Technology One (ASX: TNE) is Australia’s largest enterprise software company, providing products to over 1,300 corporations, government agencies, local councils, and universities. TNE’s product is essential with high switching costs, translating into a highly sicky user base. This ensures that TNE’s sales are resilient despite the macroeconomic backdrop, which has been on display over the past year, a time when we have witnessed widespread downgrades. Consequently, TNE shares have performed well – up 18% in 2023 and 47% in the past year. Our earlier report can be viewed by clicking here.
We have retained exposure to Technology One since recommending a Buy at $7.83 in 2021. We think this is a very good macro-resilient business, and its 1H23 results demonstrate the same. The numbers are in-line with expectations, and TNE’s outlook has come in slightly ahead of market consensus forecasts – resulting in shares going up ~3%. Since TNE migrated from their legacy business model to a SaaS-based model, the company’s growth has become stronger. TNE maintains a 99% retention rate, with 78% of its total revenue recurring. The fact that they are growing organically is keeping their costs in check and enhancing profitability – which the markets seem to love.
The highlights of the result were:
- Total revenue of $210.3m, up 22%
- SaaS Annual Recurring Revenue (ARR) of $316.3m, up 40%
- Revenue from our SaaS and Continuing Business of $200.0m, up 18%
- Profit After Tax of $41.3m, up 24%
- Cash and Cash Equivalents of $139.1m, up 20% from 1H22 (TNE has no debt)
- Cash Flow Generation of $1.3m
- Interim Dividend of 4.62cps, up 10% (ex-dividend date: 2nd June 2023)
- R&D expenditure (before capitalisation) of $49.4m, up 19%, which is 24% of revenue
- UK profit of $3.0m, up 29%
New Client Growth shows Macro Resilience
TNE has had a higher number of customers transitioning to their global SaaS ERP solution, with over 189 large enterprise customers committing to the shift in the past year, marking the highest number recorded for a comparable period.
TNE possesses a clear and consistent strategy, and its team is executing it effectively, delivering significant value to its customers. The number of large-scale enterprises’ SaaS customers has grown by 27% to 903. Their SaaS business is experiencing strong growth and has resulted in NPAT growing 24% and ARR rising 40%.
These impressive half-year results for Technology One affirm the strength of its SaaS strategy, driving substantial growth in both Australia and the UK.
During the period, they continued to achieve numerous new clients by securing strong customer partnerships, with twenty-five large-scale enterprise customers joining them in the first half. These include Hume City Council, City of Parramatta Council, and six Victorian water authorities in Australia, as well as Waikato District Council and Massey University in New Zealand, and London Business School, Liverpool School of Tropical Medicine, and Ashfield District Council in the UK. All of these organisations partnered with Technology One to streamline their operations, enabling more resources to be invested back into their businesses. In simple terms, TNE’s software allows its customers to optimally utilise resources and thus has a financial benefit. This makes the product a Need to Have rather than a Want to Have, giving TNE a healthy MOAT.
All Segments are Performing Well
Their Net Revenue Retention (NRR), which represents the net amount of new Annual Recurring Revenue (ARR) acquired and the retained ARR from existing customers, achieved 119% for the 12-month period ending on March 31, compared to 114% for the same period the previous year. This exceptional outcome surpasses the best practices within the ERP market, which typically range between 115% and 120%.
The UK business delivered almost the same amount of new ARR in the first half of FY23 as it did for the full year in FY22 and delivered profit before tax of $3.0m for the half-year, up 29%.
They anticipate meeting their target of 115% for the full year, which, by growing NRR at this rate, would allow them to double the size of their business every five years, showcasing the strength and resilience of their strategy.
TNE is demonstrating strong growth across all its segments. Software grew by 26%, driven by SaaS growth. The introduction of SaaS+ means that consulting revenue will decrease, given that TNE is looking to completely migrate from their Legacy business to SaaS. Corporate Profits are up 69%, driven by increased royalties generated by strong product sales, plus additional interest revenue received, in line with expectations.
