Perhaps cliché, but can’t resist to bring up a perfect quote of the legend himself (RIP):

“If you want to be a good investor, you have to have a long-term perspective. You have to be willing to be very patient and wait for the right pitch. And when you get the right pitch, you have to be ready to swing hard. You can’t just take a little teeny tiny swing. You have to swing with all your might.” - Charlie Munger

So what’s the fat pitch? Well, as the title gives away, this time for me it’s Shift4 payments . A stock that has dropped from its high of $127.50 a year ago to a 52w low of $52.65. Payment stocks in general have undergone tremendous multiple compression (see graph below) and hence poor stock performance the past twelve months. PayPal’s recent earnings meltdown certainly didn’t help, dragging the whole sector down with it, regardless of whether the comparisons made any sense.

While there are valid concerns to specifically FOUR as well, the scenario in my opinion reflects more a throwing the baby with the bathwater situation, rather than fundamental problems with the business itself. Nevertheless, for those more aware this can provide an opportunity one should swing for. If management meets its guidance (which it historically has and reconfirmed during Q3’25) of $1B in run-rate adj. FCF exiting 2027, the company is trading at a <6x multiple only two years from now. This also does not even factor in the recent $1B share buy-back authorization, through which the company can repurchase 17% (!) of the shares outstanding. In return, you get a company expected grow low- to mid-teens organically, with c. 50% adj. EBITDA margins, fixed operating cost base enabling operating leverage, M&A optionality, ~20% ROIC and a management team with a proven track-record. Sounds good no?

Slap a normalized cash flow multiple on the above assumptions and it’s not difficult to see the IRR potential. Below I’ll quickly present the company, outline the main risks and opportunities with the thesis, as well as a provide my view on valuation.

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Shift4 - Quick historical recap

For those still unaware, Shift4 Payments is a financial technology provider that enables businesses to accept payments and run their operations on one integrated platform. The company makes money mainly by taking a small fee from every transaction it processes, supplemented by subscription fees for its point-of-sale software. Its revenue is largely recurring with high switching costs for customers. Shift4’s competitive edge comes from bundling payments with vertical-specific software for clients like restaurants, hotels, and sports venues, which differentiates it from standard payment processors.

I won’t go into the nitty gritty details of the business model and industry. There are plenty of write-ups explaining this (recommend my buddy Fundasy’s write-up here) and the latest investor day presentation will get you far as well. The key points I recommend to consider are:

• Substantial historical growth (net revenue CAGR of 43% between FY20-LTM25) through both organic (stated by Management to be high-teens) and acquisitions. Revenues are furthermore largely recurring in nature as they are based on transaction volumes and subscription fees (though payment volumes can swing).

• Scalable business model with margin expansion as the operating cost base (excl. network fees) is mostly fixed or semi-fixed in nature. This enables lots of operating leverage, through which adj. EBITDA can grow faster than the topline (56% CAGR).

• Sustainable business model with high switching costs, hence lower churn leading to high net retention rates enabling the company to also grow from just the existing customer base.

• Increasingly diversified customer base as FOUR expands into new verticals and new geographies. Currently holds strong market share in restaurants, hospitality and sports & entertainment. Around 2/3 of income is currently from North America.

• Strong cash conversion as capex and NWC requirements are not excessive. Furthermore, much of capex (and CAC capitalizations) is growth orientated (POS terminal leases and software development) which in a more terminal state would decline a lot and increase cash conversion levels further. Moreover, deleveraging would also boost the adj. FCF conversion (see historical trend below).

• Management that has historically proven to be strong capital allocators with deep company and industry experience. Incentives are furthermore aligned with skin in the game through equity ownership (founder still owns 25%).

Shift4 - Key risks to watch

Below I’ll outline the main concerns, risks and opportunities that investors currently see in FOUR. Let’s start with the risks and partly why the stock has tumbled so much lately:

1. Succession/founder risk: Founder and ex-CEO Jared Isaacman recently resigned to become the head of NASA. Isaacman has been critical to FOUR’s success story, and naturally investors become concerned regarding leadership and strategy going forward. Isaacman has since been replaced by Taylor Lauber, close partner to Isaacman since 2018 and the previous president and Chief Strategy Officer of FOUR (and funnily enough one of FOUR’s first interns many years ago).

   My view: While I would’ve preferred Isaacman to stay, Lauber is on paper a perfect successor. He’s been involved in creating the company’s current strategy with Isaacman pre-IPO, has payment industry knowledge and capital allocation experience from his time at Blackstone and Merrill Lynch. In addition, Isaacman stays as executive chairman with a 25% ownership stake. Hence, the founder’s ethos and growth strategy are largely preserved. Furthermore, governance actually improves as Isaacman has to give up his super-voting shares. Following the conversion to common A-shares, Isaacman voting power drops from 76% to 25%. This reduction in founder dominance and Up-C structure collapse (see opportunity below) may attract more institutional investors.

2. Acquisition integration: FOUR has executed multiple acquisitions with the recent Global Blue (GB) acquisition being a major one at a $2.5B EV. Integrating this business and technology with FOUR’s platform presents execution challenges, from IT systems integration and product melding (e.g. rolling out unified POS that handles both payments and tax refunds) to cultural and regulatory navigation across jurisdictions. Additionally, the simultaneous integration of other deals (Smartpay, Bambora, plus ongoing roll-out of SkyTab POS to thousands of new sites from Revel/Vectron) means management is stretched across many projects. The risk is that post-merger synergies fail to materialize or, worse, that operational focus on the core business lapses, causing service issues or customer churn.

   My view: This is the most legitimate long‑term risk. That said, FOUR has a demonstrated playbook for M&A integration with no goodwill impairments to date. Management’s track record includes successfully absorbing companies and converting acquired clients to its platform (driving margin expansion to 50%). In fact, since the 2020 IPO, Shift4 has deployed $5.5B on acquisitions and growth investments which comparing to my 2026 estimates (when returns on these investments are more fully captured) yields ~$1.3B in incremental EBITDA (23% return), indicating solid execution and returns (so far). I do want to note that capturing payment volumes from the GB customer base (luxury giants like LVMH, Prada and Hermes) is tough due to lower take rates and strong competition (e.g. Adyen). Therefore, the achievement of synergies and capturing new volumes through GB will be a critical point of judgement regarding management’s post-M&A capabilities at scale. If successful, the FOUR M&A thesis de-risks significantly. However if management fails, the inorganic model becomes more questionable, ROIC drops and consequently the multiple will permanently become lower as the perceived quality of the business model declines. This is the risk I monitor most closely.

3. Organic growth quality: FOUR has guided for high-teens organic growth in net revenue, but there is skepticism about the purity of that metric. In Q3’25, reported organic growth was ~18%. However, some of this ‘organic’ uplift comes from converting merchants acquired in prior years (e.g. merchants from 2022–2024 acquisitions like VenueNext, Finaro now switching to FOUR processing). In other words, a portion of growth attributed to “organic” is actually integration-driven (formerly non-FOUR volumes now being monetized). This raised concern that true same-portfolio growth might be lower than advertised if conversions are masking a deceleration.

   My view: While the accounting nuance is valid, conversion-fueled growth is still real, recurring growth. FOUR’s strategy is to acquire customer bases and then cross-sell or upsell them; with the main example being converting gateway-only clients into full end-to-end processing clients (this can 4x income on an existing merchant alone). That revenue may stem from past acquisitions, but it is now effectively organic (no further M&A needed to achieve it). Importantly, it’s a lever that can continue for several years and given FOUR’s acquisitive model, I have a hard time seeing it not being a core growth component going forward. As of the Q3’25 report, FOUR has a $35B+ volume backlog of signed merchants pending activation, much of which comes from acquired networks like Vectron (65k EU merchants) and Revel (18k locations). Finally, even if FOUR would completely stop acquiring, the payment industry is still a GDP+ growing market in which FOUR is an innovative player and market share gainer. Hence, completely disregarding M&A effects, I still estimate high single-digit organic growth for FOUR, which does not warrant a single-digit cash flow multiple.

4. Capitalized CAC: A common critique FOUR has incurred that customer acquisition costs are not fully captured in the P&L, as the company capitalizes these costs which are then amortized over 4 years (hence not included in EBITDA at all). Furthermore, many customer are acquired through M&A, which is also capitalized on the BS and flows through investing cash flows. The argument is that this creates unfair comparisons to peers, such as Toast, who incur most of said costs through sales & marketing expenses on the P&L.

   My view: Again, from an accounting perspective this is correct. However, no decent analyst or investor looks solely at adj. EBITDA. The actual costs for customer acquisition costs outside M&A are captured within OCF, hence the adj. FCF figures the company presents. Regarding M&A, I’m more of an advocate that it does not truly matter whether growth is completely organic or inorganic. What matters is what the returns on those investments are. While FOUR manages to acquire merchants (largely through M&A) at $1000-$2000 per merchant, figures for peers as much higher (3x according to management), with Toast for example even having an average CAC of $20,000. Combining this with strong net retention rates, FOUR’s LTV/CAC becomes simply superior. In conclusion, I don’t care whether FOUR acquires customers through M&A, partnerships or an own sales representative. I care about the returns on the cash flows invested, which in this case are heavily in FOUR’s favor.

   “So in certain examples, we generally spend about 1/3 of what our largest and best competitor spends to acquire a customer in the restaurant vertical. It’s not to say we don’t invest in organic sales capabilities. We obviously do that. And we win lots of customers like the ones that you’ve mentioned. But if we can buy a sales team that has proven to be successful in a particular geography and then enable that team with our products, it’s just a lot easier to bet on success.” - Taylor Lauber, ICR Conference January 2026

   In addition, the ‘Netflix’ strategy of acquiring merchants and successful sales teams also reduces the risk of failure.

   “I was speaking to an investor recently who said, I liken your strategy a lot to Netflix. And what I mean by that is, why should I care whether you make a movie and produce the entire thing yourselves or if you go to Cannes and you buy one. Intuitively, I think you're going to be much lower risk buying the movie that's already been produced now that you've seen it, as long as you pay the right price, than making one from scratch.” - Taylor Lauber, ICR Conference January 2026

5. Debt load: FOUR has taken on substantial debt financing to fund its acquisitions spree. As of Q3’25, total debt was ~$4.7B (net debt ~$3.2B with $1.5B in cash), which is substantial in comparison to the company’s market cap. Based on my 2026 estimates, net debt stands at c. 2.4x adj. EBITDA and 4.7x adj. FCF. This raises concerns about interest burden (~$60 M/quarter).

   My view: While the debt level is certainly elevated, it is important to understand that (i) FOUR always has operated with relatively high leverage, and has a proven track-record of deleveraging, (ii) the debt load is relatively less significant if you factor in pro forma figures (see my 2026 estimates above), (iii) FOUR has strong cash flow generation that can be used to pay down debt and cover interest payments at the same time, (iv) most debt carries fixed interest rates (~6% blended) with 5+ year maturities and (v) FOUR has a BB- (stable) credit rating. Thus, although FOUR has a high absolute amount of debt, the company’s growing FCF provides a credible path to de-risking (if needed).

   

6. Payment commoditization: Payment processing is often viewed as a commodity service, with many providers racing to the bottom on fees. Major processors (Fiserv, Global Payments) and upstarts (Toast, Square) all offer payment acceptance, so merchants have choices and can pressure fees. This raises the risk of margin erosion for Shift4 if its offerings aren’t differentiated.

   My view: FOUR’s strategy explicitly counteracts commoditization by bundling payments with proprietary software and value-add services. Once Shift4’s tech is embedded in a merchant’s operations (POS, loyalty, analytics), switching isn’t trivial. The company becomes ‘essential infrastructure’ with high switching costs rather than a replaceable processor. This sticky integration grants pricing power, which can be seen from FOUR’s blended payment spread held at ~62 bps in Q3’25 even as it moved upmarket to larger clients. By contrast, pure-play processors often see spreads compress when serving bigger merchants. FOUR has avoided that fate by selling a full-stack solution that customers value (not just the lowest cost on swipe fees). Additionally, FOUR operates in verticals with specialized needs (e.g. stadiums’ POS for concessions, hotel property management links) where its tailored software creates a moat, which is harder to replicate by competitors.

   

7. Related-part transactions / governance issues: In January 2025, the SEC charged FOUR $750k with failing to disclose ~$4.7M of compensation paid between 2021–2023 to relatives of executives. For example, the CEO’s half-brother (now CCO Michael Isaacman) was paid $1.1 M/year as a non-exec employee, and the CEO’s father (Donald Isaacman) as board member (resigned August 2025). Moreover, FOUR pays for access to Jared Isaacman’s private jets and lodges.

   My view: I believe this is a proper yellow-flag and something one has to keep an eye on. However, the related-party payments were relatively immaterial financially and have been brought to light and are now properly reported. Importantly, with the founder’s impending Up-C collapse (converting his super-voting shares to one-share-one-vote), FOUR will no longer be a ‘controlled company' and must fully comply with NYSE independent governance rules. With founder control waning and greater board independence, FOUR’s governance is maturing from a founder-controlled startup to a more typical public company structure.

8. Macro Environment (cyclicality): FOUR is highly exposed to consumer discretionary spending through restaurant and hospitality customers. Management has commented ‘modestly worsening same-store sales’ in restaurants and hotels during Q3’25 and Q4’25. High inflation and rising interest rates could crimp consumer spending on dining and travel, directly reducing merchants’ payment volumes. A recession would similarly significantly impact FOUR (as most businesses…)

   My view: Not much to comment here, it is what it is. Although it is worth highlighting that FOUR is diversifying to new verticals (e.g., luxury retail) and geographies, which reduces cyclicality somewhat. Also, even when SSS growth if flat or negative, FOUR can still report positive overall growth due to new customer wins and backlog conversions (for example, FOUR still grew during Covid-19).

9. AI risk: Probably the main concern for investors right now for software-like companies is the lower barrier for entry due to AI (‘vibe-coding’). This has also put question marks on FOUR’s model regarding its moat. The risk would be if a competitor leverages AI to drastically lower costs or create a superior integrated solution.

   My view: Payment processing can’t be vibe‑coded because moving money is one of the most tightly regulated, high‑risk, zero‑tolerance-for-error activities in tech. Every transaction must comply simultaneously with PCI-DSS security rules, anti–money laundering laws, KYC identity requirements, sanctions screenings, card‑network operating regulations, and state and international financial regulations. Any deviation can lead to fines, chargeback liabilities, frozen accounts, or losing the ability to process cards entirely. Beyond compliance, processors operate in a threat landscape full of fraud, synthetic identities, and automated attacks, all while maintaining near‑perfect uptime, precise ledgers, deterministic workflows, and fully auditable controls. In other words, payment systems must be engineered with the rigor of financial infrastructure, not vibe-coding from someone’s basement. If anything, I believe AI will increase internal productivity and facilitate M&A integrations. In the long-term, this should become margin accretive to the business, hence in my opinion more a positive rather than a negative.

10. Regulatory considerations: As mentioned before, payments is a highly regulated industry with AML regulations, fraud protection and IT cyberattacks. Nevertheless, a more recent risk that has come up is the proposed 10% Credit Card Interest Rate Cap Act. This act would significantly suppress interest income from revolving balances. If issuers can’t pass along higher interest, this incentivizes them to reduce cardholder benefits, lower credit limits, or shut down riskier accounts, leading to fewer transactions and lower interchange volume for FOUR. Fewer transactions mean reduced processing fees, eroding both revenue and fixed-cost absorption in their unit economics. Indirectly, as banks tighten underwriting, merchants may see lower card usage among customers, reducing purchase frequency and ticket sizes. This further contracts FOUR’s volumes, hence revenues.

    My view: The interest rate cap is solely a temporary proposal and not even approved yet. If it were to go into effect, I do think some negative impacts will incur on volumes. However, I also believe consumers will find ‘other ways’ to consume (e.g. BNPL). So, while a net negative, I do not believe this will have consequences on the terminal value of FOUR.

As can be seen from the list, there are lots of factors to keep track of that make the investment thesis more complex that it seems at surface level. However, as I’ve expressed in my views above, I believe most of these risks are mitigated, and to some extent even provide opportunities as well.

Shift4 - Opportunities going forward

Now that we have discussed the risks and potential downsides, let’s dive deeper into the upsides to the thesis:

1. Pessimistic outlook on organic growth: Recent reports from payment companies such as Visa, Mastercard and American express exhibited that consumer spending has remained robust and continued to do so in January 2026. Furthermore, alternative data such as OpenTable indicates further growth in comparison to the previous year. Many analysts have, based on management comments, adjusted their growth assumptions downwards. While I believe some caution is needed, the set-up looks a lot like what we call in Sweden ‘Analytikermassage’, where management indirectly adjusts analysts’ expectations to avoid any surprises at earnings releases. Given the recent change in CFO, I expect there to be some sandbagging so the new CFO can under promise and overdeliver. This might in the short-term have a negative impact if 2026 guidance comes in soft.

   Nevertheless, despite the heavy M&A, FOUR’s underlying business has strong momentum and the conversion of acquired customer bases provides a multi-year tailwind. For example, Vectron’s 65k EU restaurants mostly use non-integrated terminals today. FOUR is integrating its payments into those venues, representing a surge of new ‘organic’ volume without new sales effort. Management noted it activated $6B+ of new volume in Q3’25 and still has $35B signed volume not yet live (pipeline). This implies that even without fresh wins, the next several quarters will see robust growth as backlog merchants go live. In addition, converting customers from just gateway processing to full end-to-end processing is a massive boost to topline and profitability. Looking ahead, product initiatives like SkyTab POS are still ramping and a new all-in-one POS terminal in collaboration with GB including VAT refund and DCC services is being developed for launch in 2026. In conclusion, I think FOUR has several levers that can maintain organic growth in the teens going forward

   

2. International expansion: FOUR historically earned ~90%+ revenue in the U.S., but is now aggressively going global. The Finaro acquisition (closed 2023) gave it direct acquiring licenses across Europe, Israel, and Asia. In July 2025 it acquired Global Blue, instantly adding operations in 50+ countries (Global Blue serves 300k+ merchants for VAT refunds in Europe and Asia). This not only diversifies FOUR geographically but also creates an untapped opportunity for acquiring new merchants. In Australia/New Zealand, the pending Smartpay acquisition (closing Q1 2026) brings ~11k merchants. FOUR’s international expansion is a game-changer as it sizeably increases the company’s growth runway. If FOUR realizes even a modest share of payment volume from Global Blue’s client base, and scales its presence in Europe, international revenue could significantly expand in the coming years. Importantly, international merchants often have fewer integrated solutions available, meaning FOUR can fill a gap in those markets. The CEO has stated before that the international markets are similar to the US 15-20 years ago, hence ripe for disruption and a fully integrated platforms like FOUR’s.

   

3. New verticals & use-cases: FOUR has already expanded beyond its legacy restaurant niche into sport venues (VenueNext), gaming/casinos, hospitality, specialty retail, nonprofits, and now through the GB acquisition in luxury retail. These expansions show FOUR’s platform is adaptable and not limited to restaurants. Each vertical has its own software requirements, which FOUR mostly acquired or partnered to obtain that domain expertise (e.g., acquiring an events-ticketing platform for stadiums). The result is a broad ‘omni-vertical’ offering, which not only increases revenue opportunities but also reduces reliance on any single industry. As these newer verticals ramp up, they contribute incremental high-margin revenue (often leveraging the same core processing infrastructure). Essentially, each successful vertical entry acts like a mini ‘startup’ inside Shift4 with massive scaling potential. Given the early wins and acquisitions in place, it’s likely FOUR will further monetize industries like casinos, theme parks, airlines (GB gives airline relationships for duty-free) etc. In addition to to verticals, FOUR ca also expand through increasing its product suite to customers. A recent example of this is the launch of their global stablecoin settlement platform, which enables instant settlements and moving of money 24/7 through crypto.

   

4. M&A optionality: Although leverage is currently stretched, it is reasonable to expect more tuck-in and opportunistic M&A going forward from FOUR that will aid the international and vertical expansion mentioned above. This optionality also means FOUR can opportunistically acquire technology or customer portfolios to accelerate its roadmap. For instance, in late 2025 it agreed to buy Bambora North America (Worldline’s business) which brings 140k SMB merchants via 500 software partners, a big boost to its distribution network in hospitality. Because Shift4’s core platform is already built, incremental acquisitions tend to be bolt-ons that can be integrated relatively quickly (1–2 quarters). With valuations in fintech contracting FOUR will also be able to buy companies at more reasonable prices. While large, transformative M&A is likely on pause (debt is being managed down), smaller deals (like software providers or regional payment portfolios) can continue. Essentially, FOUR has proven itself as a consolidator in a fragmented industry and has an ongoing opportunity to build an even stronger, more comprehensive company over time. This M&A upside is something analysts typically don’t forecast, mostly given its complexity and lumpiness. However, if executed correctly, there are plenty of examples out there (e.g., serial acquirers) that have proven this can generate significant alpha (if performed at a good ROIC).

   

   

5. Potential take-private or buyout ‘floor’: FOUR’s management has openly suggested the company is undervalued by public markets, and has received multiple acquisition offers from strategic suitors at prices ‘materially higher’ than its stock price ($64 early 2024). Isaacman and the board rejected those offers, indicating they didn’t reflect Shift4’s growth trajectory. However, the interest from players like Amadeus Group and Fiserv (rumored) demonstrates a high floor value for the business. In addition, Isaacman has historically hinted at going private due to frustration of public market valuations. In summary, while the goal is to remain independent and keep compounding value, shareholders have a nice fallback. If the public market won’t credit FOUR appropriately, a private buyer likely will at a premium to the current stock price (<$60).

6. Share Buybacks: Management always has different avenues to which it can allocate capital: (i) organic growth initiatives, (ii) M&A, (iii) buybacks or (iv) dividends. Capital allocation is considered a core competency by management, which their track-record and previous experience proves. In November 2025, FOUR authorized a $1B share repurchase (about 17% of shares) which seems like a rationale decision given current valuations (~5x. run-rate FCF exiting 2027). I believe the below quote from the most recent earnings call says it all.

