number of customers, as well as a strategy to increase the number of products used by the existing customer base. TNE sees potential for further expansion of their addressable market, forecasting for their Total Addressable Market to increase over 180% between now and 2031. This is driven by increasing the wallet share opportunity within existing customers (from 6.2 products per customer in FY22 vs 15 available products), as well as new product launches.
TNE has ~1,200 enterprise customers, with 810 on the cloud as at FY22. The Company is targeting +90% of customers to be on the SaaS platform by FY26. From FY18-FY21, the increase in the number of customers on the SaaS platform has been in the range of 90-100. In FY22, the Company added 173 customers, which is above the limits of TNE’s customer integration capacity of ~100 additional customers per year onto the SaaS platform.
Assuming (conservatively) that the Company will add ~90 customers per year onto the SaaS platform by FY26, then the +90% will be comfortably achieved. Some of the additions will come from new customer growth, which has averaged around 23 net additions per year over a 3-year period to FY21.
Margin Targets Achievable
The Company reported a Profit Before Tax (PBT) margin of 30% for FY22. This was below FY21 partly as a result of margin dilution from the Scientia acquisition, which generates a PBT margin of 5%. Although the PBT margin was below the Company’s guidance of 31%, TNE has retained its 35% PBT target “in the next few years”, after increasing this target from 30% in 2021. Excluding the Scientia acquisition, the PBT margin in FY22 was 32%.
We consider the 35% PBT target to be achievable, as customers move to the SaaS model and as legacy costs of running both on-premise and SaaS support systems run down. Also, TNE is moving to change its fee structure for customers moving to CiA, from the historical “SaaS fee + implementation” model to a “one fee” all-inclusive model that shifts responsibility to TNE.
One of the risks in achieving the 35% PBT target is inflationary pressures on operating and CAPEX costs. While TNE has an established record of managing its cost base, accelerating growth could result in higher-than-expected costs – most importantly, wage inflation, given global technology talent shortages.
Net Cash Position Expected to Expand Further
TNE’s balance sheet remains in a net cash position. The cash balance as at 30 September 2022 was $175.9m, with no debt. Normally strong cashflow in 2H22 (as a higher % of annual invoice dates are weighted to the 2nd half) recovered the cash balance from a recent low of $116m as at 31 March 2022, as a result of TNE using internal funds to complete the acquisition of Scientia.
We expect the cash balance will continue to expand to FY25, as the Company executes on its SaaS transition. The increasing cash balance also provides TNE with capital management optionality (including the continuation of dividend payments) and enables the Company to fund R&D expenditure. This is expected to double over the next five years, as TNE aims to expand its addressable market by rolling out new products.
Technology One’s fundamentals are highly attractive, underpinned by a recurring revenue profile (>90%), low churn rates (<1%), a highly cash generative business model, a net cash balance sheet, a track record of consistent performance, achievable medium-term targets (ARR of $500m and PBT margin of 35% by FY26) and a 3-year EPS growth profile of +14% over FY22-25 on a CAGR basis.
With the shares currently trading on a 1-year forward P/E multiple of ~44x, which is above the upper end of the trading range over the last four years (35-43x), we consider that the market is starting to factor in TNE’s medium-term targets.
Evidence of a step-change in ARR performance in the UK following the Scientia acquisition, as well as maintaining a higher rate of additional customers per year onto the SaaS platform are two key factors that would support a more positive view on the shares.
TNE has trended very well since the lows in May. After making a new high at the end of January, it is natural to see it cool off from here. At this rate, we expect the current consolidation to end soon and for Technology One shares to resume their uptrend.
Michael Gable is managing director of Fairmont Equities.
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