On the geographical front, TNE has a huge total addressable market at its doorstep. Their APAC market penetration in any single vertical does not exceed 15%. The UK market is also deemed to be 3x larger than its current APAC market. Therefore, there is a significant growth runway ahead, and TNE is organically capturing it.
Strong growth is expected for the entire FY23, with the company identifying significant growth opportunities in the forthcoming years. As they continue to acquire more customers and expand their SaaS Platform globally, their profit margin is projected to expand as well.
Technology One has also maintained a significant investment in research and development (R&D), focusing on platforms that drive growth, including SaaS+ (Solution as a Service), App Builder, their Digital Experience Platform (DXP), and enhancing the functionality and capabilities of their global SaaS ERP solution.
Typically, Technology One’s cash flow generation is concentrated in the second half of the year, aligning with annual customer payment dates, resulting in negative cash flow during the first half. However, in this half-year, they achieved a break-even cash flow generation result, with cash and cash equivalents increased by 20% compared to the previous corresponding period. They expect strong cash flow generation for the entire year, representing approximately 90% of Net Profit After Tax (NPAT). Cash flow generation is expected to gradually align with NPAT starting from FY24.
Outlook – Solid Growth Trajectory Continues
TNE has been doubling in size every 5 years, and it is in a good position to achieve strong growth throughout the entire year. The company issued guidance; they expect growth in Net Profit Before Tax of 10% to 15% compared to FY22.
While aggressively expanding its SaaS business, TNE also aims to decrease their legacy license fee business, which is projected to amount to approximately $2.0 million for the entire year, a decrease from $10.0 million in the previous corresponding period (pcp). Although this will significantly impact their Profit and Loss statement for the year, it is an essential part of their strategy to foster growth in their SaaS business and strengthen their recurring revenue base.
Despite concerns regarding the deteriorating economic environment due to inflation and rising interest rates, Technology One should be able to sustain strong growth. Several factors contribute to their confidence:
- The markets they serve, such as local government, higher education, and government sectors, demonstrate resilience.
- During economic downturns, these customers turn to ERP software to enhance operational efficiencies. By utilising their global SaaS ERP solution, TNE’s customers can achieve savings of ~30%.
- Subscription revenue contracts incorporate inflation adjustments, enabling TNE to pass on added costs to their customers.
- TNE continues to benefit from improved profit margins due to the significant economies of scale derived from its unified global SaaS ERP solution.
In the long term, driven by the success of TNE’s global SaaS ERP solution, we can expect increased adoption of their products by existing customers, the acquisition of new customers, and global expansion.
The company is on track to achieve their long-term figures of Total Annual Recurring Revenue (ARR) of $500 million by FY26, surpassing its current base of $350.6 million. Investments in R&D to develop growth-oriented platforms should aid in maintaining their pace of doubling in size every five years. Furthermore, the economies of scale derived from the global SaaS ERP solution will continue to contribute to the expansion of their Profit Before Tax margin, which is projected to surpass 35%.
What’s Priced in?
For the full year FY23, markets have priced in $416 million in revenues, $178 million in EBITDA, and $100 million in Net Profit after Tax. This translates to a 13% growth in revenues and NPAT, and it means that markets expect TNE to grow organically without added costs to help boost its sales.
Given the growth ahead, TNE is trading at an FY23 forward P/E of 50x, which then reduces to 37x by FY25 as the full effects from its SaaS business model take effect. Is this a premium price? Relative to technology stocks, TNE is fairly valued. Given the market cycle, we should see TNE shares continuing to perform well.
Technology One delivered a 1H23 result that was in line with market expectations. They have demonstrated an ability to pass on inflationary costs to their customers and, as a result, kept their costs in check while continuing to grow revenues. The commentary on TNE’s full-year outlook was positive, as revenues are generally skewed to the second half of the year. Profit margins are expected to expand. We believe TNE is fairly valued at current prices. As such, we maintain our ‘Hold‘ recommendation.