   “I wouldn’t be able to discuss capital allocation without the notable dislocation in our own valuation despite the continued performance and numerous opportunities we see ahead. In short, our own equity is one of the more attractive opportunities we see. And with expanding cash flows and accelerated deleveraging, we simply can’t ignore it. To that end, our Board has authorized the new $1 billion stock repurchase program, which is the largest in our history. We will be implementing a plan to purchase at what we view as highly attractive levels right away.” - Taylor Lauber, Q3’25 earnings call

7. Up-C structure collapse (governance unlock): In Dec 2025, Jared Isaacman agreed to collapse Shift4’s Up‑C dual-class structure, a move with significant shareholder benefits. Within 60 days of starting as head of NASA (mid-February 2026), he will convert all his Class B & C super-voting shares to ordinary Class A shares and terminate the Tax Receivable Agreement (TRA) with FOUR. First, ending the TRA removes the $542M liability which likely will be negotiated down (expect result to be announced with Q4 earnings). Second, collapsing the Up-C means Shift4 is no longer a “controlled” company. Its corporate governance profile improves, all directors will be elected by the same Class A vote, and the company must meet stricter independence requirements. This should appeal to a broader investor base (some institutions avoid controlled companies). It may also lead to index inclusion potential down the road, as dual-class stocks are sometimes limited in indices. Furthermore, Isaacman’s voting power goes from ~76% to about 25%, meaning minority investors gain a greater voice. In short, by February 2026, FOUR will be a cleaner story that attracts a broader range of investors.

8. FIFA world cup 2026: A more minor, but still interesting upside in the short-term is the FIFA world cup that is being held in the US, Canada and Mexico this summer. FOUR has a strong presence in World Cup venues, notably it powers payments at MetLife Stadium, which will host the World Cup Final and 7 other matches, as well as many other stadiums likely used in the tournament. Moreover, the World Cup is a global proof-point for FOUR’s technology. Successful execution (fast transactions for huge crowds) will enhance its credibility with other large venues worldwide. It’s essentially a live advertisement, which could translate into new client wins. Also, World Cup tourists boost spending in hotels, restaurants, events, many of which may be FOUR clients in host cities. For example, FOUR serves major hotel chains and restaurants in places like Miami, LA, and Dallas, where merchants should see a surge in volume.

In conclusion, I believe many of the risks associated with FOUR are exaggerated and do not warrant the company trading at the multiple it currently does. Combining that with the opportunities outlined above, I’m in the camp that finds it more likely that FOUR will overdeliver going forward, which the market at some point has to value.

Shift4 - My take on valuation

Finally, the juicy part! As mentioned multiple times, management targets $1B in adj. FCF as exit run-rate for 2027E. This guidance was presented during the investor day in February 2025, and was reconfirmed in November during Q3’25 earnings. Knowing that, at 100.7m in fully-diluted shares (including conversion of preference shares, outstanding SBC commitments and up-c collapse) and a $58 share price, we get a 5.8x run-rate multiple on those cash flows only two years out. Applying for example a 10x-15x LTM exit multiple range on those assumptions gives a stock price range of $85-$127, significant upside to today’s $58 share price. Below I highlight IRR outcomes based on different FY27E exit multiples and net revenue CAGRs, while assuming EBITDA margin expansion to 51.2% and 55% adj. FCF conversion. As you can see, the chance of exceptional returns is high to say the least…

Now utilizing different FY27E adj. FCF outcomes, the results are still mostly dark green.

Now the above tables do not even factor in the $1B buyback, which can repurchase c. 17% of current shares outstanding. In the sensitivity table below, I try to outline the new IRRs, based on different average repurchase prices, while keeping the NR, margins and cash conversion in line with the calculation above. Starting to see a pattern in these results?

The above calculations are a bit rough but rather than being exactly wrong, they are likely more directionally correct (consistently confirming 20%+ IRR potential. Again, extremely low exit multiples are required for the stock to underperform in the next two years. Frankly, I do not believe at all that FOUR, given its business model, warrants such a multiple discount in comparison to the overall market.

In addition to the simplified exercise above, I’ve also performed a more detailed DCF with 2029 exit multiple approach on UFCF (also considering the debt load, minority interest etc.). The outcome of this (which can be seen below), still shows significant upside to today’s price, all while not even factoring the use of accumulated cash flows on new M&A targets and buybacks.

In conclusion, I believe that FOUR currently is stupidly cheap with substantial upside potential. I think the market is being irrational regarding the business model quality and sustainability of merchant acquirers, ascribing these business multiples way below the overall market, while in my opinion being equal, if not superior, businesses (yes I think GPN and FISV are also too cheap). Specifically regarding FOUR, I think investors are placing too much emphasis on the potential risks I’ve outlined above and fail to see the forest through the trees (e.g., looking at ND/EBITDA ratios on an LTM instead of pro forma basis…). Combining that with the opportunities I mentioned, FOUR is in my opinion a ‘swing big’ opportunity right now, hence currently represents 80%+ of my portfolio. Big mistake? Time will tell I suppose…

Disclaimer: I’m long Shift4 Payments at the time of writing this post. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

People that have followed me for a while and know my investment style are aware that I’ve a weakness for quality compounders. Durable, growing cash flows with high reinvestment rates are truly a sight to behold, however often come with hefty price tags that turn value investors’ stomachs upside down. These ‘compounder bro’ stocks therefore create certain division within the investor base, with one side praising the stock to >50x earnings, citing historical performance and top percentile CAGR even if you invested at a 100x P/E in 1999. The other, more skeptical, side throws Buffet quotes your way and pitches their 2x earnings coal miner from South Africa.

As usual, the ‘truth’ lies in the middle and gravitates more towards the common term Growth At a Reasonable Price (GARP). In other words, quality often warrants a premium, but its size is what makes and breaks portfolio CAGRs.

Below, I’ll outline five quality businesses that I believe are trading at or close to fair value that I’m closely tracking, and that fit my investment criteria. As always, this is not financial advice and do your own due diligence.

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1. Indutrade

Indutrade AB ($9.8b EV) is a decentralized industrial group that acquires and operates 200+ niche B2B companies worldwide. These subsidiaries sell technical components, systems, and services (e.g. valves, sensors, hydraulics) to a broad range of industries. Revenues are diversified across sectors and geographies, and a large portion comes from recurring customer needs (maintenance, consumables) rather than one-off projects. Indutrade’s edge lies in its “local champion” strategy, where it acquires well-managed niche leaders and lets them run independently, preserving entrepreneurial drive and customer loyalty. This fuels steady organic growth and a pipeline of acquisitions.

The group has compounded earnings and topline at a 11% CAGR over the past five years with solid returns on capital (15% EBITA margins & 20%+ ROCE). The stock has however remained flat over the past four years as the EBITDA multiple compressed from 30x at the end of 2021 to around 17x today, which is more in line with historical averages (excl. post-covid boom).

While the stock is still not ‘cheap’ per se, I have a hard time seeing the next five years perform worse than the past five. Going forward, I see a high-quality business with a disciplined capital management approach that can deliver sustainable, profitable growth (slightly above GDP organically + HSD inorganic). Combining this with limited multiple contraction and a c. 1% dividend, I believe low- to mid-DD returns are feasible.

Tempting buy zone: low 200’s

2. CSW Industrials

CSW Industrials ($4.7b EV) is a diversified industrial company that generates revenue by selling a broad range of niche products for critical applications in construction, HVAC/R, and heavy industrial markets. The company’s income is earned primarily from one-time sales of specialty consumables and engineered equipment, supplemented by recurring demand as customers repurchase consumable products for maintenance and repair needs. Similar to Indutrade, CSW combines GDP-like organic growth with acquisitions, which has led to HDD revenue and earnings growth over the past five years. In contrast to Indutrade, CSW boasts higher gross (~45%) and EBITDA (~25%) margins.

The stock experienced a tremendous run-up during 2024, doubling in price and seeing its multiple expand alongside it. Post-covid in April 2021, it took over 2 years for the stock to exceed the price level at a similar multiple as the 2024 peak. Hence it has not been surprising to see the stock being currently down >20% YTD and losing close to 34% of its value at the October lows, from which it has recovered over the past two months.

I believe CSW is an interesting compounder that, similar to Indutrade, can easily continue to grow earnings at a DD rate going forward, especially following the relatively large acquisition of Aspen in March this year. The company still has modest debt levels, providing plenty of additional ammunition to make interesting acquisitions and continue the compounding journey.

Tempting buy zone: ~240

3. Judges Scientific

Judges Scientific ($0.6b EV) is a UK-based buy-and-build group in the scientific instruments sector. The company grows by acquiring small niche instrument manufacturers and helping them expand, while also driving organic growth in its subsidiaries. Judges makes money by selling specialized scientific equipment (and related services) globally to laboratories, universities, industrial R&D departments, and testing agencies. This model yields high margins (gross margin ~60–65%, operating ~20–25% in normal years) and strong cash flows (operating cash conversion ~90%+), reflecting solid economic quality. The group’s edge lies in its disciplined acquisition strategy (buying companies at 3–7× EBIT) and the defensible niches of its products, which together result in durable returns (historical DD revenue and EBIT CAGR and ROIC comfortably >15%). Key risks include the cyclical nature of research spending (e.g. recent US funding cuts and China slowdown) and succession risk, with long-term CEO and founder David Cicurel stepping back in February 2026.

Judges has recently faced a wave of negative news, primarily based on the risks mentioned above. While I believe near-term growth will be limited, the company should do well over the long-term and get back to consistent DD earnings growth. Regarding succession, David will remain on the board overseeing the business model and acquisition process. His successor, Tim Prestidge, brings considerable experience from Halma (another successful UK serial acquirer) and joined Judges in February 2023. At face value, he seems like a strong replacement, despite the big shoes he has to fil.

Judges’s stock has currently been flat for five years, despite revenues and earnings having close to doubled. YTD the stock is down >30%, even after a +25% rebound from recent lows. The market seems to me to be in “wait-and-see” mode with the stock’s return to an upward trajectory dependent on upcoming results and acquisitions. Given the historical track-record of the company with regards to fundamentals, I believe the current price at c. 13x EBITDA (lower end of its historical range) is attractive and will likely reward patient investors in the long-run.

Tempting buy zone: below 6,000

4. Mainstreet Equity Corp.

Mainstreet Equity Corp ($2.4b EV) is a Canadian residential real estate company that makes money by acquiring undervalued mid-market apartment buildings, renovating them, and renting them out at higher market rates. This model has produced steady, high-margin rental income and strong growth in asset values (NAV). The company’s economics are solid: it enjoys ~67% operating margins on its rental revenue and has historically compounded its portfolio and cash flows at mid- to high-DD rates. Mainstreet’s edge lies in its focus on a niche (smaller apartment properties that larger investors overlook) and in efficiencies from clustering buildings, which together yield above-average returns. Key risks include sensitivity to interest rates (due to significant use of debt), government policy changes and rising vacancy rates.

I’m generally not a REIT-focused investor, but Mainstreet has always caught my eye. Its long-term FFO growth (15%+ CAGR) is impressive, alongside 50% insider ownership and a driven founder in Bob Dhillon. Combine that with structural growth drivers (immigration + housing shortage), a fragmented market ripe for consolidation, solid unit economics, and disciplined capital allocation, and you get a proper compounder cocktail.

Mainstreet is currently trading close to its historical average, which during that period has delivered outstanding returns. In my opinion, the present valuation is fair: it’s not a deep bargain that assumes zero growth (those would be like 10x FFO or less), but it’s also not baking in outrageous assumptions (the stock isn’t at 30x FFO). Hence, Mainstreet poses an interesting investment opportunity for those looking to add a solid REIT compounder and believe in Mainstreet’s growth story. Limited multiple contraction alongside continued FFO growth should result in DD annual returns.

Tempting buy zone: 160-180

5. Constellation Software + family

Probably the most widely discussed stock within the quality investing circles right now is Constellation Software ($54b EV), currently experiencing its largest drawdown historically (which are rare and often not extreme). For those unfamiliar, Constellation Software makes money by acquiring and managing hundreds of small vertical market software businesses that provide mission-critical solutions with high switching costs in niche industries. Its revenue is largely recurring with high margins and cash conversion. Cash flows are reinvested at high ROIC (targeting >20% IRR on deals). Key risks that have recently impacted the stock price include AI disruption risk and a leadership transition with founder Mark Leonard (commonly considered the GOAT of capital allocation) stepping back due to health reasons.

First, while Mark Leonard has been pivotal to Constellation’s success, I believe his stepping back has been blown out of proportion. The capital allocation approach and playbook he created are deeply embedded in the company’s culture. Moreover, his successor, current COO Mark Miller, has executed this playbook for over 25 years. Hence, I see no material risk to the strategy going forward. Regarding AI, I do see this as a more substantial risk, as it could lower barriers to entry and potentially commoditize core software products. However, I’ll take time to assess any real impact. On the flip side, one could argue that (i) Constellation’s software products are extremely niche and difficult to replicate due to complex regulatory and operational requirements, (ii) switching costs are high, and customers value stability and compliance over cutting-edge tech, and (iii) portfolio companies can leverage AI themselves with better data and expertise (AI startups don’t necessarily have an ‘edge’).

Constellation is down >30% over the past twelve months, whereas family members Topicus and Lumine also have dropped significantly from their 2025 highs (same goes for VMS peer Vitec in Sweden). Given my views on the risk outlined above, I do believe this presents an interesting opportunity to invest in the CSU family. The reinvestment runway remains substantial (VMS is a huge market), allowing the company to keep deploying capital at high rates of return. With a c. 4% forward FCF yield and mid-DD FCF growth expectations for the medium-term going forward, I think a lot would have to go wrong for the company not to deliver a DD CAGR over the next five years.

Tempting buy zone: below 3,000

Anyhow, these are just a few examples of interesting stocks I’m currently watching. Let me know if you like this format or have suggestions for improvement, maybe I’ll turn it into a series going forward. Also, share your favorite pick below or drop your own idea in the comments!

• GLG operates in a stable, non-cyclical market that exhibits mid-single digit annual growth on average. Furthermore, this market demonstrates a high degree of localisation and fragmentation with GLG, despite being a leading player, holding a market share below 5%. Moreover, in recent years the company has expanded its operations beyond the Swedish borders, thereby amplifying the potential for market consolidation. The combination of organic and inorganic growth avenues positions the company favourably to achieve sustained double-digit growth rates over an extended period of time.

• The company is led by CEO Johan Nordström, who together with most of his team has been running the business since 2015 after turning around the company’s strategy from its inception in 2009. Since his appointment, the focus has been on profitable growth through a decentralised structure and operational efficiency, heavily inspired by the DBS framework from Danaher Corporation. Management owns >20% of the company with 6.6% owned by Johan Nordström and 1.7% by GLG’s chairman of the board and Instalco’s CEO Per Sjöstrand.

• GLG currently trades at a 5% reported UFCF yield adjusted for financial leases. Through a continuation of organic growth in line with the market, disciplined acquisitions and slight margin improvements, I derive a fair value range of approximately SEK 70-78 for 10%-15% IRR.

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Note: this write-up will be less detailed and more to the point than usual due to time constraints. For more detailed discussions, feel free to reach out through this platform or twitter.

Green Landscaping Group - Business Model

The company consists of 49 operating subsidiaries and is active within three main service areas:

1. Ground maintenance (~50%): largest service area concerned with renovation and maintenance of grounds and green areas. Typical work involves cleaning, lawn mowing, pruning, planting, harvesting and road maintenance. Contracts typically run for three to five years, with the option to extend for an additional two to four years. For housing cooperatives, contracts are typically one year, with annual renewal. Customers are primarily county councils, municipalities, property managers, property companies and others who own or manage green areas

   associated with urban development.

2. Landscaping and construction (~35%): design and construction of green

   outdoor environments. This service is not limited to just planting trees and plants, but also includes factors like soil quality, drainage, and irrigation systems to ensure the long-term health and sustainability of the landscape. Project areas include marketplaces, residential outdoor environments, parks, churchyards, playgrounds and recreation sites with 3-6 month contracts valued in the range of SEK 1–20 million. Furthermore, landscaping and construction services exhibit a close interrelation with ground maintenance services and are often seen as an upsell opportunity within the scope of ground maintenance contracts. Customer mainly include municipalities, municipal companies and construction companies.

3. Road maintenance and snow & ice removal (15%): the name explains itself. This service area is obviously more seasonal in nature, with contracts often starting in September running through early May at the latest. Contracts include fixed prices for resource readiness, as well as remuneration for each service occasion. Apart from regular snow and ice removal, the company also offers de-icing preparations through salt/sand/gravel mixtures, including collection services by sweepers post-season. If you are a heavy advocate of global warming and believe that the Nordics will be the next Costa del Sol, you might want to write off this income steam.

As mentioned before, many of the company’s maintenance contracts extend over multiple years of time. This naturally imposes a risk of cost inflation, which has especially been a relevant topic as of late. Nevertheless, this risk is mitigated by the fact that most of the customer agreements with a longer duration contain indexation clauses that adjust prices based on inflation. These indexations typically occur on an annual basis, which is why there is a small delay between costs elevations and price adjustments.

The company has three main financial targets, namely (i) 10% annual growth (both organic and inorganic), (ii) 8% EBITA margin and (iii) pro forma ND/EBITDA of below 2.5x GLG strategy focuses on profitable growth, that combines single-digit organic growth rates with a decentralised acquisition approach. The company describes targets with annual sales between SEK 30-150 million to be the sweet spot with further focus on (i) possibility of achieving synergies in delivery and purchasing, (ii) long-term customer relationships and profitable contract portfolios, (iii) strong local brands and (iv) skilled entrepreneurs who have fostered a healthy organisational culture with competent management teams. On top of this, GLG also performs smaller bolt-on acquisitions with annual sales around SEK 20 million that require the same criteria but often are integrated/absorbed into existing operations post-acquisition. As said above, GLG utilises, like many serial acquirers, a decentralised approach where acquired companies operate as an autonomous subsidiary with their own PnL. Acquisitions are commonly also partly financed through equity in order to bring the entrepreneurs on as investors in GLG.

Below you’ll find a self-compiled overview of historic acquisitions. Note that annual sales figures are taken from the company’s reports, whereas paid multiples are my own rough estimations. These estimations also do not take acquired net cash (debt) into account, hence the real multiple paid is most likely a bit lower. If I had a gun to my head, my conclusion would be that GLG pays around 5x EV/EBITDA for its acquisitions and targets 15%-20%+ returns on their investments.

A final, yet important, note of the company’s strategy is their focus on profitability enhancements and efficiency through an internal control system and team called LEAN. This system is based on four cornerstones: planning, daily control, continuous improvement and ongoing follow-up. These cornerstones aim to facilitate higher work efficiency, improved processes and reduced costs. The LEAN team serves as a catalyst for spreading best practice between companies and is led by Pierre Kubalski, who takes inspiration from his ex-employer Danaher and their approach of focusing on creating a culture of continuous learning and improvement (i.e. Kaizen).

Green Landscaping Group - Industry & Competition

GLG operates in a large, non-cyclical market that is highly fragmented and localised with over 18.000 companies in the Nordics alone. The presence of fragmentation becomes evident as the aggregate market share held by the leading three players in each Nordic country is below 15% (often even below 10%). The company estimates its addressable market to total around SEK 105 billion, split between Sweden (SEK 40b), Norway (SEK 44b) Finland (SEK 16b) and Lithuania (SEK 6b). This corresponds to a current market share of approximately 7% in Sweden, 4% in Norway and 1% in Finland and Lithuania combined. However what is perhaps more interesting is that GLG recently entered the German market through its acquisition of Schmitt & Scalzo GmbH. The CFO mentioned during a recent presentation that the DACH market is similar to the Nordics, meaning lots of smaller players with less large competitors. Furthermore, it was mentioned that the amount of companies in Germany alone is about 4x the size of the Nordic market, significantly enhancing the company’s opportunity and runway for market consolidation.

The Swedish market has historically grown around 4%, which due to low inflation has mainly been volume driven. Moreover, municipal spending as percentage of total budget has been relatively low ranging around 5%-6%, making it more immune to budget costs and hence more resilient to economic fluctuations. The Norwegian market has shown slightly higher growth rates, mainly due to increased regulations regarding quality assurances (e.g. special service licenses are required to participate in contract procurements). This has also led to higher price levels and profitability, as service companies can demand higher compensation for skilled labour. Lastly, the Finnish market can be considered the most immature of the three, being much more fragmented than its Nordic peers with top three players holding less than 5% market share.

The company has exposure to both the private and public sectors, being slightly more tilted to the latter (~60%). This market provides stable and recurring income streams through long-term relationships and contracts. Furthermore, the overall market is supported by industry trends such as population growth, urbanization (including higher expectations on green urban areas) and climate change (ESG).

Regarding competitive advantages, customers that offer major contracts often put specific requirements on suppliers and they use structured tendering processes. This creates barriers to entry for smaller companies in the market, which in combination with GLG’s full service offering (from construction to maintenance) provides the business with a competitive edge.

Green Landscaping Group - Opportunities & Risks

Below I’ve summarised my interpretation of the company’s key opportunities and risks.

Opportunities:

• Continued market consolidation within existing markets.

• Geographical expansion with medium-term focus on the DACH region.

• Margin improvement through the internal control system LEAN.

• Acquisition of higher margin targets outside of Sweden. For instance, Norwegian targets typically exhibit elevated profit margins attributable to heightened delivery standards, resulting in comparatively higher pricing levels.

• Improvement of legacy and underperforming subsidiaries (10 companies with <5% EBITA margin).

• Above market organic growth by capturing more market share.

Risks:

• Interest rates, which substantially affect the company’s debt levels and cash flows. The recent increase in the interest rate environment is generally not a net positive for serial acquirers, although a positive aspect is that competition for deals decreases.

• Poor M&A performance (ROIC < WACC).

• Weather conditions. Warm winters result into worse performance for the group.

• Increased competition. Barriers to entry are relatively minor for smaller projects, which leads to more competitive tender biddings and hence lower margins.

Green Landscaping Group - Management & Ownership

GLG’s background can be divided into two parts. Firstly, the company was founded in 2009 through the merger of several landscaping businesses by a private equity firm. For several years the company’s strategy was an aggressive focus on net sales growth, but it lacked underlying stability and profitability. Which brings us into the second part which is when current CEO Johan Nordström was appointed in 2015. Together with his team, he managed to build more stability and shifted the strategy to focus more towards improved margins, quality, customer satisfaction and productivity (i.e. profitable growth).

For detailed information regarding the management, follow this link. The common trait one can identify by looking into management’s experiences is a history of turnaround cases and strong focus on efficiency and continuous improvements. Again, lots of inspiration is derived here from Danaher (stated on their own “Our History” page), which is not coincidental given that the head of LEAN operations, Pierre Kubalski, has previous work experience at Danaher.

Management is incentivized through stock warrants and bonus schemes (capped at 50% of fixed annual salary) based on numerous performance metrics such as growth, profitability, working capital, cash flows, leverage levels and other soft factors. However, the main incentive in my opinion is management’s skin in the game. CEO Johan Nordström holds 6.6% of the company’s shares, which equals >50x his annual remuneration. Management (both at group and local levels) own >20% of the shares in total. Other significant shareholders worth highlighting are Staffan Salén (long-time board member / chairman of real estate giant Sagax) and chairman of the board Per Sjöstrand (CEO of Instalco, a serial acquirer within installation services). In conclusion, both the management team and the board demonstrate a commendable level of competence.

Green Landscaping Group - Key Financials

Please note that the figures provided herein and those to follow are solely derived from reported data. The company has not presented pro forma figures, which may result in certain comparisons not being like-for-like.

GLG has undergone an impressive growth journey over the recent years, which for the majority has been driven by acquisitions. During this growth phase, margins have also expanded mostly due to improvements in legacy businesses (older BUs with profitability issues) and margin-accretive acquisitions. From FY18, the company has performed a revenue CAGR of 41.8%, whereas EBITDA has compounded at 76.0% annually.

However, it is important to consider that the company has performed an IPO and a rights issue during this timeframe, utilising the raised funds to accelerate the acquisition strategy. Moreover, the company has used equity to partially finance their acquisitions and provide incentives to local management teams. This has led to a share dilution CAGR of 9.3% over the aforementioned period. Nevertheless, examining the growth on a per share basis still presents remarkable results with a revenue per share CAGR of 29.8% and EBITDA per share CAGR of 61.1%. Evaluating the historic period, my calculations show that approximately 88% of the net sales growth has been driven by M&A and foreign exchange effects, with the remaining 12% being derived from organic initiatives. Again, organic growth rates have historically ranged around 5% for the markets GLG is currently active in. These growth rates have recently been slightly elevated due to a post-covid rebound and higher inflation levels.

GLG has also continuously grown its order backlog alongside the topline growth. Due to the long-term nature of mostly maintenance contracts, the order backlog is not an exact approximation of near-term sales. The back log has historically ranged between 1.5x-2x LTM revenues and still provides, despite the above, certain insights on the company’s sales direction (see correlation between both trajectories).

Examining GLG’s cost base, it’s obvious that main cost items are related to personnel expenses. Direct costs (e.g. project workers, sub-contractors, materials etc.) have averaged around 45.2% over the historical period. Despite some swings (mainly during covid), these costs have remained relatively stable over time in relation to sales. Remuneration to overhead employees has averaged 31.9% historically and has demonstrated more operating leverage over time standing at 28.3% as of the LTMMar23 period. Other external costs and operating expenses experienced slight reclassifications of admin, recruitment and external services costs in FY22, but have as a sum remained stable between 13%-14% of net sales over time. EBITDA margins have, as mentioned before, expanded rapidly during the recent years, going from 4.7% in FY18 up to 11.8% in LTMMar23, resulting into best-in-class margins for its market. However, I consider it unlikely that GLG can continue the expansion trend in a similar pace as it meets natural resource (i.e. people) constraints. I believe incremental margins (~12%-14%) provide a reasonable indication of where the margin ceiling might be.

Looking at GLG’s capital returns in the graph below, we can observe a historical uptrend, which does not come as a surprise given the margin uplift the company has experienced (remember, higher ROIC drills down to margin improvements and/or capital turnover). Due to the acquisitive nature of the business, combined with some capex and working capital requirements, GLG’s capital return ratios are in my opinion mediocre. The positive part is that the company does create value as ROIC > WACC, yet incremental improvements appear to be limited at 12%-13% (see ROIIC). I’ve added an adjusted ROIC calculation that excludes goodwill for illustration purposes, however it’s not a ratio I consider appropriate given the acquisition strategy of the business.

Further examination of the company’s balance sheets shows that the main assets consist of intangibles (i.e. goodwill, customer relationships and brands) and leases, whereas liabilities are primarily related to loans. Net working capital constitutes mostly of receivables, payables and other current liabilities. NWC has historically experienced some swings but seems to average between 1%-1.5% of revenues. Lastly, GLG has had quite some leverage in the past (>3x ND/EBITDA) but currently holds a leverage ratio of 2.2x pro forma EBITDA. I consider this level neither a cause for concern nor low.

GLG’s cash flow has improved in-line with what can be expected looking at the PL items. UFCF margin (before leases) has improved from -2.1% in FY18 to 8.4% over the LTM period. UFCF per share has compounded at a 47.8% CAGR since FY19, while capex as percentage of revenue has averaged at 2% historically. However, the major caveat here is that margins are much lower if you adjust for financial leases. Converting these leases to an operational nature decrease UFCF margins by approximately 3ppt (5.0% over the LTM period). Looking at the relationship between reported EBITDA and a lease adjusted version of UFCF, cash conversion seems to range around 40% in a normalised situation. This is an important aspect to have in the back of your mind while looking at EBITDA numbers or multiples. While I still believe EBITDA development is a good proxy for the business, a good rule of thumb is to divide EBITDA numbers by 2.5 (or multiply EBITDA multiple by 2.5) in order to arrive at good enough estimation of cash flows.

Green Landscaping Group - Valuation

GLG currently trades at SEK 73 per share with a market cap of approximately SEK 4.2b, which according to my calculations corresponds to a 5% adjusted UFCF yield. The company trades <10x LTM EV/EBITDA on a reported figures, which is lower on a pro forma basis given recent acquisitions. From the graph below we can see that GLG is currently trading at a discount compared to its historic average from IPO (on a reported basis) and even below one standard deviation of the average.

So at a first glance, GLG might appear cheap. Below is a quick comparison screen against fellow landscaping stocks and service/installation businesses with an M&A approach. What stands out is that multiples overall are relatively low, which can be explained by the limited scalability of the business model combined with rather slim margins. Moreover, return on equity/capital/assets are modest across the board. Yet, what stands out to me is that GLG appears to be trading in-line or below peers, while boasting stronger growth rates, margins and capital returns than the average. This represents a discount that in my eyes seems unwarranted.

To isolate GLG and obtain a better grasp on potential forward returns, I’ve constructed a relatively straight-forward DCF that takes both organic and inorganic growth into account. The main assumptions from the model for the FY23E-FY27E period are:

• 5% organic combined with 10% inorganic net sales growth CAGR from FY24 and forward

• Number of acquisitions to average around 9 per year with an average deal size of SEK 64m (i.e. SEK 100m in annual sales). Average paid multiples of 5x EBITDA and 0.6x sales.

• Group EBITDA margin going from 11.8% to 12.9% in FY27E.

• Capex to average 2.2% of net sales, NWC to decrease from 1.6% to 1.2% of net sales and financial lease payments steady at 3.4% of net sales.

• UFCF conversion to average at 39% over time improving slightly year over year.

Combining these assumptions with a 10% discount rate and 15x pro forma UFCF exit multiple gives me a fair valuation of SEK 70. If the current trading multiple remains stable at exit, I believe there exists a good opportunity for >15% IRR given the company’s ability to grow free cash flow per share above this rate.

Green Landscaping Group - Conclusion

Green Landscaping Group is considered a leading player in a highly fragmented market, operating a decentralised structure that emphasises operational efficiency and profitable growth. The business presents in my opinion an attractive roll-up investment opportunity due to its stable market, potential for market consolidation, and growth prospects. With a focus on organic and inorganic growth, GLG has the ability to achieve sustained double-digit growth rates over a long period of time. Furthermore, the management team and board demonstrate a high level of competence and ownership, which further supports the company's prospects for success. While the company’s financials aren't exceptional given the business model and industry, it still supports plenty of opportunities for value creation. GLG is currently trading at historically low multiples and from my perspective an unwarranted discount to peers. Its current valuation suggests a potential for above market rate returns and a 15% IRR without relying on multiple expansion. Although I do not own the stock at the time of writing, I will seriously consider a position if it trades below SEK 70.

Disclaimer: I have no position in Green Landscaping Group at the time of writing this report. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

• Teqnion enjoys strong growth durability due to a combination of organic and inorganic opportunities. Its business strategy of acquiring industrial niches with a 5-year free cash flow payback period enables high returns on invested capital and consequently value creation. Despite a 40% sales CAGR from FY16 accompanied by margin expansions, Teqnion still remains in its early days with a market cap of <10% compared to regional peers.

• Teqnion is a founder-led business run by Johan Steene, who continues to retain a sizeable personal stake with a 5.8% ownership. Additionally, the company is characterised by a high degree of insider ownership with over 40% being held by individuals within management and the board. Steene has together with his team and partner in crime Daniel Zhang managed to establish a diversified industrial group with a culture that can be described as both disciplined and down-to-earth. The current management team is relatively young with many more years left in the engine, driven to continue the company’s success story.

• Teqnion exhibits impressive growth with high capital efficiency ratios and essentially zero dilution. The company's historical cash flows have been remarkably strong with relatively high cash conversion ratios due to the modest requirements for capital expenditures. However, the cyclical nature of the business is evident through fluctuations in working capital, particularly with regards to inventory levels. The company currently trades at 16x. reported LTM EV/EBITDA, which is slightly above its historic average. Given numerous assumptions based on a disciplined continuation of the historical strategy, I believe Teqnion is currently not trading far from a fair valuation and holds room for substantial upside.

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Teqnion’s business model

Teqnion was founded in 2006 by the current CEO Johan Steene, who together with his partners at the time envisioned to build an industrial conglomerate at a much faster pace than peers had accomplished before them (i.e. Indutrade and Addtech). However, blue skies during the favourable industrial time of 2006 quickly turned into dark clouds as the Global Financial Crisis hit. One of the partners decided to quit and the subsidiary UpTech Norden AB filed for bankruptcy. Steene had to basically start from scratch again, although this time he was determined to build in a slower and more sustainable manner.

Fast forward more than a decade, Teqnion has grown to a group consisting of 24 individual businesses, each specialized in an industrial/technical niche. Companies range from subcontractors performing steel cutting and welding services to manufacturers of food trucks and wheelchairs. The individual companies generally boast revenues between 25m-100m SEK and are almost consistently profitable. For FY21, I estimate the top 5 businesses to account for 41% of total net sales and 46% of total EBITDA. In terms of geographical distribution, sales exposure is primarily concentrated in Sweden (estimate ~80%), but the company also has a presence and is expanding into other regions such as Europe, the United States and Japan. In short, despite the presence of certain concentrations, Teqnion already exemplifies a decent level of diversification through its niches and amount of subsidiaries. Diversification is a key focus point for management as “the whole is greater than the sum of its parts”. Below you’ll find illustrations of my estimations regarding top line and EBITDA contribution per subsidiary. I’ve taken figures for the FY19-FY21 period due to yearly fluctuations, which distort the view if it were only based on one financial year. Additionally, be aware that there’s a significant difference between top 5 contributors for sales and EBITDA as a consequence of different margin profiles between the subsidiaries.

Teqnion’s strategy is rather clear and consistent: expanding through a combination of organic growth and quality acquisitions. When evaluating potential acquisition targets, Teqnion focuses on factors such as sustainable cash flows, profitability (> 10% net income margin), strong returns on capital, solid market/niche position, minimal business risks and cultural compatibility (i.e. entrepreneurial mindsets). Furthermore, Teqnion strives for simplicity by acquiring companies with easy to understand business models and does not engage in buying “förhoppningsbolag” or turn-arounds. The cash flows generated by the acquired subsidiaries are reinvested into new acquisitions following the criteria above, creating a repeating growth cycle: “The cash flows from our operations are reinvested in new cash flows that are invested in new cash flows...”. Acquisitions are always conducted in cash (no share issuances!) for 100% of the shares (two exceptions) consisting of a 50/50 split between own cash and bank loans. I’m personally a fan of this approach as it reduces post-deal conflicts and minimises the risk for reckless investments. Teqnion has stated in their IPO prospect that they target 5x. P/E or 4x. EV/EBIT acquisition multiples. However, my impression is that this is not a religious benchmark, with the main aim rather being to earn their investment back within 5 years through cash flows. Analysing historic acquisitions and adjusting for outliers, I estimate multiples to be around 6x. EBITDA on average. Given organic growth and margin expansion post-deals, the estimate seems to be reasonable but perhaps a bit on the high-end (e.g. unrewarded earn-outs are included in the EV)

As said before, Teqnion utilises a decentralised approach where autonomy remains within the subsidiary to encourage the entrepreneurial spirit, or in Steene’s words: “We do not control, we support”. This support comes in the form of strategic aid, organisational development and financial resources from the holding company (from now referred to as HQ). Teqnion does not aim to achieve ‘typical cost synergies’ by centralising common functions, such as IT, finance, HR and legal. The reasoning behind this is to not lose competence and undermine the acquired company’s culture. Acquired companies often consist of small teams where individuals can be seen as family members. This leads to that those responsible for accounting are often much more than just accounting. Management states that through experience they have learned that interference in order to achieve standard cost synergies does not lead to the desired results.

Teqnion’s approach appears to have been quite successful so far as acquired companies still tend to improve their margins while continuing to report high single-digit organic growth rates. After discussions with management, it appears that margin improvement is mostly derived from two soft factors: strategic help and knowledge sharing. Firstly, HQ supports its subsidiaries wherever needed and always assures that the subsidiary does not feel like they are on their own. Since HQ has a more independent and broader overview on the subsidiaries’ operations, they are often more capable of identifying common or repetitive mistakes, for which they then recommend (not order!) solutions for improvement. A more concrete example for this is pricing. As a standalone company, subsidiaries are often more reluctant to raise prices as they fear the downside (customer loss or even bankruptcy). However, as a part of Teqnion the subsidiaries have additional support, are not end-responsible and even hold a sort of safety net. More often than not, the implemented price hikes turn out to be successful and value accretive due to increased confidence in local management teams. Secondly, the cross-sharing of knowledge also enhances company margins. More concrete examples of this is sharing of supplier contacts, prices and production methods. All of these increase efficiency and decrease direct costs, hence lead to higher margins. Teqnion holds two meetings for CEOs per year where they hope to achieve not only cross-sharing of knowledge, but also group cohesion and an unified business culture.

As a group, the company follows three main financial targets:

1. Net debt / EBITDA < 2.5: This is directly derived from Steene’s experience during Teqnion’s early years in that there are no shortcuts. In order to minimise risks and building something sustainable, financial stability is crucial.

2. EBITA margin >9%: Again, profitability is a core principle within Teqnion. High margins and accretive returns are a key requirement for new projects and acquisitions.

3. Double earnings per share at least every 5 years: After the two points mentioned above Teqnion aims to improve shareholder value by increasing profits per share.

These targets are in my opinion not necessarily unique (plus a bit conservative apart from the leverage ratio) and follow a classic serial acquirer playbook. Nevertheless, this playbook has been proven to enable exceptional results with regards to value creation. If it ain’t broke, don’t fix it. The company used to have a dividend policy, however I’ve been informed this will cease to exist so it can be reinvested into the business instead. This is something I applaud since dividends are in my opinion not the best use of capital right now for Teqnion considering their reinvestment opportunities.

Given all the points mentioned before, I believe management has a good grasp on how to operate the business model and create sustainable value for shareholders. A sentence I personally love to hear from CXO Daniel Zhang (the “M&A general"): “We are religiously disciplined when it comes to capital allocation.”

Industry & Competition

Since Teqnion owns numerous companies in various niches, the company is engaged in different industries and end-customers. The company had previously adopted a reporting framework that was segmented into the categories of Niche, Growth, and Industry. However, management has recently decided to discontinue this method, as it was found that the categorisations were not utilised internally by the company and were deemed to have limited significance (with which I agree). Nevertheless, in an attempt to still categorise Teqnion’s subsidiaries, I’ve identified the following main exposures:

1. Construction: Teqnion owns a few companies that provide or are involved in the production of building materials and the design of houses.

2. Infrastructure: Subsidiaries providing equipment, tools and services to infrastructure related projects, such as railways, trains, cars, trucks and trailers.

3. Electrification: Exposure to electronical components and safety products.

4. Defence: Subsidiaries providing equipment, materials and services to military organizations and marine customers.

5. MedTech: Subsidiaries providing laboratories with medical technology products and consumables.

I believe it is critical to note that the exposure to different industries is quite dynamic for Teqnion. The composition of industries present today is vastly different from that of just a mere couple of years ago. It is also certain that the balance and diversity of industries will continue to shift in the future as the number of subsidiaries can be expected to approximately double in the next five years. Management has described Teqnion as a canvas that they just started painting, where there’s a certain idea in their head but the end-result remains unknown.

It is however notable that the majority of subsidiaries possess some form of industrial sector exposure and are primarily concentrated on Sweden. As is commonly known, the industrial sector is subject to cyclical fluctuations, and as such, Teqnion is also subject to these fluctuations. Nevertheless, it can be argued that the presence of niche industries within the company helps to mitigate any performance dips. For example, companies with defence and electrification exposure currently offset declines in performance for construction companies. Consequently, the cyclicality within Teqnion is absolutely present, but won’t be as severe due to the company’s diversification.

Teqnion’s diversification also increases the amount of competitors the group faces. Competitive advantages are mainly build through long-term customer relationships and market leading positions in specific niches. Furthermore, certain companies sometimes do no even face competition as they are too niched. Through these advantages Teqnion aims to not compete on price and achieve stability through a business cycle. I’m of the personal opinion that Teqnion’s subsidiaries do enjoy some sort of stability and advantages through their business models. However, I would also argue that certain subsidiaries do not hold strong economic moats.

With regards to M&A, Teqnion does not face a lot of competition. Teqnion scouts in niches that are often not considered “sexy”. Furthermore, the acquisition size is usually not interesting enough for larger players or private equity. But what perhaps is most to Teqnion’s advantage is relationships. Nine out of the last ten acquisitions were not performed through an M&A broker. Teqnion’s management commonly reaches out to businesses themselves with acquisition inquiries. If interested a deal can be made, if not, management often stays in contact and through that builds a network. M&A is a people’s business and Teqnion’s management understands this. Their purpose is to make Teqnion feel like a home/family to potential sellers, offering perpetual ownership and ensuring that entrepreneurs leave their life’s work in safe hands. This provides them with a strong advantage over competitors who are more fixated on flipping the business. To summarise, I do believe Teqnion has an M&A edge due to size, type of acquisition targets and deal-making approach.

Opportunities & Risks

As with every company, Teqnion possesses both opportunities and risks. Opportunities I believe exist mostly in the form of additional diversification through M&A. As mentoned before, I expect Teqnion to approximately double in amount of subsidiaries in the next 5 years. Besides exposure to new industries, I also expect Teqnion to gain additional geographical exposure through acquisitions outside of Sweden. Teqnion has already exhibited this with the acquisitions of Belle Coachworks in England and Reward Catering in Ireland during 2022. After talks with management, it seems highly probable that we will see more acquisitions in these regions and the Nordics in the upcoming years.

In addition to what I mentioned above, I also see opportunities through operating leverage in the business model. HQ costs are in general quite scalable and during a conference call management stated that they could double in size before they would require additional support. Furthermore, although centralisation of back-end functions is not in management’s interest right now, I personally do see potential here as soon as Teqnion reaches a larger scale (but could take 20+ years). I find it hard to believe that the benefits do not outweigh the soft downside once we are talking about millions of SEK instead of thousands. I might however be wrong in this, but other serial acquirers have proven this can be an extremely lucrative way to improve margins and consequently return on capital. Lastly, operating leverage comes from the soft factors for margin improvement mentioned before.

Teqnion logically also faces some risks that need to be taken into consideration. Main risks I identified are: cyclicality, inevitable diminishing returns on capital and management. Firstly, the nature of Teqnion’s business model and industry exposure makes it subject to cyclicality, including plenty of macroeconomic factors. Moreover, due to the acquisition approach with 50% financing through bank loans, Teqnion will also be negatively impacted by rising interest rates.

Secondly, as Teqnion continues to expand it will likely need to undertake larger acquisitions in order to sustain growth. These larger acquisitions lead to more complexity, increased competition and higher multiples resulting in lower returns on investments. While this scenario may not be imminent for Teqnion, it is a reality that must be taken into consideration. Furthermore, larger acquisitions can also entail risks that can erode shareholder value, such as imprudent investment practices motivated by a desire to inflate numbers and appease shareholders.

Which bring me to the third and perhaps most important risk factor, the management team. Teqnion culture and disciplined approach to capital allocation have been shaped by the current leadership team. By losing these key factors, the company and consequently the stock will suffer. While serial acquirers such as Addtech, Lagercrantz and Indutrade can be considered quite successful, there exists a survivorship bias here. Several companies have attempted a similar strategy but failed due to one common reason: overaggressive and reckless management teams. Common signs are low-quality acquisitions, excessive use of leverage and massive shareholder dilution. Throughout this write-up I’ll argue that Teqnion does not demonstrate any of these warning signs, however one should always be aware and evaluate management on their capital allocation decisions and risk management.

Management & Ownership

I have emphasized the significance of management on multiple occasions and I believe I cannot stress its importance enough, especially in the context of Teqnion. Management plays a crucial role in providing support to the existing subsidiaries, making strategic investments into new ones and establishing a productive company culture. In my opinion, the duo Johan Steene and Danial Zhang are the focal point for Teqnion's management efforts.

Steene is the founder and CEO of Teqnion, has a background in civil engineering and is an avid fan of long-distance running (i.e. ultramarathons). Besides having tried the infamous Barkley Marathon, Steene has won a bronze medal for running 266km in 1 (!) day. He also won the Big Dog's Backyard Ultra by being the last runner left after 455.9km in 68 hours. One thing that stands out to me when listening to Steene is that he demonstrates a great focus on discipline and long-term thinking. This is partly derived from the story about Teqnion’s early days I mentioned before, having to rebuild the company after perhaps a bit of a false start. In addition to this, I’m rather confident you wouldn’t be able to run 6+ marathons in one day or 455.9km in three days without a remarkable amount of discipline. Steene furthermore appears to me as a friendly and down-to-earth person, which I believe helps tremendously with how Teqnion operates and acquires targets (again, people’s business).

Zhang is the company’s former interim-CFO and current CXO. If you’re not familiar with the CXO title then don’t worry since it’s made up. Zhang’s position is more comparable to head of M&A or as they refer to “the M&A general”. Zhang is a huge fan of both Warren Buffett and Charlie Munger (having posters of them in his office), who are well-known for disciplined ways of thinking themselves. It therefore does not surprise me at all that there appears to be great chemistry between Steene and Zhang. Zhang has a background in economics, consultancy experience at both McKinsey and Bain, and a history of playing the arbitrage game in betting. Zhang strikes me as tactical thinker and has written a book called “An investment thinking tool box”, which I can definitely recommend. Furthermore, after quite an extensive conversation with Zhang over the phone discussing Teqnion, I can share that my impression of Zhang is that of a humble person with a good head on his shoulders.

Steene and Zhang lead Teqnion’s HQ together with the rest of the team that can be seen in the picture below. It is also worth pointing out that Teqnion recently appointed Carina Strid as the company’s new CFO. Strid has previous experience as financial reporting specialist at KPMG and CFO experience at Ratos (public company in Sweden that’s also active with M&A) and Tagehus.

Steene and co have managed to establish a strong company culture that follows the main characteristics I mentioned above, namely disciplined and down-to-earth. Discipline is mainly demonstrated through the group’s personalities, view on capital allocation decisions and use of leverage (see 1st financial target). I consider this an immense asset as it reduces the downside risk of Teqnion as an investment. Furthermore, it enables long-term thinking and assures Teqnion’s success remains sustainable.

Down-to-earth can be observed through management’s background and actions. Examining the background, you’ll quickly come to the conclusion that management does not possess classic CV’s with MBAs and board memberships at other listed companies. Only Zhang and Strid hold economic degrees and as management put it: “If we had to compete on a IQ test we would probably lose”. Down-to-earth can also easily be observed through simply listening to conference calls, interviews and reading the company’s reports. It is not often that you see quotes and comparisons to Kung-Fu Panda (Q1 2021) and House of the Dragon (Q3 2022). Management appears intrinsically motivated because they simply love their job and do not seek any form of prestige. Moreover, the team is relatively young with Steene turning 50 and Zhang only being 33, meaning they’ll most likely continue for many more years to come. Asking Zhang what would make him consider to leave his answers have been: (i) change in culture, (ii) Berkshire Hathaway knocking on the door and (iii) ice cream truck driver. Funnily enough I reckon the latter to be the most probable.

Final point of importance to highlight is that there exists a strong alignment between management and shareholders. Steene still owns 5.8% of the company and Zhang has been increasing his stake practically every month (~0.24% of total). Another significant shareholder is the chairman of Teqnion’s board Per Berggren (who owns 50% of Vixar AB), who has supported Steene since 2008. Moreover, fellow founder and board member Erik Surén holds 4.6%. Other noteworthy shareholders include Swedish investment company Spiltan and Chris Mayer from Woodlock Family Capital, also well-known for his popular book 100 baggers.

Teqnion’s Financials

Teqnion has experienced remarkable growth reporting a 40% CAGR between FY16 and LTM22 due to a combination of organic and inorganic growth, and is currently sitting at record-high orderbook levels. Examining the individual subsidiaries individually on a pro forma basis, I estimate growth rates for the historic period to average around 7% per year, which is slightly above the 5% target stated at the IPO in 2019. EBITDA margins have expanded and range between 13%-15%. However, when examining Teqnion’s revenues I believe it is important to focus on net sales and disregard other income. This is because other income includes non-recurring and non-cash items, such as subsidies, negative goodwill and revaluation of contingent earn-outs. Moreover, Teqnion has enjoyed some FX tailwinds due to the SEK weakening over the past years which are also included under other income. To remain consistent it is also worth adjusting for other operating costs, since this includes non-core expenses such as FX losses and asset write-downs. So for comparison purposes I’ve excluded these effects in the graph below and we observe EBITDA margins to range more between 11%-14%

Majority of costs consist of direct costs (COGS) and personnel. Gross margins have expanded a bit due to the addition of margin accretive subsidiaries. Additionally, part of the impact can most likely also be attributed to increased pricing power both post-acquisition and for original subsidiaries. Personnel costs have remained relatively stable due to a mix effect of increased number of FTEs and lower personnel cost per FTE, which can be explained by the scalability of HQ costs. Other costs (e.g. rent, IT, travel, consumables etc.) have also remained relatively stable in comparison to revenues. Below is an overview of Teqnion’s income statement (note that margins are not adjusted here).

Teqnion’s balance sheet does not hold any surprises and is as expected for an industrial acquirer. Large items include goodwill, debt-like items and trade working capital. The company has a net debt/EBITDA of 2.1x including financial leases and deferred income tax and 1.6x excluding these items, which I do not consider problematic (around/below average of peers). Net working capital mostly consists of inventory and accounts receivable and has ranged between 9%-18% of net sales (bit lower in reality on a pro forma basis). One can observe a rising trend over the recent period mostly due to inventory build-up. This is not a company specific issue and management has stated to be working on it. Teqnion’s cash conversion cycle is consequently also a bit above the historical average but should be expected to normalise in the upcoming periods. EBITDA/WC has consistently been 80%+ over the recent years, indicating strong returns on incremental capital, effectiveness and the possibility to self-finance growth.

Investigating Teqnion’s capital efficiency it becomes clear that management has performed a remarkable job with regards to value creation through high returns on equity, assets and invested capital. Following management’s target of acquiring businesses with a 5 year free cash flow payback period and Teqnion’s organic growth, it is not surprising to see both ROIC and ROE average above 15%. However, as mentioned in the risk section, these ratios should be expected to decline over time as the business grows. Moreover, the cyclical nature of the business impacts both growth and margins which consequently lead to fluctuations in capital efficiency ratios (see FY19 in the graph below)

Unlevered free cash flow conversion has averaged at 62% historically, which is quite expected given the company’s business model and industry. FY19 has been a negative exception due to issues with customer orders and rising supplier costs. One can also observe a recent dip in conversion rate which is due to the inventory build-up mentioned before and above-average capex levels. Teqnion’s capex is relatively low, averaging around 1% of net sales historically, which management has explained by highlighting that their strategy is based on acquiring new companies with low capex needs.

To summarise the financials section, Teqnion has experienced great momentum thanks to organic and inorganic initiatives while also boasting strong returns on their investments. The company’s business model does not differ notably from other industrial acquirers apart from the low capex needs. Furthermore, Teqnion demonstrates a healthy balance sheet and cash flows, although working capital should be taken into strong consideration when evaluating the business. Lastly, the company does not utilise share issuances for their acquisitions, so all of the above can also be seen as on a per share basis.

Teqnion Valuation

At the time of writing Teqnion trades at SEK 156 per share which corresponds to a market cap of approximately SEK 2.5b (shortcut for SEK/USD is to divide by 10). The company trades at around 16x. EV/EBITDA on a reported basis and closer to 15x. on an estimated pro forma basis. Current UFCF yield is around 2.5% but closer to 4% on a normalised basis (accounting for nearer to historical average conversion ratio). From the graph below we can see that Teqnion is currently trading at a premium compared to its historic average (on a reported basis). However, if you bought the company at 20x EBITDA close to the IPO, you would still be up 300%+ today.

I do believe the above graph is a bit misleading as it is not based on pro forma numbers, hence not taking fully consolidated acquisitions into consideration. Furthermore, since it’s based on LTM figures it’s backward looking and does not take future growth rates into account (Teqnion has no analyst coverage so no NTM exists). Over time I would expect the multiple to remain relatively stable as Teqnion grows (i.e. between 10x-20x EBITDA) with decreased business risk through diversification pushing the multiple up, but decreased growth and ROIC pulling the multiple down. A common question is also whether Teqnion as a group should trade at a higher multiple than what it acquires for (~5x-6x. EBITDA). I personally see this as a non-debate and would argue a valuation premium due to: (i) lower business risk because of higher diversification, (ii) improved operational performance as part of the group and (iii) inability to replicate or access the same portfolio of companies.

Constructing a DCF for Teqnion is a bit of a tricky exercise because of the individual subsidiaries and acquisition focused strategy. Nevertheless, I’ve attempted to model the company based on historical observations and management’s comments regarding their strategy (see business model section). The key assumptions used are:

• 5% average organic growth.

• Number of acquisitions gradually increasing from 2 in FY23 to 6 in FY27.

• Average deal size increases from SEK 40m in FY23 to SEK 50m in FY27.

• Average multiple of 6x. EBITDA and 0.8x sales.

• Group adj. EBITDA margin going from a through in FY23 (12.8%) to record-high in FY27 (14.8%).

• Leverage to slowly decrease towards the 1x. ND/EBITDA threshold.

The results following these assumptions can be found in the picture below. I arrive at a fair value of SEK 141 utilising a 15x. pro forma UFCF exit multiple and 10% discount rate, which would indicate the stock is currently slightly overvalued but not by an excessive amount. I would consider the downside to be when Teqnion trades at the multiple it acquires for (6x. EBITDA / 10x. UFCF), which would result into a share price of SEK 85 for a 10% IRR. I have however argued before why I would not find this type of valuation reasonable.

I want to be very clear that these results include a large amount of assumptions that will certainly differ from reality in the upcoming 5 years. Therefore, my recommendation is to take my fair value estimation for what it is: an estimation. Personally, I do believe I’ve been conservative with certain assumptions such as organic growth, acquisition multiples, number of deals and exit multiple. It would not surprise me if Teqnion manages to beat my 18% sales and 18.6% EBITDA CAGRs over the next 5 years and trade at a higher multiple. This leaves in my opinion room for further upside. To conclude, I see the current share price as slightly overvalued, but do still consider it an interesting opportunity for those looking to initiate a position. For those already holding or requiring higher investment returns, I would personally hold off and wait for the share price to drop below SEK 140 .

Conclusion

I believe Teqnion exhibits numerous attributes of a high-quality investment, such as substantial growth, impressive returns on invested capital, robust cash flows and strategic diversification. Management team's alignment with shareholders, focus on capital allocation and strong relationship building further reinforce the quality aspects of the business. Furthermore, Teqnion’s subsidiaries demonstrate healthy organic growth and post-deal margin expansion, as well as certain competitive advantages derived from their niche markets. However, Teqnion also entails substantial risks through their acquisition strategy, once again emphasising the importance of management for the investment case.

Given the quality characteristics of the business and continuation of in my opinion modest assumptions, I believe Teqnion is not excessively overvalued and still holds reasonable potential for outperformance. By standing on the shoulders of giants in their industry, I expect Teqnion to continue their success story and join the ranks of prominent Swedish serial acquirers.

Disclaimer: I’m long Teqnion AB at the time of writing this report. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

• Keystone’s differentiated platform business model offers lawyers more freedom, flexibility and autonomy. This has enabled the company to attract lawyers and increase its market share in the £9B+ UK law firm mid-market. Despite its historic growth, the company is still in its early days with <1% market share while operating in the second largest legal market in the world.

• Keystone is a founder-led business with CEO James Knight still owning 28.6% of the company’s shares. Since FY19, Keystone’s topline and earnings have compounded at a 16% and 17% CAGR respectively. The company boasts strong returns on invested capital, scalable operating expenses and a favourable net working capital structure through its platform model. These factors lead to low capital requirements and high cash flow conversion, substantially improving the quality of the business oppose to peer professional service firms.

• Keystone currently trades at 16x. LTM EV/EBIT, which is at historical lows (avg. ~30x.). While I personally deem its historical valuation to be excessive, I believe its current valuation provides an interesting opportunity for market-outperforming returns because of the company’s capital structure, management team and growth opportunities. Utilising a 10.7% topline CAGR, some operating leverage, 10% discount rate and a 15x. UFCF exit multiple in FY27 (i.e. January 2027), I derive a fair value of £4.95 per share, which implies 15% upside to its current price of £4.31. While this upside seems relatively insignificant, I believe my assumptions are rather conservative. This limits the downside and leaves significant upside in case of stronger growth durability or higher exit multiples.

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Keystone Law’s Business Model

Keystone Law was established in 2002 and operates with an unique business model where it provides a platform to self-employed lawyers. Lawyers can earn up to 75% of the fees invoiced and receive numerous kinds of resources in return, such as IT infrastructure, finance and administrative support, compliance and risk management tools, marketing and business development aid, internal network, office location and junior legal support.

An important aspect of the platform model is that Keystone only pays its lawyers once the client has paid. This improves the resilience of the company and enables higher cash conversion due to lower net working capital requirements. The business model can consequently be seen as a win-win for all parties involved. Keystone is able to collect part of the fees with higher cash conversion and lower risk, whereas lawyers receive a large cut than with conventional partnership models and have more flexibility and freedom in the way they conduct their work. Through the model illustrated below, Keystone has become a “legal disruptor” in its industry and has been recognised as one of the best law firms in the UK by the Times.

Keystone’s lawyers offer a wide range of legal services, including commercial, property, litigation, employment and family law. No client represents >5% of recurring revenues and clients are spread across 50 sectors. Furthermore, the client base constitutes primarily of SMEs and high net worth individuals. In conclusion, Keystone appears to be a well-diversified firm with no client, lawyer, practice or sector dependency.

Keystone’s primary growth lever is organic recruitment of new lawyers that bring their clients with them. The company is structured through so-called pods, which represent service companies owned by principal lawyers, who are the senior lawyers. These pods have service and compliance agreements with Keystone basically turning them into Keystone service entities. Pods can also employ junior lawyers (i.e. other fee earners) who through compliance agreements also become Keystone lawyers. Keystone has since January 2013 grown from 117 principals to 399 principals and 80 other fee earners (479 total). Annual lawyer churn is said to be around 5% of which the majority is due to retirement.

UK Legal Services Market

Keystone operates in the UK legal services market, which after the US represents the largest legal service market in the world with £36.8B in annual fee revenues. The UK legal service market is globally recognised as the most international due to the widespread use of English law as the framework for international commercial contracts and dispute resolutions. This market is primarily dominated by the a ‘global elite’ with the top 15 law firms owning approximately 50% of the market.

However, Keystone specifically targets the £9B+ mid-market segment. Comparing the market size to its current revenues, Keystone appears to have 0.8% market share in this segment. Besides having a large addressable market, Keystone also appears to still be in its early days where it can continue to grow and capture market share through the onboarding of new lawyers. Moreover, the total market itself is also estimated to continue to grow around 4% per annum. Hence, the combination of increased market share and industry growth provides Keystone the opportunity to grow organically at high single digit or double digit rates. Lastly, it is worth noting that new model law firms, such as Keystone, have been growing at three times the rate as those of traditional mid-market law firms.

Keystone competes against both the aforementioned traditional mid-market law firms and newly established law firms that operate through similar models as Keystone. The Legal Services Act 2007 allowed for the creation of the platform model, challenging the long standing models of the traditional law firms. Prior to the Legal Services Act, equity partnership was the only basis on which a lawyer could access the highest level of remuneration within a law firm. While I do not believe Keystone has a significant competitive edge (most professional service companies don’t) it does have a first-mover advantage and leverage over traditional firms through higher compensation structures and more personal freedom via the platform model. It is also worth highlighting that although similar platform model companies exist, Keystone is the only one included in the UK top 100 law firms, giving it a brand reputation advantage.

All in all, Keystone operates in a large addressable and growing market. The company is still in its early days with plenty of market share left to capture, especially from traditional mid-market law firms. All of this ensures growth durability for many years to come. The question remains whether Keystone’s business model, brand and first-mover advantage are sufficient to successfully capture and realise the growth opportunities ahead.

Keystone Law Management

As mentioned earlier, Keystone Law Group was established in 2002 by current CEO James Knight and his partner Charles Stinger. In 2014, PE firm Root Capital acquired a 35% stake in the company through which Charles Stinger retired, meaning Knight is the only founder currently involved. The PE firm has partly through the IPO in 2017 exited its position in Keystone. Knight is currently the largest shareholder owning 28.58% of the company, indicating significant skin in the game and alignment with other shareholders. Ashley Miller, the company’s finance director, is the second largest insider owning 0.66%.

Looking at Keystone’s management team, it becomes apparent that many within senior management have been with the company either since or before the PE investment in 2014. This to me is a good sign, as it signals a positive company and working culture. All members also possess several years of relevant working experience. Rather than listing all the names plus CV’s, I recommend reading the resources provided by the company if you are interested in this topic. Keystone has a long-term incentive plan for its executives granting share awards that cannot exceed 100% of the individual’s base salary. The plan includes a three year vesting and a two year holding period during which the shares cannot be sold. Performance criteria is 70% based on EPS growth and 30% based on comparative total shareholder return. I personally believe the incentive plan aligns well enough with shareholder value creation.

Keystone Law Financials

Keystone has experienced robust growth over the recent years with a 16% revenue CAGR between FY19-LTM23. Gross profit margins have remained relatively stable around 26%-27%, which vary based on utilisation rates and type of business demand. EBIT margins have slightly expanded to 11.5% in the LTM period after a dip and rise during covid. Keystone experiences some forms of operating leverage as the incremental costs for onboarding new lawyers are not that high. This leads to enhanced profitability margins as Keystone grows.

Two key KPIs for Keystone that every investor should follow are the total amount of fee earning lawyers and earnings per lawyer, as these two KPIs determine the topline development of the company. As can be seen from the graph below, both the amount of fee earners (12% CAGR) and revenue per fee earner (4% CAGR) have increased gradually over the years, with a pricing dip during covid and recruitment issues during FY22 and FY23. The latter has explicitly been mentioned in the company’s latest reports, as it faces strong recruitment headwinds in “the biggest war for talent seen in over a decade”.

Interestingly, from the revenue bridge below it becomes observable that the company is facing for the first time a decline in revenues due to recruitment issues (in my historic dataset). In the previous years, onboarding of new lawyers has been the main source of topline growth, only being outpaced by pricing impacts in FY22 and H1 2023. Once again, both pricing and onboarding of more fee earners are the two growth levers that Keystone can pull. Inflation will help drive price increases going forward, however these increases are commonly made redundant through pressure on wages (i.e. salaries must go up). Hence, recruitment is perhaps a more valuable growth pillar that also enables the operating leverage to kick in more effectively. In summary, the current recruitment headwind is a major point of concern and important to the investment thesis.

Analysing the balance sheet, it quickly becomes evident that Keystone operates an asset-light business model. As mentioned before, this is partly due to Keystone not paying its lawyers until they have been paid by the client first. Net working capital (NWC) remains consequently only slightly positive, ranging historically between 5%-8%. Its main components include receivables, accrued income and payables. NWC has decreased as percentage of revenues because of a substantial decrease in DSO

Other major balance sheet components include IFRS leases, intangible assets (lawyer relationships), cash and deferred taxes. The company has a net cash position of £5.4m (including deferred CIT and IFRS leases). Due to the company’s asset-light business model and strong profitability, Keystone boasts extremely high capital efficiency ratios which can be seen in the graph below.

Lastly, due to its asset-light business model Keystone also exhibits strong cash flow generation with minimal capital expenditure and NWC needs. Keystone has historically managed to convert 93% of EBIT into free cash flow and around 100% in both FY21 and FY22. Therefore, for quick and dirty valuation practices it is not unreasonable to utilise EBIT multiples as it can be regarded as a close proxy for free cash flows.

Keystone Law Valuation

At the current share price of £4.3 and 31.4m shares outstanding, Keystone Law trades at a market capitalization of £135m. Looking at the enterprise value by factoring in net cash, the company currently trades at an EV/S of 1.8x, EV/EBIT of 16.3x and a EV/UFCF of 15.5x. As can be seen from the graph below, the company is trading at historically low multiples. I believe this is a double-edged sword. On the one hand I believe historical multiples have been pretty elevated, hovering between 25x-35x EBIT. On the other hand I think current valuation is pretty fair/cheap for this kind of business based on all the factors mentioned throughout this write-up. I reckon the truth lies somewhere in the middle, but as with all valuation exercises it remains a subjective game, including different assumptions and perceptions of the same company.

Having said that, below you can find the output of my short-term forecast model. The main assumptions include a modest increase in total fee earners followed by an acceleration as the labour market loosens. However, the growth in the forecasted period remains well behind that of the historical period because I want to use a conservative approach. Price per fee earner is expected to compound slightly above inflation but below the historic average as it recently experienced a significant bump due to inflationary pressures. My result is a revenue estimate £114.8m in FY27, which represents a market share increase from 0.77% to 1.11%, assuming the earlier mentioned 4% market CAGR.

Gross margin, share based payments and other operating income are held stable in relation to revenues. Administrative expenses are expected to scale slightly because of the operating leverage mentioned earlier, leading to 11.8% EBIT margin at the end of the period. Furthermore, capex remains limited and I expect slightly negative effects from NWC as the company grows and DSO normalises. Effective tax rate is held constant at 20% of EBIT (UK CIT is 19% on PBT) and share dilution through share based payments is appropriately accounted for. I utilise a 10% discount rate (my minimum IRR requirement) together with 15x UFCF exit multiple. I believe this exit multiple might also be a bit conservative given the quality of the company, but it leaves room for further upside. Using the aforementioned assumptions I derive a fair value of £4.95 per share, implying 15% upside to the price at time of writing. The sensitivity table illustrates the potential up- and downsides. Overall, I believe the potential upside outweighs the downside as I could easily see the company beating my growth expectations and/or potentially trade at a higher multiple at the end of the period. Therefore, I regard the current price of Keystone as fair and potentially cheap.

Conclusion

I believe the recent drawdown has provided an attractive investment opportunity in Keystone Law Group. The company displays many high quality characteristics through its differentiated and asset-light business model, solid financials, growth durability, large addressable market, capital efficiency, high cash flow generation, net cash position and aligned management team with skin in the game. Nevertheless, while the company enjoys some form of competitive edge through its brand and first-mover advantage, I definitely do not believe Keystone to possess a strong economic moat.

Given all of the mentioned characteristics and the utilisation of what in my opinion are relatively conservative assumptions, I find the current share price more than fair for this type of business and see substantial potential upside through both organic growth and multiple expansion. By continuing to not play by the traditional rules, I expect Keystone to become a much larger entity than it is today.

Disclaimer: I’m long Keystone Law Group PLC at the time of writing this report. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

• Spyrosoft offers a wide range of IT services and solutions that help businesses with their digital transformation. The total addressable market is massive and will experience robust growth from industry trends such as cloud migration, cybersecurity, AI, IoT and Robotics.

• While Spyrosoft operates in a highly competitive market, it has through its management team and decentralized organizational structure managed to win many clients and expand the business at a rapid pace. The company is founder-led, run by a experienced and visionary leader with insiders owning 82%+ of the company.

• Spyrosoft was ranked 5th by the Financial Times as fastest growing company in Europe 2021. The company has reported a 3-year top line CAGR of 76% while also sustaining strong profitability margins and returns on invested capital. Despite certain characteristics of its business model, the company presents in my opinion an attractive risk/reward opportunity at 10.6x EV/EBIT.

Spyrosoft’s Business Model

Spyrosoft was founded in 2016 and operates within the IT sector by offering clients a comprehensive suite of software development solutions that can be tailored towards their specific needs. Below is a full extract of their services from the company’s latest financial report:

• Business and Product Design – designing digital products and services, prototyping and testing them

• Technological Consulting – technological audits, estimation of project costs, development of digital strategies, automation of software development processes, as well as consultancy in the use of public clouds.

• Enterprise Software – software development in the areas of backend and frontend, mobile applications, data architecture.

• Embedded Software – development of devices and software for their automation, creating communication solutions, applications for embedded devices.

• Artificial Intelligence and Machine Learning – using AI and ML technologies in the designed digital solutions together with consultations regarding their functioning.

• Cloud Solutions – migration to the cloud, cost optimisation and delivery of software in the cloud.

• Optimisation – automation of software development, delivery and testing.

• Managed Services – audits and acquisitions of IT systems, support and maintenance of operating systems, management and maintenance of servers, infrastructure optimisation, data security.

It should be noted that while Spyrosoft grows it continuously expands its suite of services to meet market demands. For example, the company has started to offer eCommerce development services to help customer build and integrate their digital platforms. Additionally, the company has added cybersecurity services and signed two contracts related to this. Going forward one can expect additional service offerings to arise.

Apart from the aforementioned services the company also offers three specific software solutions/tools for clients, namely AllPro, DebtPro and Build Operate Transfer (BOT). AllPro is a project resource management tool that has been in development since 2017. The tool is an expansion for existing ERP systems to help with employee and project related tasks. DebtPro is a debt management platform specifically targeted for the financial services industry that aids debtors to improve debt recovery from creditors. BOT represents an IT outsourcing solution for clients that require a local software development team. Similar to the services expansion, more self-developed solutions and licensed IP should be anticipated and provide interesting opportunities to the overall offering of the business.

Spyrosoft currently has >800 FTEs and serves >100 clients spread across different geographies but are mainly based in the UK, Germany, US and Poland. The company also recently opened an office in Buenos Aires, Argentina, in order to better serve the growing number of clients in the US market (i.e. time-zones) and attract new IT talent. About 80% of the company’s revenues comes from contracts established outside of Poland and Spyrosoft managed to retain 98% of their customers during the Covid-19 pandemic, which I consider quite impressive. Furthermore, the company’s services are offered to the following industries (note: again an extract from their latest financial report):

• Automotive - As part of services for the automotive industry, Spyrosoft offers the production of embedded software as well as its integration and validation in accordance with the requirements of the A-Spice standards applicable within the industry. The offer for the automotive industry also includes the design and implementation of processes related to Functional Safety.

• Financial Services - Spyrosoft designs systems that comprehensively support loan processes and debt management systems in financial institutions. The Groups offer also includes the design of solutions in the area of digital banking and for the fintech sector. In addition, Spyrosoft offers the production of software supporting the processing and analysis of financial data.

• Industry 4.0 - The Spyrosoft Group offer for enterprises from the industrial sector focuses on the automation and communication of industrial devices, as well as the provision of enterprise system solutions that allow the exchange of data between devices and the support of industrial equipment fleet management processes.

• Geospatial Services - Spyrosoft creates software for the comprehensive processing of spatial data. It offers solutions in the field of spatial data storage and its intelligent analysis. It also designs enterprise systems that enable the use and management of geospatial information.

• HR and Education - Spyrosoft provides solutions that automate processes related to human resource management. The Group's offer includes the design of temporary work systems, systems for managing remuneration and benefits, as well as educational systems.

• Healthcare & Life Sciences - Spyrosoft Group provides embedded software for medical devices, designs their communication and implements advanced algorithms to support accurate diagnostics performed by medical devices. In addition, it offers the design of enterprise systems - supporting the management of a medical enterprise, patient care or monitoring the operation of medical devices.

IT Industry & Competitive Edge

Cloud, Artificial Intelligence, Machine Learning, Cybersecurity, Internet of Things and Industry 4.0 are all buzzwords you’ll commonly come across looking at IT industry trends. Despite these concepts being loosely tossed around, the underlying trend of digital transformation in businesses is strong and the mentioned concepts become more important for companies each day. However, plenty of companies lack internal resources to perform these digital changes on their own and therefore require consulting services from companies such as Spyrosoft.

Googling several reports about the IT services market, many point to high single digit or low double digit growth rates based primarily on a wider spread adoption of software-as-a-service and cloud-based offerings. Looking more at Poland specifically, one can derive multiple reasonings for its attractiveness as an IT services hub. Firstly, as an EU member, Poland has experienced strong GDP growth over the last decade and established a healthy and stable economy. Secondly, Poland has become one of Europe’s most digital nations with the IT sector representing close to 10% of the country’s GDP. This has provided a friendly environment for software development and led to a large pool of skilled IT talent that can be employed at relatively lower costs than in other countries, including the ones targeted by Spyrosoft (i.e. UK, Germany and US). Third and lastly, Poland also proposes a favourable geographic location by being in the center of Europe with solid English proficiency (16th out of 122 countries). For more details I highly recommend reading the following sources: #1 and #2.

I feel it is safe to conclude that the IT services sector enjoys favourable tailwinds and can be expected to exhibit healthy growth over the coming years, especially in Poland. The picture below provides an illustration of the traffic growth for software development companies in Poland and once again visualizes this trend. In addition to this, the Covid-19 pandemic appears to have accelerated the demand for IT services as digital transformation has proven to be a crucial business component.

Nevertheless, the IT service sector is highly fragmented and competitive by nature. It is for example not necessarily hard for a skilled individual to start providing IT consulting services on their own. Therefore, it is rather difficult for companies like Spyrosoft to develop a competitive edge in this market. Luckily for Spyrosoft, the total addressable market (TAM) is huge. According to the most recent investor presentation of EPAM systems and a Gartner IT spending forecast, construct & consulting services pose a $460B market with Digital Platform Engineering and Product Engineering services representing approximately $150B. As a consequence, Spyrosoft only needs a small piece of the pie to grow and is not obligated to become a market leader.

The company’s market strategy to differentiate itself can be considered quite interesting. According to a podcast episode with CEO Konrad Weiske, Spyrosoft mainly targets the mid-market segment since this segment appears to be underserved of quality solutions by smaller companies and is not attractive enough for the larger players in the industry (e.g. EPAM, Capgemini & Accenture). Through management’s experience and network, the company has managed to capture a large clientele relatively fast, grow their market share and establish a reliable reputation in their targeted segment. In conclusion, while I certainly believe Spyrosoft does not possess a significant moat à la ASML or Alphabet, I think its historic execution and market strategy demonstrate some sort of differentiation to help them grow their piece of the pie, which can be further strengthened by offering new services and tools in the future. In the consultancy business it is largely about the people and reputation, and Spyrosoft seems to be on a good trajectory to succeed in both aspects.

Management & Culture

Spyrosoft was founded in 2016 by the current CEO Konrad Weiske and his partners to fill a gap they saw in the market. Weiske has over 20 years of experience in the IT sector including several large organizations such as Siemens, Nokia, Vodafone, IBM, Microsoft and Intive. This experience in combination with the obtained network enabled him together with his team to create what Spyrosoft is today in a quick manner. It is also impressive to note that Spyrosoft was built from scratch without any financial support from external investors (only GBP 200k at the start). Additionally, the public share debut of Spyrosoft in 2020 on the NewConnect exchange was without the issuing of any new shares and a specific part of the existing shares was issued exclusively to Spyrosoft employees. Just a few weeks ago, Spyrosoft also uplisted to the Warsaw Stock Exchange. The company’s track-record is in my opinion outstanding and Spyrosoft was even ranked as 5th fastest growing company in Europe by the Financial Times. To learn more about this reward, the company’s history and culture I highly recommend to read their blog post about it.

Looking at the shareholder base, it becomes obvious management has enormous skin in the game. While Weiske himself currently owns 29.37%, co-founder and CFO Wojciech Bodnarus and board member Sebastian Lekawa own 26.57% and 26.12% respectively through their spouses. This implies that >82% (!) of the outstanding shares are owned by insiders. Hence, management is clearly aligned with other shareholders. In addition to this, management only receives a yearly compensation 60.000 PLN (~13k EUR) for their services without any other options or warrants, meaning their current holdings represent a meaningful part of their wealth. As the famous quote from Charlie Munger goes:

“Show me the incentives and I will show you the outcome.”

With regards to the culture, Spyrosoft works with a decentralized structure that is build bottom-up where the engineers are the main focus point. Teams are given a lot of autonomy so they can operate independently and provides the best quality of service possible to their clients. The company’s core value is authenticity and it does not want to identify itself as “yet another corporate entity with a complex structure and overcomplicated processes”. Although information is limited, Spyrosoft appears to receive strong recommendations and positive reviews from both employees and customers. The following quote by CEO Konrad Weiske in an interview provides in my eyes an excellent representation of the attitude and vision you want to see from a owner-operator:

“The company was created by engineers, as we received education and worked as developers ourselves, for engineers. In my opinion, it’s also quite important to have constant engagement from those who started the company. We are not an establishment that was started by a private person and later taken over by a private technical fund where people with no technical experience are in charge. We own the company, and we are in it for the long term. I don´t mind if the profit is smaller as long as the company develops in the right direction. We are not here for a short-term profit; we are here to build something that we consider to be ours and built with people we like to work with. That’s the main purpose.”

Opportunities & Risks

Given the company’s size and the earlier mentioned growth of the industry, Spyrosoft has plenty of opportunities left to explore that can stimulate growth rates for many years to come. The main ones I’ve identified are:

• New services and licensed IP: As mentioned in the business model section, Spyrosoft has through the years added several additional services to its suite of service offerings including eCommerce and cybersecurity. As technology develops at a rapid pace every day, the company will undoubtedly continue to add whatever new trends emerge and meet the market’s demand. In addition to this, as the company gains more expertise and experience in a wide range of technological areas Spyrosoft has the opportunity to develop additional licensed IP as it did with AllPro and DebtPro. These software-as-a-service type of solutions generally possess superior unit economics, are easier to scale and provide more recurring income streams to the business, consequently enhancing the entire value proposition of the company.

• International expansion: Over the years Spyrosoft has strengthened its international presence with opening offices in the UK, US, Germany, Croatia, India and more recently Argentina. The North American market is perhaps one of (if not the) largest markets in the world where there remains plenty of market share to capture and grow the company. Also, given the preferable geographical position of Poland, the company holds the opportunity to expand its services even further across continental Europe (e.g. Austria, Switzerland, the Netherlands etc.) and neighbouring regions (e.g. Nordics, South & Eastern Europe).

• M&A: Spyrosoft has grown mostly organically since it was founded but did perform a small acquisition in the beginning of 2021 when it acquired a majority stake in Norbsoft, a software company specialized on mobile applications. Furthermore, the Q4 FY21 reports states that the company has signed a LOI in January 2022 to acquire a controlling stake in a yet to be announced company. CEO Konrad Weiske has also stated on numerous occasions that M&A will become a meaningful component of the business strategy going forward in order to acquire new talent, service offerings and clients. Considering the extremely fragmented market of the IT service industry, further consolidation makes sense. Moreover, the thought of Spyrosoft being acquired by one of the larger market players in the future is also plausible, however I do not expect this in short/medium-term.

Besides several opportunities Spyrosoft naturally also possesses certain risks which need to be taken into careful consideration:

• Employee retention: I’ve mentioned it multiple times and will do it once again, but in the consultancy service industry the people are an absolute crucial factor that determine the success of the company. As Spyrosoft grows it will become increasingly difficult to find and attract new IT talent, however I could argue that given Spyrosoft’s current size there are still plenty of opportunities to increase the pond in which they fish. Nevertheless, another issue that arises is the ability to keep talent on board. Spyrosoft currently provides employees with a lot of autonomy and even gives higher management positions the opportunity to create subsidiaries in which they hold a partial stake to stimulate the entrepreneurial drive and provide incentives to stay with Spyrosoft. The company has also mentioned to start engaging in stock options to incentivize employees to stay with the company. Despite all of that, the consultancy industry is sometimes a warzone, where employees freely jump from one opportunity to the next. Talent retention and employee turnover can be tough for which no exception will be made for Spyrosoft. The loss of key personnel forms therefore a substantial risk.

• Competition and pricing power: As mentioned before, the IT services market is fragmented and highly competitive, where means of differentiation are slim. Therefore, rising competition for both clients and employees are a natural phenomenon. Moreover, given the recent rise in inflation, the company faces internal pressure of growing wages. The question here remains on Spyrosoft’s ability to forward these costs to the customers.

• Business model scaling: IT services or consultancy models in general experience a poor reputation from investors as these business models (i) require a lot of human capital which is extremely expensive and (ii) are particularly difficult to scale. Scaling can basically only be derived from employing more consultants/engineers. Humans can only work for a certain amount of hours per day that cannot be leveraged, hence compose the exact opposite of for example software solutions. While Spyrosoft has demonstrated to be able to grow significantly by increasing their workforce, this process will become increasingly difficult and bring additional problems such as integration, growth and cultural issues.

Spyrosoft Financials

Spyrosoft started from scratch at the end of 2016 but has grown to over PLN 173m (EUR 37m+) in revenues in FY21. From the end of FY18 to today, the company has achieved a revenue CAGR of 76% (!) with stable EBIT margins in the range of 11%-18% on a LTM basis. Unfortunately I was not able to find any detailed breakdown of revenues with regards to geographies and types of services. The company appears to experience some slight form of seasonality with revenues mostly being flat in Q1-Q3 but strongly rise at the end of the year.

The largest costs for Spyrosoft are obviously employee costs which can be split into two parts (i) COGS and (ii) G&A. Cost of goods sold (COGS) mostly comprises of employee expenses directly affiliated with the projects and services the company delivers (i.e. consultants/engineers), whereas the General and Administrative (G&A) costs refer to employee costs for back-office and management functions (e.g. HR, Finance & Management). Gross margins have ranged between 26%-41% and are highly dependent on numerous factors such as the client, type of project, seniority mix of the team, onboarding pace of new engineers and utilization rates. On average gross margins fluctuate around the mid-thirties. Other operating expenses are minimal and seldom go above 1% of revenues. As the company continues to invest I expect EBIT margins to remain in the low-teens for now. While operating leverage is limited for this kind of business model, I do expect EBIT margins to move towards high-teens as we’ve seen this from historical figures and more mature competitors.

Looking at the balance sheet the company appears relatively asset-light as it does not operate with large fixed assets. As of the most recent quarter, the company also holds a net cash position of approximately PLN 6m (incl. financial leases and excl. deferred income taxes) giving it a proper arsenal to continue to invest in the business and perform acquisitions. The only negative stems from a net working capital (NWC) perspective as the company, similar to many other consultancy firms, has a large build-up of accounts receivable and an average DSO of around 60 days. Again, this is not uncommon for these types of business models, however this structure does have a significant impact on cash conversion and hence free cash flow. Nevertheless, despite the NWC composition, Spyrosoft still manages to achieve high returns on invested capital (ROIC) due to its asset-light business model (>40% according to my calculations).

Valuation

At the current share price of PLN 248 and 1.1m shares outstanding Spyrosoft trades at a market capitalization of PLN 270m (~ EUR 58m). Factoring in the net cash, the company currently trades at an EV/S of 1.6x, EV/EBIT of 10.6x and a P/E of 16.6x. This appears rather cheap at a first sight considering the company’s growth, profitability, financial health, industry trends and management team. Additionally, comparing the multiplies to those of larger companies in the same sector (e.g. Accenture, Capgemini, Cognizant and EPAM) it becomes apparent that Spyrosoft is trading at a significant discount. However, counter-arguments can be made based on the following factors:

• Free cash flow conversion is not particularly high, ranging between 50%-75% of EBIT.

• Lack of scalability and operating leverage prevents the bottom line from substantially outpacing the top line.

• Intense competitive environment puts the terminal value of the company at risk.

• Spyrosoft is a micro cap based in Poland with low liquidity. Given the current political climate it also appears that Polish equities are overall trading at a discount due to the war in Ukraine.

To arrive at a fair valuation of the business I simply modelled the core financials 5 years into the future. Firstly, I expect strong growth in FY22 as the CEO has stated that the Q4 FY21 performance (+57% YoY) should continue in the subsequent periods. By FY26 I assume a 27% 5-year revenue CAGR which while still being quite high represents a strong deceleration from the past few years. Due to larger investments being made into the opening of new offices and launches of new services, I expect a small downtrend in EBIT margins for the first few years which should pick up again over time. Both Capex and D&A will also follow this trend. NWC I assume to remain constant to its historic average of 15.8% of revenues. Effective tax rate on EBIT is set at 20%. Absolute cash flows should improve significantly by the end of the forecasted period due lower investment rates and higher margins. For simplicity sake I’ve excluded M&A activity. Below is an overview and result of these assumptions (note that UFCF CAGR is relatively high due to the low base in FY21).

Using a 10% UFCF yield as exit in FY26 and 15% discount rate due to the company’s size and geographical location, I derive a fair value of PLN 373 which is a 50% upside from today’s share price. I do not see any significant currency risks that need to be accounted for as the PLN has over time been fairly stable against the EUR. Since I believe my assumptions are neither aggressive or unreasonable I would personally say the stock is cheap and offers an attractive risk/reward at current levels. Nevertheless, 5 years is a long time-frame in which a lot can happen and my estimations will with 99% certainty be wrong.

Conclusion

Spyrosoft is in my eyes an exciting business that offers a limited group of investors the opportunity to embark on journey in what I believe will become much larger than it is today. The company offers a broad range of IT services and solutions that can be extended to new areas for many years to come. The industry it operates in is never standing still and besides being extremely large it will always create new forms of demand. Moreover, Poland in specific appears to have developed itself in a lucrative hub for IT professionals and outsourcing practices. While competition is fierce and means to differentiate oneself are tough, I believe the company exhibits strong determinants to increase their share of the pie over the next decade. Spyrosoft possesses multiple forms of optionality through new services, international expansion and M&A, whereas it also contains substantial risk that need to be taken into consideration such as employee retention, competition and scalability issues.

Management has both the relevant experience and enormous skin in the game by owning >82% of the total shares outstanding. Its execution from its founding in 2016 has also been remarkable. On top of that, CEO Konrad Weiske seems to have build a strong working culture and decentralized organizational structure that promotes the company’s core function: the engineers. His vision and ambitions are well-thought-out and confirm that what you love to see from a founder.

Financial momentum has been strong and Spyrosoft has managed to report an impressive top line growth rate in combination with stable profitability margins. The company is relatively asset-light and boasts strong returns on invested capital. Furthermore, Spyrosoft operates with a net cash position allowing additional room for further investments. The main down part is the relatively poor cash flow conversion which is derived from the company’s NWC structure. Concerning valuation, I believe the company should trade at a relatively low multiple due to some of the aforementioned risk characteristics, the fact that it is Polish and that it is a micro cap with poor liquidity. While the business model is commonly not much appreciated by investors, I believe there are plenty of examples out there that have demonstrated significant alpha generation over the recent years. Following my findings, assumptions and valuation approach, I think the risk/reward for Spyrosoft to perform similarly is favourable.

Disclaimer: I have no position in Spyrosoft at the time of writing this report. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

• Epsilon Net aims to develop a one-stop-shop for any kind of business in its region. The company has already established a market leading position in most of its segments, while a significant part of the potential customer base still remains without a software solution.

• The company enjoys strong tailwinds in increased user adoption of enterprise and cloud-based software solutions, which today still remains at an extremely low base in Greece. Epsilon Net also experiences a favorable regulatory and political environment with policies promoting the adoption of its products.

• The company is founder-led with the owner and CEO still holding a 64,36% stake. Moreover, the fundamentals of the company have experienced a positive upwards trend over the recent quarters, which can be expected to continue in the foreseeable future. Epsilon Net trades at less than 12x. EV/EBIT on annualized numbers for FY 2021, which can be argued to be cheap given the company's business model and current market position.

Epsilon Net's Business Model

Epsilon's business model can be divided into three main parts:

1. Epsilon Net Software

2. Epsilon Net Network

3. Epsilon Net Training

Epsilon Net Software is the first and most crucial part of the business, as this provides software applications to both accounting offices and individual businesses. Epsilon has the ambition to become a one-stop-shop destination for the modern professional. The company does this through offering over 19 products with a wide range of different modules, involving topics such as accounting & tax, human resource management & payroll, ERP and e-invoicing software.

Epsilon Net provides on-premise accounting, payroll, tax (Tax System 5) and CRM software to accounting offices through the EXTRA brand for small offices and the Hyper.Axion brand for larger ones. It also provides a cloud-based version through an application called Epsilon Cloud. Software applications for businesses are mainly provided through the Pylon platform, which is a unique software development platform from which developers can build their own or integrate software applications. The platform was first developed in 2013 and launched its first product in 2015, after which it has continuously been expanded with new features. The Pylon platform is, depending on the type of product, provided through three alternatives: On-Premise, Rent (Pay-As-You-Go), Cloud (Microsoft Azure). The platform furthermore offers customized solutions depending on the type of business, as can be seen from the product portfolio below. The benefit of the portfolio is that Epsilon Net can appeal to a wide range of businesses, which follows their mission statement of:

“To follow the developments in the technology and information society, creating specialized and reliable products and high-quality services, in order to fully meet the needs of all business units.” - Epsilon Net 2020 Annual Report

Lastly, in 2020 Epsilon Net launched the Epsilon Smart solution, which is a leading e-invoicing software for small- and medium-sized businesses that is provided through the cloud in the form of a subscription model (€5-€18 p/m) or Microsoft Dynamics 365 for larger enterprises. The software eliminates the need for printed documentation and allows for fully automated invoice processing in an easy, safe and quick manner. In addition to that, the implementation of a new legislation has made e-invoicing mandatory for all Greek companies and freelancers from July 2021. The software is directly connected to the myDATA (Digital Accounting and Tax Application) platform of Greece's Independent Authority for Public Revenue (IAPR), making it regulatory compliant. This has boosted the adoption of the product significantly and will be further touched upon later on.

The second part of the business, Epsilon Net Network, consists of databases and tools for professionals to solve tax and labor issues. This is mainly done through e-forologia, a networking portal for professionals to find solutions to specific business issues. Other tools also include the Online Bank (a database for tax and legislation code laws), Tax e-Calender, Komvos (a platform to ask experts specific tax and labor questions), Epsilon 7 (a scientific department for developments within accounting), and a tax and accounting e-magazine. E-forologia and the other information tools are monetized through a subscription model, giving extra perks such as unlimited access, additional support and personalization options.

The third and final part of the business is Epsilon Net Training, which as can be seen from the sales breakdown figure above consists of approximately 4% of revenues. This business unit provides education in two main ways. Firstly, the company provides in cooperation with the Association of International Accountants (AIA) education and certifications for subjects such as Auditing & Internal Review, International Financial Reporting Standards (IFRS) and Management Accounting & Cost (MAC) to students. Secondly, Epsilon Net provides seminars, workshops and corporate business training to enterprises and departments requiring additional training in the field of accounting, financial management and taxation.

Epsilon Net currently has over 750 employees and 8 subsidiaries, through which is serves over 75.000 clients with no significant customer concentration. The company is mainly active in Greece, but does have a presence in other European countries, partly also attributable to the recent acquisition of ERP provider Singular Logic. Epsilon has seen a solid growth in its recurring revenues as percentage of sales (~59%) over the recent years, as well as the percentage of recurring revenues being derived from cloud-subscriptions instead of the maintenance pay-as-you-go model. This trend can be expected to continue as the company's strategy is to introduce new and transfer existing clients to the Pylon Cloud & Web solutions. Cloud revenues grew 96,8% in 2019 and a staggering 231,5% (!) in 2020. This transition is of considerable importance, as it not only provides more predictable income streams, but also lower costs and hence higher margins for the company. Furthermore, customer retention rates have ranged steadily between 97,5%-98,5% demonstrating the criticality of the business software.

Industry & Competition

Greece is one of the lowest countries in the EU with regards to digitization, ranking overall 27th out of the 28 EU member states. Noteworthy is the below average performance of the integration of digital technology and low penetration rate of cloud applications for enterprises (7% in 2018 vs. 18% EU-average). This poor development can partly be explained by the economic difficulties Greece has faced over the recent decade. As stated in the investor presentation of its Greek competitor Entersoft:

"The Greek financial crisis and the pandemic left a 10-year technological gap to Greek enterprises that needs to be bridged." – Entersoft's Corporate Presentation

However, the Greek government is aware of the issue and has taken several actions in order to improve its digital economy with the aforementioned obligation for e-invoicing being just one example. The Greek Ministry of Digital Governance presented a digital transformation "bible" describing the strategy for digital transformation for the years 2020-2025 including 7 goals (see figure below). Especially the goal of facilitating the transformation to digital enterprises can be considered of importance to Epsilon Net, as the government aims to implement policies (e.g. tax incentives) to promote the adoption of digital technologies, such as Epsilon Net's product suite.

In addition to that, Greece anticipates to receive €32B from the EU Recovery Fund, which is expected to increase to a total of €72B by 2027. The country has formally submitted its 'Greece 2.0' national recovery plan in which digital transition forms one of the four key pillars. The resources from the Recovery Fund will therefore also be allocated to financing strategic projects within the field of digitization. In conclusion, besides the common tailwind of requiring new technological solutions to increase corporate efficiency (e.g. cloud-based services) and under-development of Greece in the field of digitization, Epsilon Net also experiences a favorable regulatory and political environment with policies promoting the adoption of its products.

The need for digitization in Greece becomes furthermore evident when examining Epsilon's market share in the ERP software segment. Through the acquisition of Singular Logic, Epsilon has managed to capture a 35% market share within commercial ERP software. Nevertheless, 40% of the markets remains without any software provider, clearly illustrating the infancy and opportunity of the industry in Greece. In addition to that, around 25% of SMEs (excluding micro) with a software provider are estimated to have ERP solutions by non-competitive local vendors. The total amount of enterprises that Epsilon could target is estimated at 750k+. Breaking down the customer mix, Epsilon Net derives approximately 60% from small businesses, 35% from medium enterprises and 5% from large corporations.

Epsilon Net is furthermore a market leader in accounting offices and HR & Payroll services with 75% and 80% market share respectively. The company has recently strengthened its dominant position within these markets through the acquisitions of Singular Logic and Data Communication. This has led to the company having >15.500 accounting and tax software installations and >7.500 within HR & Payroll. Especially the dominant position within accounting offices can be see as huge advantage as this forms an additional sales channel, consequently allowing easier access to new SME clients (similar to Fortnox in Sweden). In addition to that, the market leading position within HR & Payroll installations enables easier penetration into medium and large enterprises.

Accessing potential clients through the sales channels mentioned above constitutes one of the main competitive advantages of Epsilon Net. Other advantages include its large product portfolio enabling client specific customization, flexible cost policies (on-premise, rent & cloud), negligible migration costs and the offering of a comprehensive and fully integrated (cloud) platform. As said before and common for ERP-based software providers, the end-goal is to become a one-stop-shop software provider for any kind of business. This introduces high switching costs for clients if they want to exchange their back-end technological infrastructure, consequently making Epsilon's product sticky (see low churn rates).

However, the company logically faces competition from different directions. AnacondA S.A. and UnionSoft are competitors in both the markets of accounting offices and HR & Payroll services. Within accounting offices Epsilon Net also faces competition from Provasis, which has launched a competitive e-invoicing product to Epsilon Smart in the form of Provasis GO. For HR & Payroll systems Epsilon Net also competes with Lavisoft. With regards to ERP software, competition appears more significant including companies such as SAP, Microsoft, SoftOne, Megasoft, Tesae and Entersoft. Especially the latter can be considered interesting as it also a publicly listed peer. Entersoft, although similar in size, appears in a more mature state with lower organic growth but higher margins and ROIC. Entersoft also appears more concentrated on larger enterprises with a more standardized product portfolio (including an e-commerce integration). What is interesting to note is that Epsilon Net, despite having only 31% more sales than Entersoft, invests close to 3x the amount in R&D than Entersoft (€6.3m vs. €2.4m).

All in all, I do not believe Epsilon Net to have an untouchable "moat", however I see no reason for the company to lose its dominant market position and I expect it to continue with meaningful software innovations for all kinds of enterprises. This together with the aforementioned industry tailwinds and competitive advantages make me believe that the company can capture additional market share and stand at the forefront of the digital transition of the region.

Management & Ownership

Epsilon Net was founded in 1999 and originally started in the field of specialized vocational training on financial issues. The company combined its training with information tools which led to the creation of the Network business unit mentioned before helping businesses with their financial and tax legislation problems. It wasn't until 2002 until Epsilon started to enter software industry.

The company is led by its founder, chairman and CEO Ioannis Michos who has previous work experience as a business consultant and an academic background within economics and finance. Michos recognized early on that there existed an opportunity in the market when companies started to switch from Windows DOS to NT technology. After successfully having established its training and database units, Michos decided to create a software product that helps business professionals with their operations. In 2015 the company entered a new stage when the Pylon platform was launched and focus started to increasingly shift towards cloud-based services. The success Michos has achieved with Epsilon Net becomes further evident from the awards it has won. For example, the company was declared as one of the best businesses in Europe and won the 'National Winner' award at the European Business Awards in 2018, while being included on their 'One to Watch' list. The company has furthermore been recognized as 'Best Workplace Hellas' for 6 consecutive years by the internationally accredited organization GreatPlace to Work. That same organization awarded the company with a 19th place of best 20 workplaces in Europe. This demonstrates that Michos has not only established a solid product, but also a great working culture.

Not only is Epsilon Net founder-led by a driven entrepreneur, but Michos also has significant skin in the game. The CEO still holds 64,36% of the current shares outstanding, meaning there's no need to even look at incentive packages to conclude that shareholder interests are aligned. His substantial stake also explains as to why the company distributes a small dividend. Barca Global Master Fund is an American investment firm holding 8,27%, while there are no other significant shareholders.

Opportunities & Risks

Epsilon Net holds several opportunities that can help with sustaining solid growth rates for the upcoming years:

• Market share: Even though Epsilon Net already holds dominant market positions in all of its software segments, there still exists room to capture more market share. In addition to that and as mentioned before, a significant part of the Greek market remains without a software solution or utilize a local vendor. Estimations say that there exist over 750.000 SMEs in Greece alone, which implies Epsilon only holds a 10% market share with its 75.000+ clients. Hence, the company can sustain considerable growth rates even with a steady market share as the company's total addressable market (TAM) grows due to the digital transition of the region.

• Product innovation, cross- & up-selling: Epsilon Net invests heavily into R&D and has consistently been adding new software solutions and modules to its product suite over the recent years (e.g. Pylon & Epsilon Smart). This allows the company to find new revenue streams, as well as sell additional services to its already established customer base. Interestingly, the 2020 annual report states that the company is developing and investing in the field of financial technology (Fintech). Moreover, an article from July last year states that one of the future goals is expanding software products, including bank payments. Epsilon Net already has a strategic partnership with the National Bank to offer e-banking services through the Pylon ERP commercial application, making it easy for users to perform online payments and bank transactions. Therefore, it is not unreasonable to expect the company to walk a similar path as software peer Fortnox with "Fortnox Finans". The company can in the future function as a payment service provider and claim a take-rates on transactions.

• International expansion & verticals: Epsilon Net is currently mainly active within Greece, but did gain more international exposure through its acquisition of Singular Logic. The company has however on several occasions expressed its ambitions to expand abroad, especially since the software is easy to deploy. Countries of interest include for example Cyprus, Bulgaria and Romania. The company has also mentioned on numerous occasions that it is interested in entering new market verticals and that it wants to strengthen its position in those it already has entered (e.g. Pylon Auto Service).

• M&A: Epsilon Net has performed several mergers and acquisitions in the past with Singular Logic and Data Communication being the most significant recent examples. The company can further utilize this strategy to add new software to its product suite (e.g. fintech) or enter new markets (both geographic and vertical).

Nevertheless, some risks also need to be taken into consideration:

• Greek macro environment: Greece is notoriously known for its debt crisis following the aftermath of the Global Financial Crisis in 2008. The country has suffered from significant declines in GDP, high unemployment rates and extreme debt levels. While the economy has started to rebuild (see "Greece 2.0" plan), the country is ranked as number three with regards to highest debt-to-GDP with a staggering 210% (!). Greece has received a lot of monetary and fiscal aid and will now also be a huge beneficiary from the recovery fund proposed by the EU due to the Covid-19 pandemic. The policies of the European Central Bank (ECB) and its quantitative easing programs are also important to follow as it maintains investors' confidence in the country.

• M&A integration & lack of innovation: As mentioned above, Epsilon Net is not shy of indulging into M&A activity. This always proposes certain risks as value creation through M&A can be extremely difficult. It is therefore important to closely track the acquisitions Epsilon Net makes and determine whether capital is appropriately allocated. In addition to this, Epsilon Net needs to continue innovating its product suite in order to not fall behind. If failing to do so, customer churn will increase and growth rates will decline. Moreover, Epsilon Net spends significant amounts on R&D for which the company should be held accountable in case it doesn't lead to solid returns on those made investments. Out of its 751 employees, 276 work within R&D (36,8%).

• Competition: The lack of innovation is directly connected to the rise in competition. Epsilon Net holds certain competitive advantages but does not hold any significant 'moat'. The nature of the software industry is that it is constantly changing and very profitable, hence new players will consistently enter in order to capture a piece of the pie. Therefore it is important that Epsilon Net offers a superior product to stay ahead of new and already established players.

Financials

During the period 2015-2020, Epsilon Net has compounded revenues at a 14,6% CAGR while operating profits grew at a 53,5% rate annually. There are two important things to note here. Firstly, although the growth rate does not seem as spectacular as for some other software companies, it can be considered rather impressive looking at the economic development of Greece over the recent years. Greece's GDP has grown -0,9% annually over the last 5 years and 1,1% excluding 2020. Furthermore, the recent developments in the industry have enabled Epsilon Net to accelerate their sales growth and reported 48% organic growth (110,6% w/ inorganic) in Q1 2021.

Secondly, the growth rates indicate a strong sign of the company's operating leverage as operating profits have compounded at a much faster rate than revenues. EBIT margins have increased from 3,9% in 2015 to 16,8% in 2020 and a 27,7% EBT margin in q1 2021. This is mainly due to the low costs involved with new installations of Epsilon Net's software. In addition to that, cloud-based revenues have increased significantly over the last three years, from €361.600 in 2018 to €2.359.000 in 2020 (11% of total revenues , but 63% of incremental revenues in 2020).

When examining the development of Epsilon Net's costs, it becomes clear where the increase in margins comes from. Cost of sales have declined as a percentage of revenue from 51,6% to 40,4%, which can be partly explained by the switch towards more cloud-based products with lower installation costs. Gross margins have consequently increased to close to 60% in 2020 and can be expected to continue to increase over the following years (75,6% average incremental past 4-years). Administrative expenses have also scaled nicely with revenues and dropped from 2,2% to 1,6%. However, sales and marketing (S&M) expenses have had a much larger impact on the relative decrease in operating costs than administrative expenses. S&M dropped from 20,8% in 2015 to 11,7% in 2020, contributing significantly to the increase in operating margins together with cost of sales. In contrast to these relative declines, research and development costs have increased over the recent years, going from 21,8% in 2015 to 28,9% in 2020. I personally do not see this as a negative, since the company is still early in its journey and significant R&D investments can lead to lucrative organic growth runways with high returns on invest capital.

Epsilon Net has also (unsurprisingly) managed to strongly increase its operating cash flows from €1,6m in 2015 to €6,1m in 2020 (30,3% CAGR). Free cash flows reached €5,35m in 2020, equaling a close to 25% FCF margin. However, even though growth rates have been mostly above double-digits, the company's ROIC has only averaged 10% between 2015-2020. Nevertheless, it's not the absolute ROIC that matters, but the change over the past years from which we can see a rather consistent improvement. To obtain a better picture of the story it's also important to look at ROIIC in order to get an indication of potential moves in capital efficiency and operating leverage. Here we can see that the figures are much higher than the derived ROIC with a 3-year ROIIC of 41%.

Examining the balance sheet, it becomes observable that Epsilon Net has a net cash position with €20,7m in cash and equivalents and around €17,6m in debt and capitalized leases. Hence, the company appears to be in a solid financial position and has room for further M&A opportunities and other types of investments. When looking at the company's net working capital (NWC) two things stand out. Firstly, NWC as a percentage of sales has declined from 38% in 2015 to 21% in 2020, demonstrating improvements in capital efficiency. Secondly however, Epsilon Net's cash conversion cycle (CCC) has remained relatively stable over the years ranging between 90 to 112 days. This is due to a positive increase in the DPO, as well as an increase in the DSO. Especially the high and increasing DSO (178,8 in 2020) is rather concerning and can also be seen as a risk, as customers in general have relatively long credit terms. In conclusion, management has substantial opportunities left regarding the conversion of capital into cash.

Valuation

Epsilon Net as of now has no sell-side coverage nor provides any official guidance for the coming quarters/years, hence it is rather difficult for me as a private investor to determine future expectations. As a consequence, most of my assumptions will be derived from recognized trends and unofficial talks with the company's IR.

At the time of writing Epsilon Net trades at €8,70 per share implying an enterprise value of approximately €115m. For 2021 estimations, it's easiest to work from annualized Q1 numbers. Based on this, I expect the company to produce just over €32m in revenues, which remains conservative in my eyes. Although Epsilon Net's recent acquisitions will slightly suppress margins, I still believe that the company through its previously discussed operating leverage can achieve 30% EBIT margins over 2021. This consequently leads to €9,6m in EBIT for 2021, which implies the company is trading at less than 12x. EV/EBIT for FY2021. This can be considered rather cheap, especially given the company's business model and industry tailwinds. Moreover, I expect growth rates to be at least double digits over the following years and wouldn't be surprised if the high organic growth rates could be sustained into 2022. In addition to that, I expect margins (both gross and operating) to increase due to the scalability of the business model and transition to cloud-based products. Looking at the peer-comparison table below, it also stands out how low the multiples for both Epsilon Net and Greek peer Entersoft are compared to the other more recognized businesses. Therefore, I determine the current valuation as highly attractive.

A potential reason for the low valuation can be due to the company being quite undiscovered as it currently is pretty small in size and domiciled in Greece on the Athens Stock Exchange with no sell-side coverage. Furthermore, the state of the Greek economy also has implications on the associated risks to Epsilon Net, hence resulting in a larger discount compared to peers in more stable regions. Lastly, while Epsilon has shown to be able to improve its fundamentals drastically over the recent quarter, it does not possess a similar track-record of high margins and ROIC as compared to other software peers (e.g. Admicom & Fortnox). Therefore, it is of utmost importance that Epsilon Net continues to execute in-line with its most recent quarters. Successfully doing so could push the multiple upwards, which in combination with its high growth can lead to substantial stock returns. For example, trading at 20x. EV/EBIT in FY 2021 would already imply a 66% upside in less than 6 months.

Conclusion

Epsilon Net stands at the forefront of a huge digitization boost in Greece, due to both industry and regulatory tailwinds. The company appears well-positioned to benefit from these trends through its business model and robust offering of software products. Epsilon Net already has a market leading position within accounting software and HR & Payroll systems, while it also has obtained a dominant position within the ERP industry, where 40% of the companies remains without a software solution. Combined with several competitive advantages, such as high switching costs, Epsilon Net is poised for strong organic growth rates in the upcoming years. The company is furthermore led by its ambitious founder and CEO Ioannis Michos, who still holds 64,36% of the total shares outstanding. The company also holds plenty of opportunities to increase its income streams through increasing its market share, adding more modules, introducing new products (e.g. fintech), international expansion and M&A. Nevertheless, Epsilon Net also faces noteworthy risks from macro factors and competitors.

Fundamentally, Epsilon Net has continuously shown improvements in growth rates and operating leverage. These trends can be expected to continue, partly thanks to the growth in cloud-based revenues. The company also has a net cash position with a solid balance sheet, although the conversion from capital to cash should be watched. With regards to valuation, the company appears cheap based on annualized figures for FY 2021 (12x. EV/EBIT) and compared to other software peers. I therefore expect solid returns going forward as the fundamentals continue to improve in combination with a potential multiple expansion as the company attracts the attention of more investors. The key is that Epsilon Net turns its recent performance into habit rather than an act.

Disclaimer: I’m long Epsilon Net at the time of writing this blog post. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

• Fortnox is developing a sticky one-stop-shop ecosystem that constitutes the backbone for many SMBs. The company enjoys typical industry tailwinds and is a market leader in Sweden (~26% MS), which it will focus on to strengthen even further in the upcoming years.

• Fortnox holds several growth opportunities with tremendous potential that can significantly expand the company's TAM and ARPC, enabling high non-linear deteriorating growth rates for this decade. However, the ability to execute by the management team remains a question mark for now.

• Using base case assumptions and the set targets for 2025, I believe Fortnox is currently trading at a fair value range. I consider 350-380 SEK an attractive price area where I expect market outperforming returns with a 5-year 10%-14% IRR and strong potential for further upside. Nevertheless, the case is relatively high risk with substantial downside if fundamentals come in below expectations.

Fortnox's Business Model

Fortnox has managed to create a market leading, cloud native and SaaS-based platform for SMBs in Sweden to solve financial and administrative burdens. Similar to other platforms, clients can add modules (products) with new functionalities that help their companies grow. The accounting and invoicing modules are the most popular ones and can be implemented for a mere 99 SEK per month (~10$). Furthermore, Fortnox is in the process of developing several new services and offers an ecosystem with open APIs and integrations, allowing users to purchase additional features through an app store. The marketplace enables Fortnox to offer services without the need to develop it themselves. This in combination with their own modules transforms Fortnox into an one-stop-shop solution for SMBs.

To easily breakdown Fortnox's business model, one can divide the company's services into eight product areas, including 4 core, 3 growth and 1 support:

Core:

1. Accounting: the main value proposition and product area where the company started its journey. As the name implies, this product area helps companies with their bookkeeping and keeping track of accounts payable. It is furthermore connectable with banks and other authorities, enabling seamless insights and payment possibilities. Since the platform is cloud-based, customers can access the information from anywhere at anytime on their mobile phones or other devices. The main development to look out for in this area is real-time AI bookkeeping. This feature will be released to the entire customer base during 2021 and aims to remove all manual labor in the bookkeeping process. Additionally, the real-time information provides updated insights that can be transformed into valuable advice to customers about future trends and opportunities for their businesses.

2. Billing: product area that enables clients to send invoices and quotes to their customers, keep track of their inventories and project planning. The idea of this module is to make billing easier. Last year Fortnox sent out 500B SEK worth in invoices (~10% of Sweden's GDP) with 1 invoice being sent out every other second. The aim for this area is two-folded. Firstly, 1/3 of the invoices were sent to consumers outside of the platform, meaning there are still many potential customers left to onboard that have already been in touch with Fortnox. Secondly, Fortnox is focused on activating the already acquired users by enabling them to perform all activities through the Fortnox system including invoicing, consequently reducing the incentive to leave the platform.

3. People: product area focused on the people in the organization, including services such as payroll, benefits, insurance, time reporting, receipts and travel management. The payroll service is connected to all necessary authorities and is currently the fastest growing product area. Fortnox aims to process 1 million monthly payslips by 2025 and completely digitalize as well as automatize the payroll administration for both large and small businesses. The insurance segment is also a noteworthy product with large potential. While it's still in early development, Fortnox can function as a middleman offering pension services and different type of insurances (car, company, health etc.), which increases income, reduces churn and enhances the overall offering of the company.

4. Financing: product area in which Fortnox sees large opportunities and currently is investing in the most. The first part of this product area is concerned with the dealing of invoices including distribution, collection and factoring. Distribution and collection simply imply that Fortnox allows users to outsource the invoicing process by sending reminders to the user's customers and automatically process the collections. It furthermore offers users to temporarily finance the uncollected invoices against a set interest rate per month (2.5%). In addition to this, through the factoring process the company also offers users to sell their invoices to Fortnox. Fortnox utilizes real-time credit rating scoring to estimate credit risks and appropriate yields. The advantage here for Fortnox is when both parties are within the Fortnox ecosystem providing larger amount of data points, consequently enhancing the credit risk assessment process. Combining the real-time credit scoring with AI bookkeeping further enables Fortnox to offer financing solutions to customers facing potential needs, such as lack of capital. However, what is potentially most interesting in this product area is the payment service, which will gradually be deployed during 2021. This service is still in the very early stages but aims to provide customers with cash management accounts and company debit cards, allowing Fortnox as the issuer to claim a take-rate on each transaction (>1% of TPV). Moreover, the payment service supports locking customers into the ecosystem, discouraging users to leave the platform. The finance vertical currently represents 14% of Fortnox's revenues, but can be expected to increase throughout the upcoming years. Growth:

5. Insights: recently launched product area to utilize the customer's data to provide noteworthy insights and feedback on their business operations. Main offering is the ToDo product, which simply functions as a to-do list that also aims to incorporate integration partners. The goal is to also offer a platform with automated business operations to SMBs.

6. Connect: further supports the needs of SMBs by offering ID, mailbox and storage services. Although these are minor services, they further strengthen the platform and enable customers to perform all business operations through one system.

7. Integration Services: probably the most exciting growth area where Fortnox offers its customers a marketplace with 3rd party software integrations that offer additional business tools, further extending the ecosystem. The marketplace enables Fortnox to become an one-stop-shop, consequently reducing customer churn and increasingly leverage their customer base. As of now Fortnox offers over 400 partner solutions and charges customers a monthly fee of 59 SEK to enable these integrations. This pricing model resembles a significant opportunity to Fortnox as it can transform towards an Apple/Google Play store model where pricing is based on take-rates (~30%), which in return increases income. Fortnox has stated this to be a future goal. Support:

8. Infrastructure: product area focused on customer support and subscription management. Area is more of a CRM product for Fortnox itself, as well as a center to help customers with their specific problems (help center).

Besides the product areas, Fortnox distributes its services through two main sales channels: direct customers & accounting firms. Direct customers simply add the services through the Fortnox's website or application, whereas accounting firms use Fortnox's software for their clients and because of that turn them into Fortnox customers as well. Both sales channels are extremely scalable as their costs of acquisition of new customers (CAC) are close to 0. The partnership with accounting firms is also mutually beneficial, as Fortnox can connect customers with accounting services and vice versa. The portion of sales being derived from each channel is estimated to be approximately 50/50.

Industry & Competition

As of the time of writing, Fortnox is only active within Sweden and has from the most recent quarter (Q1 2021) approximately 385.000 customers (26.2% 5-year CAGR). Fortnox stated that there are 1.5M addressable businesses in Sweden and therefore currently has based on these figures a 25.6% market share. Nevertheless, these numbers are up for debate as several different totals have been thrown around before by both Fortnox and investment firms, whereas cloud-based SaaS applications also do not have a 100% penetration rate. The main takeaway is that there's quite some room left for growth in the current market. Fortnox was initially developed for smaller business, hence the majority of the customer are companies with less than 10 employees. However, Fortnox's system is also applicable to larger organizations with companies such as Volvo and Apotea using the platform as well. The underlying market growth for new businesses has been around 2% over the last two decades in Sweden.

As mentioned before, partnerships with accounting firms are important to Fortnox. Fortnox currently has partnerships with 6000 accounting firms, including all of the Big 5 (KPMG, Deloitte, PwC, EY & Grant Thornton). In 2021, Sweden had approximately 23.500 accounting firms, hence Fortnox has a similar market share here as with their customer base (25.5%). Fortnox has the highest penetration rate in large and medium-sized firms and plenty of opportunities left for smaller accounting firms (16%).

During the most recent Capital Market Day (CMD) presentation, Fortnox presented several targets for 2025, including growing the customer base organically to over 700.000 customer (14% CAGR) and establish over 12.000 partnerships with accounting firms (~50% MS). The company also guided to improve its average revenue per customer (ARPC) per month from 171 SEK in Q1 2021 to >300 SEK in 2025, but more on that later.

Fortnox faces competition from multiple players in the industry (both legacy and cloud-native) with the main competitor being Visma SPCS, who as estimated by SEB has somewhere around 238.000 customers at the end of 2020. Fortnox also faces competition from Hogia, although their solution is mostly on-premise with only a minor part being cloud-based. Björn Lundén is also a more common alternative to Fortnox, but also appears rather insignificant in size compared to both Fortnox and Visma with an estimated 12K customers.

Besides these legacy/more established players, Fortnox also faces competition from smaller start-ups that attempt to take market share through their cloud-native solutions. Some examples here include Bokio (80K users at the end of 2019, but also active in GB), Speedledger (owned by Visma), Wimt, Dooer and PE Accounting. Finally, Fortnox is also starting to face competition from abroad with 24SevenOffice (Norway) and Talenom (Finland) entering the Swedish market. Talenom has made some small acquisitions from 2019 in Sweden, yet still remains very small in size today. 24SevenOffice mainly focuses on larger enterprises and is therefore not a direct competitor to Fortnox, nevertheless there does exist some overlap.

Fortnox is a clear market leader in Sweden but the important question remains: How does Fortnox differentiate itself and what is their edge? I believe Fortnox's main value proposition is their comprehensive ecosystem and product suite. Through integrating various modules besides accounting and invoicing (e.g. payments & insurance), Fortnox is creating a sticky one-stop-shop ecosystem that removes the incentives for users to leave the platform. The marketplace furthermore strengthens this advantage by enabling users to integrate that what Fortnox is unable to offer themselves (e.g. CRM). As a result, Fortnox positions itself as the backbone of SMBs. Furthermore, Fortnox has an amazing opportunity that its services are required for basically any kind of company. No matter whether you're a hairdresser, pharmacist or a restaurant, all these businesses require accounting, invoice, insurance and payment services. The only downside here is that Fortnox cannot tailor their ERP system to specific industries, putting it at a disadvantage compared to more niche players (see Admicom post).

Aside from its comprehensive ecosystem, Fortnox has clearly enjoyed a first-mover advantage in Sweden with its cloud- and SaaS-based services and is furthermore supported by all the integrations it has with local authorities (banks and tax agencies). In addition to that, Fortnox's partnerships with the major accounting firms puts it at a advantage compared to other players. All of the aforementioned competitive advantages increase the barriers to entry and aid Fortnox with maintaining their dominant market position in Sweden. Nevertheless, the main issue here is how Fortnox will compete outside of the Swedish borders where it doesn't have the first-mover advantage and no connections with local establishments. Integrations with foreign authorities and local partnerships have to be built from the ground but will also no longer be an unique advantage to Fortnox. Hence, that what can really differentiate Fortnox from others is their extensive ecosystem and is therefore a key differentiator in their competitive landscape.

Management & Ownership

Fortnox was founded by serial entrepreneur Jan Älmeby in 2001, who's also the original founder of Scandinavian PC Systems, which later got acquired by Visma (hence Visma SPCS). In 2010 he left as Fortnox CEO to focus on Fortnox International, which spun-off and nowadays goes by the name of Briox, another accounting software business focused on Finland and the Baltics. Älmeby also left his position here in 2013 to start a similar company called Computer Innovation, which eventually ended up in bankruptcy in 2019. Anyhow, Älmeby is no longer involved in the day-to-day operations of Fortnox, meaning the company is not founder-led.

Current CEO Tommy Eklund joined the company in 2020 after serving as CEO of IST Group, a leading ed-tech company in Scandinavia, for 5 years and several leadership roles at Saab prior to that. CFO Roger Hartelius has been at Fortnox since 2017 and has previous experience as CEO of IST International and CFO at Swedish digital newspaper and magazine subscription service company Readly AB. Olof Hallrup is the current chairman of the board of directors and is the only insider with a significant ownership position, whereas members of the management team hold very small stakes through shares and option incentives. Hallrup however owns through his company First Kraft AB 20,68% of the shares outstanding and was an active advocate against Visma's takeover attempt in 2016 (which did fall through). Fortnox furthermore enjoys institutional ownership by the likes of State Street,, Morgan Stanly, Swedbank and JP Morgan. Overall I'm not that impressed by the management team, but they do deserve time to prove themselves. I find it however good to see that the chairman owns such a significant stake, making sure that the interests of shareholders and those in charge are aligned.

Opportunities & Risks

Even though Fortnox has already captured a significant share of the market, I see several opportunities for the company to sustain high growth rates over the upcoming years, giving the company a lot of optionality:

• Verticals: The vertical part for Fortnox is two-folded. Firstly, Fortnox still holds tremendous room for growth through expanding their current offerings and modules. I already pointed out before that payments (finance), integrations and insurance are growth areas with large TAMs that can aid the company to support top line growth, increase ARPC and reduce customer churn. Secondly, Fortnox can through their ecosystem expand to new verticals over time to fulfill all the needs for their customers, consequently strengthening their on-stop-shop solution (e.g. CRM).

• Pricing Power: Fortnox's prices have remained unchanged for several years and a price hike does therefore not seem unreasonable, especially since this will be cost-free and therefore go straight to the bottom line. Nevertheless, CEO Eklund stated during the recent CMD that price increases are not in the business plan for now and therefore also not included in the 300 ARPC target for 2025. This can be seen as a positive sign due to it making it easier to onboard customers at lower prices and increase the ARPC even further in the future.

• International Expansion: Fortnox is only active in Sweden for now and has no near-term ambition to expand abroad until the Swedish market is completely dominated. However, the opportunity for international expansion can be huge as can be seen from the picture below. Expanding to other Nordic countries would double the market size for Fortnox. Additionally, expanding towards Central Europe increases the TAM even more. Nevertheless, international expansion is not easy as it requires a lot of local tailoring and competition against already well-established players. Fortnox has already pointed out that if it were to expand abroad soon, it would most likely do it through an acquisition, which is the next point.

• M&A: Fortnox has stated M&A will be part of their growth and the company can utilize it in two main ways. Firstly, M&A can be used to strengthen existing or enter new verticals. Fortnox can leverage its customer base here to derive more value from new software capabilities. Generally, smaller tech start-ups lack the customer base Fortnox has, whereas Fortnox does not have the time to develop everything themselves, therefore making it a perfect fit. Recently Fortnox performed its first acquisition through buying Offerta Group AB for 300M SEK, a marketplace to receive tenders from service businesses. This was followed by three smaller acquisitions and one can most likely expect more in the future that enhance Fortnox's service offerings. Secondly, as mentioned above, Fortnox considers M&A a viable option when it comes to international expansion. Here it is mentioned that the reason for acquisition is more about the type of company rather than the region, although the Nordics seems to be the most plausible.

Despite all these opportunities, Fortnox also faces some serious risks that need to be considered. Apart from the common risk factors such as competition and potential lack of innovation, the major risk I see in the business is management execution. Even though current management shows no signs of being incompetent, I find the lack of solid track-records and skin the game concerning. Fortnox awaits a tremendous amount of challenges in the upcoming years with capturing more market share, increasing module adoption, M&A and possibly international expansion. These are no easy tasks and preferably I would've liked to see either experienced executives with exceptional past performance or founder-led driven entrepreneurs. Since Fortnox has neither from my point of view, I identify this as one of the biggest negatives regarding the investment case.

Financials

Fortnox has experienced a remarkable journey over the recent years with both strong top line growth and significant margin expansion. While revenues have compounded at a 40% CAGR from 2015 to 2020, operating margins have increased from 19% to 37% leading to an astonishing 61% CAGR over the same period. The graph below provides a clear visualization of this impressive development.

Top line growth is supported by strong new customer intakes which experienced a 26% CAGR from 2015-2020 growing from 115.000 to 367.000 customers in 2020 and 385.000 in Q1 2021. At the same time, ARPC increased from 113 in 2016 to 169 in 2020 and 171 in Q1 2021. The growth in operating income clearly demonstrates the scalability of the business model and the operational leverage Fortnox can achieve through it. The main expenses Fortnox has are Personnel, Purchased Services (COGS), Other External Costs and D&A. The figure below demonstrates that operating leverage is mainly derived through Personnel and Other External Costs, whereas Purchased services have remained relatively stable and D&A has slightly increased over time.

Fortnox has grown its cash position considerably over the recent years and currently has around 470M SEK in cash on the balance sheet (~2% of market cap.). Since Fortnox has approximately 175M in interest-bearing liabilities, the company has a negative net debt position and a robust balance sheet. The cash position and a Net Debt/EBITDA of approximately -0.9x. gives Fortnox a strong position for more acquisitions in the future. Fortnox furthermore works, like many other SaaS peers, with negative working capital enabling strong cash flow generation. Over the last 5 years, around 76% of EBIT converted to FCF on average. Fortnox has also experienced strong returns on invested capital with a 55% 5-year average (see figure below), clearly above their cost of capital and hence resulted into solid value creation. In addition to that, Fortnox has a 4-year ROIIC average of 87% (!) and a 3-year average of 79%, once again demonstrating the capital efficiency and operating leverage of the business. Both ROIC and ROIIC have been calculated following this paper.

Valuation

At the time of writing, Fortnox is trading at 413 SEK per share, which amounts to a market cap of around 25B SEK (~$3B). Fortnox has experienced remarkable returns with the stock increasing close to +1700% in price over the last 5 years, becoming a compounding favorite amongst Swedish investors. The stock is currently valued at 34x. EV/Sales and close to 90x. EV/EBIT, making the stock far from cheap. Moreover, the stock is trading at a premium compared to its historical average (see graph), although it can be partly supported by the improvement in margins and consistency in top line growth. Despite the high multiples, I believe Fortnox is trading close to fair value today given its growth trajectory.

For my assumptions to derive the fair value of Fortnox today I assume the company to meet its 2025 targets of >700.000 customers and an ARPC of 300. While I believe the ARPC can exceed 300 through increased module adoption and pricing power, I set the ARPC to 300 for the base case. I estimate a linear trend in ARPC improvement (12% CAGR), whereas I expect gradual decreases in net new customer intakes at a 14% CAGR, leading to a ~47% market share in Sweden. Fortnox's total revenues have always been higher than their final amount of customers multiplied by ARPC, since ARPC is a rolling 12-month figure that excludes non-recurring revenues. The number of customers multiplied by ARPC have been relatively stable around 88%-90% of revenue, hence for my future estimates I follow the past patterns of around 12% non-recurring revenues and derive a 28% revenue CAGR between 2020-2025. I furthermore only assume organic growth and no international expansion plans. In addition to this, I expect further operating leverage over time consequently increasing EBIT margins from 37% in 2020 to 50% in 2025. As can be seen in the assumptions below, this increase is mainly derived from decreases in personnel and other external costs. The increase also implies that Fortnox continues their achieved incremental EBIT margin of 57% in 2020 over the next 5 years on average. Lastly, for simplicity sake I assume that 79% of EBIT gets converted into FCF, which is equal to the last 4-year average.

Using these assumptions I derive the following figures:

Now for the final step in the valuation I assume a 10% discount rate (my minimal requirement for annual returns) and a 25x EV/EBIT exit multiple. While I've seen 30x. EV/EBIT exit multiples for similar names, I like to remain conservative as I'm not factoring in successful international expansion in the terminal value. Utilizing all of the aforementioned assumptions, I arrive at a fair value of approximately 350 SEK per share, which it was closely trading at on May 17th.

However, in a bull case scenario revenues and margins could obviously be higher, which is not unthinkable as Fortnox has a strong history of beating their guidance. Furthermore, new and existing modules, such as payment services, together with international expansion can seriously expand Fortnox's TAM and enable the company to sustain high growth rates even beyond 2025, resulting into a much higher exit multiple. In that scenario I could easily see the stock double in the next 5 years (>15% IRR). Nevertheless, if Fortnox fails to execute their growth strategy the stock would suffer a strong decline as current valuation is already factoring in a lot of growth. Management is therefore crucial in this case, which is a point I remain uncertain of for now. From my base case scenario I expect modest/slightly above market returns with optionality for a significant upside. I therefore see 350-410 SEK range as a decent area to accumulate shares, although I personally won't consider starting position until the stock drops below 380 again given the opportunity costs of my other holdings.

Comparing Fortnox with industry and other software peers demonstrates the premium the company is trading at. I personally believe this premium is fair given the business model, opportunities and execution Fortnox has shown in the past (e.g. high ROIC). Fortnox has been / is a high-quality Swedish compounder and is in my opinion one of those companies where you have to pay up for quality. Nevertheless, valuation always matters and to achieve a good risk-reward I would personally wait a bit until either the fundamentals have caught up or the stock has declined to a more attractive price level.

Conclusion

Fortnox is in my opinion one of the highest quality public SaaS companies in Europe that enjoys obvious industry tailwinds with businesses transitioning their operations to the cloud. Fortnox is developing a sticky one-stop-shop ecosystem that forms the backbone of many SMBs, regardless of their industry or focus. This alongside Fortnox's partnerships with the majority of accounting firms provides the company with a robust competitive advantage. Furthermore, Fortnox has many growth opportunities through enhancing existing modules (finance, insurance, marketplace), introducing new verticals, increasing prices, M&A and international expansion. Notwithstanding these promising prospects, the current management team has not convinced me yet of their execution abilities, which I see as a great concern moving forward. Fortnox has a remarkable track-record with significant top line growth, margin expansion and return on invested capital. In addition to this, the company has a solid balance sheet with negative net debt and a war chest for M&A activity. Assuming Fortnox reaches their targets for 2025, I believe the company is trading at fair value despite its high valuation. Using organic base case assumptions, I think the company can provide a 10%-14% 5-year IRR at 350 SEK and therefore normally market outperforming returns. Moreover, I see strong optionality (TAM expansion), enabling further longevity in growth rates, consequently leading to substantially higher returns. Still, if execution fails I expect significant downside making this a relatively high risk-reward investment case. I'm personally quite intrigued by Fortnox and might initiate a position if the price drops to the 350-380 SEK area.

Disclaimer: I’ve no position in Fortnox at the time of writing this blog post. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

Kaspi's Business Model

Kaspi's business model can be divided into three platforms that serve both consumers and merchants with their day-to-day needs:

1. Payments

2. Marketplace

3. Fintech

The payments platform is very similar to the digital wallet services offered by companies, such as PayPal and Square, with the platform enabling both consumers and merchants to send and receive digital payments. Services include debit cards (Kaspi Gold), P2P, QR, internet and mobile payments. In addition to that, Kaspi introduced Bill Payments, which enables both consumers and merchants to pay for household needs and invoices, such as utilities, internet, insurances etc. The service is furthermore integrated with the state's tax database allowing for instant settlements of accrued taxes. Furthermore, Kaspi launched its own point-of-sale (POS) solutions in 2019, enabling merchants to also process in-store payments through Kaspi. The development of Kaspi's POS solutions has been astonishing, growing from a 9% market share in Q1 2020 to 46% (!) in Q1 2021.

However, in my opinion, the most notable development Kaspi has achieved in the payments space is the establishment of the proprietary payment network. Kaspi launched this network mid-2019, basically eliminating the reliance on third-party payment processors such as Visa and MasterCard. The company disrupted the payments value chain by providing end-to-end payment functionalities between consumers and merchants through the Super App and QR technology. This has led to Kaspi taking significant market share from both Visa and MasterCard, becoming the payment processing leader in Kazakhstan. The network furthermore reduces transaction costs and allows Kaspi to fully control the customer experience and enhance their data collection.

Revenues from the payment platform are for the majority derived from membership and transaction fees (73% of payment revenues). The key KPI to look at here is the revenue-generating total payment volume (RTPV), which averages a take rate of approximately 1.3%. Take rates are the highest for other bankcards (2.3%), followed by Kaspi Gold debit cards (1.7%) and Kaspi QR through the Super App (0.95%). Due to an increasing shift to Kaspi's own solutions, take rates can be expected to decline slightly over time. P2P transfers are only monetized for external transactions, while revenues are also earned through interest from cash balances (27% of payments revenues). The amount of active consumers and merchants on the payment platform has grown explosively over the recent years, leading to strong growth rates in transactions and RTPV (157% 3-year CAGR). The average amount of monthly transactions per active consumer also nearly doubled between 2019 and 2020 (14.8 to 28).

Kaspi's second segment is the marketplace platform, which connects merchants and consumers to buy a large variety of products and services. Electronics comprise the majority of sold products, however Kaspi is experiencing a shift towards other product segments, such as clothing, cars and groceries. The platform is very comparable to those of other e-commerce companies, such as Amazon, Shopee etc. Kaspi aids its merchants with payment options, including buy-now-pay-later (BNPL), fulfillment through delivery services and marketing. Revenues from the marketplace platform are derived from take rates on Gross Merchant Value (GMV), delivery fees (6% paid), Kaspi Travel (online travel business) and subsidiaries in Azerbaijan (Turbo.az, Tap.az and Bina.az).

Kaspi's take rates have experienced a positive development over the recent years, improving from 4.6% in 2017 to 7.7% in 2020 and 8.2% in Q1 2021. This is driven by the aforementioned shift in sales, promotional campaigns, logistics monetization and marketing services. GMV has compounded at a 46% CAGR since 2017 reaching $617M in 2020, while the retention rate of active merchants has consistently been >99%. The GMV growth is mainly derived from strong increases in e-commerce and m-commerce (mobile), whereas it has been decreased due to a drop in in-store GMV. Kaspi also offers in-store shopping assistance at large electronics retailers, but while this service made up 40% of GMV in June 2019, it represents only around 1% today.

Kaspi also launched an event called Juma, which can be compared to Black Friday in the U.S. or Singles Day in China. This event is held twice a year, once in the summer and autumn, and comprised 14% of GMV in 2019. GMV per consumer is also shown to approximately double after three years of the first purchase, demonstrating extended growth potential within already active consumers. This growth in GMV per consumer is further supported by the strong growth rates in the merchant base, currently growing faster than the consumer base.

The third and final segment is the fintech platform, through which Kaspi offers its digital finance products. Revenues are mainly derived from interest fees with approximately half coming from the BPNL service, which is integrated with the marketplace platform. Similar to competitors like Afterpay and Klarna, BPNL is offered interest free for the first three months and is usually provided with terms up to 24 months. Kaspi furthermore offers general purpose loans with maturity dates up to 48 months. The average term usually lasts 7 months with loan amounts for BPNL averaging $260 and $500 for the general purpose loans.

The fintech furthermore constitutes of the Kaspi Red Shopping Club subscriptions, which allows for interest free installments up to three months and other shopping bonuses. The platform also offers instant deposits, car financing and merchant finance. The latter offers merchants additional working capital with a maximum facility drawdown of 20% of GMV or TPV. Similar to Square Capital, the loans are automatically repaid from the daily GMV or TPV of merchants through Kaspi. Merchant Finance has only recently been launched, hence as of Q1 2021 it only made up 5% of TPV, but it's growing rapidly.

Kaspi has developed a credit decision making process and scoring model that extensively utilizes risk algorithms and predictive models to estimate the credit risk of its consumers. These models are also fueled by the data insights retrieved from these consumers on both the payments and marketplace platforms. Moreover, external data from credit bureaus are supplemented to enable better quality credit decisions. Through this, the system makes 99.9% of loan approval decisions within six seconds. Kaspi also runs a large team of data scientists (>155) to consistently modify and improve the models. All of this has resulted into drops over the recent years in delinquency and payment default rates (apart from a Q2 2020 bump due to Covid-19). 97% of loans that are less than 90 days overdue are collected, while this is 40% of those after 90 days, however this figure has been steadily improving with the quarters (see 90+ collection vintages).

The interests yields Kaspi collects on its loans are on average around 32%, which appear very high but it should be noted that Kazakhstan's treasury yield lies around 9%. Nevertheless, it can be seen as a positive development that a larger part of Kaspi's income becomes derived from the payments and marketplace platforms, since they carry substantially lower risks. While the fintech platform compromised 71% of net income in 2019, it is expected to decrease to approximately 49% in 2021. I expect this trend to continue in the upcoming years, making Kaspi less like a bank and more like a technology company.

Industries and Market Dominance

I assume everyone by now is quite aware of the tremendous growth opportunities within the e-commerce and fintech industries, so I won't bother elaborating on that. However, it is interesting to take a closer look at Kaspi's positioning with regards to the three platforms. Kaspi has managed to capture significant market share in its target markets within a relatively short amount of time.

Firstly, digital payments in Kazakhstan have grown tremendously over the recent years, but accounted for only 31% of all consumer transactions in 2019. Comparing this with other emerging market countries such as China (77%), Brazil (70%) and Russia (51%) it becomes clear that there's still a significant transition to cashless payments left. Similar to what WeChat did in China, Kaspi is essentially replacing cash in Kazakhstan, hence positioned favorably for this trend. Kaspi was estimated to have a 65% market share of total cashless payments and digital transactions in Kazakhstan in 2019, up from only 15% in 2017. Kaspi furthermore has gained significant market share in the POS and network spaces already mentioned before.

Secondly, Kaspi has been the largest online retailer in Kazakhstan since 2017. Kaspi's e-commerce GMV was estimated at a 46% market share in 2019, up from 23% in 2017. The total GMV of the marketplace platform was equivalent to 5.5% of Kazakhstan's total retail trade in 2019. E-commerce still has lots of room to grow in Kazakhstan, as online retail trade only comprised 3.4% of the total retail market in 2019.

Third and lastly, Kaspi is estimated to have a 32% market share with regards to consumer loans, while also having 18% market share within retail deposits. Kaspi also sees great growth opportunities in this industry, as financial services for consumers still have lower penetration rates in Kazakhstan (6.7% of GDP) than other countries like China (18.1%), Brazil (8.7%) and Russia (8.5%). Finally from a macro perspective, it is also interesting to know that Kazakhstan's real GDP growth is expected to be around 4% for the upcoming years.

All in all, Kaspi is extremely well-positioned and I believe the following quote from the CEO provides a great summarized description:

"The combination of our scale with consumers and merchants, joined by our own proprietary payment network puts Kaspi.kz in a completely unique playing field to capture the multi-year structural growth opportunity offered by digitalisation in Kazakhstan and the broader region. We have many plans to continue building on our success both this year and over the medium-term and find it difficult to be anything other than extremely optimistic about the future." - Mikhail Lomtadze, CEO and co-founder of Kaspi.kz

Kaspi's Competitive Edge

Kaspi mainly competes with local (retail) banks and other (global) platforms/startups (e.g. Qiwi). In my opinion it is quite clear what Kaspi's main competitive edge is, namely network effects. Kaspi's Super App functions as a single gateway to all the services they offer and currently has 5.4M daily active users (DAU), +98% YoY. Comparing this with the 10M monthly active users (MAU) in Q1 2021, Kaspi has one of the highest conversion rates (54% in Q1 2021) signalling extremely high user engagements levels.

Through its Super App, Kaspi can quickly launch new services and dominate markets. A prominent example of this is the launch of Kaspi travel, which within four months of launch already managed to capture 20% (!) of the total market share. The Super App allows for easy consumer adoption, which drives both strong synergies between the platforms and explosive growth for new services.

The Super App also induces a flywheel effect by establishing high retention rates for both consumers and merchants, which consequently attracts more consumers and merchants, followed again by higher retention rates and so on. This together with the offering of high-quality services provides Kaspi with a leading brand in Kazakhstan, which becomes evident from their Net Promoter Score (NPS) of 87.3 (e-commerce industry has an average of 40). NPS is an extremely important metric for Kaspi, as the product heads of each business lines are benchmarked against their NPS scores instead of revenue or user growth. Moreover, Kaspi makes 50.000 phone calls each month with customers to obtain feedback for their products. As the CEO states, the metric is used as real-time feedback that enables constant changes in the business, rather than a tool to measure its health.

Besides its network effects, Kaspi prides itself (deservedly) of being an innovation-driven company with a strong track-record of introducing cutting-edge digital products. CEO Lomtadze has clearly stated that they do not see themselves as a bank, but as a technology company also offering e-commerce and banking services. Furthermore, he states that he's obsessed with controlling the whole customer experience and draws comparisons to both Apple and Amazon. The development of the ecosystem, building a one-stop-shop with continuous innovation that enhances the customer experience is therefore also seen as Kaspi's competitive advantage.

Management & Ownership

Kaspi was founded by Vyacheslav Kim in 2002 when he bought a privatized bank named Kaspiyskiy. However, the real transformation began in 2006 when Baring Vostok, Russia's largest PE firm, took a stake in the company. This led to Mikhail Lomtadze joining the management team in 2007, who together with Kim transformed Kaspi to what it is today.

Kim currently functions as the chairman of the board of directors and has an academic background in mathematics, physics and finance. Prior to forming Kaspi, Kim was known as an influential business man with extensive experience in the retail space. He also serves as a board member for Magnum, Kazakhstan's largest hypermarket chain.

Mikhail Lomtadze is Kaspi's current CEO, co-founder and board member. Prior to joining Kaspi, Lomatdze was a partner at Baring Vostok. Before that, Lomtadze founded its own strategy consulting and auditing firm in 1995, which later became a part of EY. Lomtadze furthermore holds an MBA from Harvard Business School and was named the best CEO in Kazakhstan in 2019 by a Forbes and PwC survey.

It becomes evident that both Kim and Lomtadze have impressive backgrounds and remarkable track-records when it comes to execution. Lomtadze strikes as a visionary leader with strong focus on customer experience, innovation and growth. He can be see as the main person responsible for the transition of Kaspi from a corporate bank to the tech giants it is today. Moreover, key members of the management team have been with Kaspi for more than 10 years, all with solid backgrounds and experience in both finance and technology (many HBS graduates). The heads of different departments have also commonly been at the company for around a decade and appear relatively young on average (~40).

When it comes to shareholder ownership, the major shareholders consist of Baring Vostok (30.7%), Kim (24.1%) and Lomtadze (23.3%), who together hold a strong majority of the shares outstanding (78.1%). Some questions have been raised about how Lomtadze got his equity stake, as prior to the IPO Kairat Satybaldy, the nephew of the former president of Kazakhstan, owned a large stake, which was allegedly transferred to Lomtadze via Kim (article for more details). Satybaldy's political connections were seen as a potential red flag, which is why he exited his position prior to the IPO. However, the question remains what influence he still holds and whether these transferred share are truly 'transferred'.

Opportunities & Risks

Before diving into the financials, I want to highlight some of the opportunities and risks associated with Kaspi. Many people online think that Kaspi's growth is limited due to high obtained market shares and limitation of Kazakhstan as a region. I would debunk this argumentation through the following three ways:

• Growth within existing business lines: even though Kaspi has already obtained strong market shares in its three platforms, the level of digitalization (including e-commerce and fintech) in Kazakhstan remains still below that of comparable countries, such as China, Brazil and Russia (see in industry section). The combination of increased levels in digitalization, capturing even more market share and the overall tailwinds of the involved industries provides Kaspi with plenty of growth opportunities left within its existing operations. In addition to this, only 34% of users use all three platforms, allowing for further synergies and growth opportunities within the ecosystem.

• Introduction of new products and services: Kaspi still holds plenty of opportunities with regards to extensions of the current ecosystem. Kaspi Travel, POS and the Merchant Finance services demonstrated how Kaspi can quickly launch and monetize new verticals. Kaspi has already mentioned plans to promote more marketing services to its merchants, which comes straight out of the Amazon playbook. On top of this, Kaspi sees medium-term opportunities in other areas of merchant operations, including accounting, HR, logistics and inventory management. Here I see a great opportunity for Kaspi to provide sticky software services such as fully integrated ERP and accoutning systems with features similar to Microsoft's Dynamics.

• Geographic expansion: Kaspi has previously always focused on their main market Kazakhstan, but has revealed its ambitions to also expand its services abroad in Central Asia and the Caucasus. While Kazakhstan has a population of close to 18.6 million people, the targeted region has a total population of 87.3 million people with $215B of consumption in 2019. Kaspi has already expanded into Azerbaijan through the acquisitions of of three leading marketplace platforms Turbo.az (a car marketplace), Tap.az (a used and new items marketplace) and Bina.az (a real estate marketplace). This move increased Kaspi's addressable market from 18.6 to approximately 28.7 million people. Furthermore, it is relatively easy for the company to expand its services abroad due to both the asset light business model and the fact that it mostly goes through a mobile phone application: "When you have everything in a mobile phone and in an application, it is much easier to scale." - Lomtadze.

However, Kaspi possesses also substantial risks, mostly related to typical emerging market issues.

• Political/Corruption risk: as mentioned before, Kaspi has had some interesting ties with the government. It should be noted that the country has an authoritarian regime with a very poor democracy index score (128th), which can also be said for the other countries in the region pictured above. Hence, political risks should be seriously considered when investing in Kaspi. Furthermore, one might wonder whether the reported numbers are too good to be true. All I can add here is that Kaspi has been consistently audited by Deloitte even before it became public, whereas I was unable to find any comments in the audit reports that might indicate forms of fraud. However, this does obviously not exclude the possibility of numbers manipulation.

• Macro risks: Kazakhstan's economy is heavily dependent on the oil and gas industry, which are very cyclical by nature. The commodity cycles therefore have a strong influence on the economy, hence consumer expenditures and as a consequence Kaspi's operations. In addition to this, Kazakhstan experiences much higher inflation rates than western countries which also bring instability to markets and exchange rates. Kazakhstan's currency (Tenge) fluctuates significantly, especially during periods of high volatility in the financial and commodity markets. Kaspi is also strongly affected by interest rates, as they dictate the yields on loans and deposits.

• Credit risks: down cycles would also severely affect the credit risks Kaspi has through the loans on their fintech platform. Economic recessions or stagnation would strongly impact the default rates, increasing NPLs and the cost of risk. Liquidity and credit risk assessment are therefore of utmost importance to Kaspi.

Financials

One can examine Kaspi's financials in two ways: per platform or consolidated. I'll first show the numbers per platform, after which I'll continue with the consolidated version for simplicity's sake. Below are some of the KPI's per platform. What stands out is that all platforms have demonstrated strong growth in their volumes, however the payment platform has grown significantly more than others. The growth in GMV is partly lower due to a transition from in-store GMV to e-commerce and m-commerce. Nevertheless, while yields and take rates remained relatively stable for both payments and fintech, the marketplace platform has experienced a strong positive development.

Looking at the table below, we can see that the trend illustrated above also holds for revenues and income per segment. We can furthermore conclude that the marketplace platform is the most profitable based on both gross and net income margins. As mentioned before, with the payments and marketplace platforms growing stronger while also bearing stronger profit margins, one can expect Kaspi's income to become less reliant on the fintech services. This is both positive in terms of profitability and decreased credit risks, consequently boosting Kaspi's valuation multiples which I will discuss later on.

Looking at revenues and income consolidated, we can see a strong upward trend since 2017 with both strong top line growth (32.5% CAGR) and margin expansion (58.7% NI CAGR).

Examining Kaspi's expenses, we can clearly see a decline in interest expenses and loan provisions as part of revenues due to the growth in the payments and marketplace segments. We also see further operating leverage in the decline of operating expenses. Meanwhile, R&D and G&A expenses remain relatively constant, whereas sales and marketing expenses have increased in proportion over the years.

With regards to Kaspi's balance sheet, we can see that the company currently as of Q1 2021 holds 324.8B KZT in cash and equivalents, while having 246.1B in debt and other liabilities, hence the company has a net cash position (note: excluding deposits and loans). Kaspi has also met both Basel III and NBK captial adequacy ratios for both Tier 1 and total capital. Provisions for impairments of loans as a percentage of NPLs have apart from 2019 always been above the 100% mark. The cost of risk (provisions / gross loans) has fluctuated between 1.8%-4.6%. At the end of 2020, Moody's upgraded Kaspi's outlook from stable to positive.

Kaspi released guidance for 2021 after their Q4 2020 report, which they upgraded after the recent Q1 2021 results. The figures are presented below. Kaspi is overall guiding for another strong year with strong growth in all segments and further margin expansions.

Valuation

At a price per share of $85, Kaspi has a market capitalization of approximately $16B. As of writing, Kaspi trades at 25.8x FY 2020 earnings and 17.7x FY 2021 earnings, which can be considered extremely low given the company's growth and profitability profile. However, since the company possesses considerable risks and Kazakhstan has 9% yields on governmental securities Kaspi deserves to be trading at lower earnings multiples than western peers. In order to estimate a fair discount rate, I simply use the CAPM approach, utilizing the 9% risk-free rate, 6.85% equity risk premium and beta of 1 since the company hasn't traded long enough to estimate its volatility compared to the market. Therefore I can simply add up the risk-free rate and equity risk premium, which gives me a discount rate of 15.85%. Note that this discount rate is almost double of that what is commonly used for similar software peers in the US and European markets, but can be supported due to the earlier mentioned factors.

Now for estimations I could of course try to forecast growth and margins for all platforms and estimate the consolidated free cash flows. One could also do a sum-of-parts (SOPT) analysis by giving a valuation to each platform individually. However, I decided to do a simple EPS and P/E exit multiple valuation, because I could already conclude from this back of the envelope approach that the stock seems very attractive at current levels.

Using this approach with analysts' estimates, 50% payout ratio, a 15x P/E exit multiple and the aforementioned discount rate, I achieve a fair price of $105.30 per share (+24% upside). The KZT currency is down around 23% over the last five years against the USD, hence it makes sense to subtract around 4%-5% on annual returns for any FX effects. Even after this subtraction, lower exit multiples or higher discount rates, there still remains plenty of upside from today's price. I therefore see the stock as undervalued right now.

A possible explanation for the undervaluation could be due to people simply not knowing about this stock and the fact that it's a company from Kazakhstan. While obviously not 100% comparable, Kaspi does not enjoy market attention similar to what companies such as Mercadolibre or Sea limited receive. While I personally understand investors' concerns regarding the previously mentioned risks, they seem more than priced in to me.

Conclusion

Kaspi basically has everything I look for in a company. It has strong top line growth while also being extremely profitable with potential for further margin expansion. Kaspi enjoys huge secular tailwinds being active in both the fintech and e-commerce industries, where the company has market leading positions for each of its business platforms. The company furthermore has solid competitive advantages through the network effects of its Super App and its focus on continuous innovation. Kaspi also has plenty of growth opportunities left by further exploiting the synergies between the platforms, expanding into new verticals and entering new geographical markets. Kaspi's management team appears extremely competent with remarkable backgrounds and experiences. In addition to that, the company is founder-led with high insider share ownership. Nevertheless, Kaspi faces typical emerging market risks that should be considered when valuing the stock. Taken these risks into consideration, I believe the stock is trading at attractive levels that can provide market outperforming returns even after subtracting potential currency effects. As a consequence, I currently see the stock as undervalued.

Disclaimer: I’m long Kaspi.kz. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

Thesis summary:

• Exasol provides a competitive offering with top speed and an attractive cost-to-performance ratio. The quality of the product is hard to ignore and Exasol's customer base confirms this message. The company is expanding aggressively and can be expected to achieve high growth rates for the foreseeable future.

• Data is the new oil. The industry is growing extremely fast and Exasol enjoys several tailwinds that support strong growth rates for many years to come. While the company isn't a market leader, they don't have to be in order to make the stock an appealing investment.

• I currently consider valuation too high given the fundamentals and associated risks. Exasol's loss making, intense competition in the industry and management execution are substantial risk factors that in my opinion outweigh the rewards for now.

Some useful definitions before diving in:

• In-memory technology: enable large amounts of data to be processed in the main memory (RAM). This allows for faster access and processing times.

• Column-based storage and compression: Columnar storage and compression reduces the number of I/O (input/output) operations and amount of data needed for processing in main memory and accelerates analytical performance.

• Massive Parallel Processing (MPP): connecting multiple servers, or nodes, to form a single unified system, based on a so called shared-nothing architecture, which means that there is no single point of failure within the server cluster. This architectural approach enables high scalability by simply adding additional nodes to the cluster as and when the volume of stored data or the need for additional performance increases.

Exasol's Business Model

Exasol provides analytical database solutions that enable firms to store, manage, access and analyze data at high speed and scale. Exasol's database solution utilizes columnar storage, in-memory analytics and MPP architecture to provide what they claim to be the fastest analytical database since 2008 (TPC-H Benchmark). The in-memory solution uses an algorithm that only loads the necessary data, keeping the hot data in memory while the cold data resides on the disk. This leads to customers only needing 5%-10% RAM compared to their raw data volumes, while other in-memory solutions sometimes require >100%.

Exasol's product helps firms to become more data driven. Exasol's database can either be added as an extension to an already existing data warehouses or replace the legacy data warehouse altogether. The database includes several use cases, such as business intelligence (BI) reporting, enabling ad-hoc queries, running data science models and AI & machine learning (ML) support. Exasol's database can be installed on-premise, in the cloud or in a hybrid environment. It can furthermore be deployed on the most popular public cloud marketplaces, including AWS, Azure or GCP, while Exasol also offers its own ExaCloud solution. The database supports multiple popular programming languages (R, Python, Luna and Java) and integrates with numerous BI and data tools, such as PowerBI, Tableau and Alteryx.

Through its database editions and the opportunity to add nodes for further scalability, Exasol follows a so-called "land and expand" strategy. Exasol currently provides the following three database editions:

1. Exasol Community Edition: A free single node edition for commercial and academic use. Max. 200GB of raw data, mainly aimed for minor data analysis needs.

2. Exasol One: Also a single node solution with max. 1TB of data, including all features and support. Applicable for SMB’s or individual departments within an enterprise (€1999/month).

3. Exasol Enterprise Cluster: Full enterprise version with unlimited scalability.

With regards to pricing, Exasol's database can be deployed in the following three ways:

1. Fully managed system: SaaS offering completely hosted and operated by Exasol.

2. Subscription-based: SaaS but deployed on the customer’s infrastructure.

3. Perpetual license: pay for set data volumes with upsell opportunities depending on data usage.

Exasol plans to only offer subscription options in the future and is therefore still in the transition from a license model to SaaS only. Recurring revenues as a percentage of revenues increased from 64.2% in H1 2019 to 90.7% in H1 2020. The pricing model scales with the data usage, hence Exasol experiences revenue growth from within its customer base as they increase their data volumes. Revenues are mostly derived from the DACH region (Germany, Austria & Switzerland), followed by the North America, Rest of the World and the United Kingdom. Exasol is expanding its headcount aggressively, going from 149 in 2019 to 223 in 2020 and targeting 300+ by the end of 2021. Number of employees is seeing its strongest growth in the sales and marketing department (70%), partly due to the primary focus being on expansion in other European countries and the US.

Competition from the Tech Giants

As mentioned before, Exasol is a relatively small player in a competitive field with both upcoming unicorns and Tech Giants. Some well-known competitors are:

• Microsoft

• Amazon (Redshift)

• Alphabet (BigQuery)

• Snowflake

• SAP (Business Warehouse & HANA)

• IBM (Db2 & Netezza)

• Oracle

• Cloudera

• Databricks

• Teradata

I'm no DBMS expert (although I've experience with SAP's business warehouse which is very unimpressive) so it's hard for me to provide a fair judgement. However, from Exasol's fillings and some independent sources, it appears Exasol's product is of high quality. Firstly, Exasol highlights that their in-memory architecture in combination with MPP forms a key differentiator through which it has managed to capture customers from some larger (more legacy) players, such as SAP, Oracle, IBM and Microsoft. The company also emphasizes its remarkable speed, stating to be the fastest in the industry even beating newer players like Snowflake. Their speed results in less infrastructure requirements and therefore lower total costs of ownership (TCO) for customers. This article comparing Exasol to Oracle explains it better than I can.

This brings me to my second and more reliable point of independent extrernal resources stating Exasol's product quality. As mentioned before, Exasol comes out on top in several of the TPC-H Benchmark tests, an unbiased non-profit organization comparing database processing performance, ranging from 300GB to 100TB in raw data volumes.

Furthermore, a recent survey by Dresner Advisory Services on Analytical Data Infrastructures (ADI) demonstrates how Exasol together with Snowflake are the overall leaders with regards to customer experience and vendor credibility. Exasol also got recognized as a strong performer in Forrester's latest report on Cloud Data Warehouses, where it received the highest score possible with regards to performance. Exasol used to be included in Gartner's Magic Quadrant, but isn't anymore due to changes in entry requirements (>40M$ in annual revenues or >50% growth). However, Exasol's enterprise cluster receives highly positive reviews on Gartner peer insights with many customers praising its performance, flexibility and customer service.

Which brings me to my final point: Exasol's customer base. Exasol has managed to acquire some impressive large customers over the recent years, such as Zalando, Otto, Adidas, CVS, Revolut, Vodafone and Badoo. The fact that these companies went with Exasol is in my opinion a strong indication of the company's product quality. Exasol currently has 195 customers in total, up from 175 in 2019. I expect a lot more customer acquisitions in the future, especially in the US, with the S&M expansions and capital injections. All in all, external reviews and the customer base appear to confirm Exasol's own message of being a strong performer in the DBMS space.

Nevertheless, Exasol faces one major problem from my point of view: its brand. As the popular saying goes: "Nobody gets fired for buying IBM", I think this quote also applies to the DBMS space, where CTOs or CDOs cannot go wrong by simply choosing Redshift, BigQuery or Snowflake. The officer responsible needs to be very confident and convinced to prioritize Exasol over its competitors. Just having a competitive/faster product isn't sufficient enough. Additionally, it is relatively easier to adopt the DBMS services from cloud infrastructure providers/ecosystems, such as GCP, AWS or Azure.

DBMS Industry

Another popular saying is that data is the new oil. Data management and analytics have received a lot of momentum over the recent years as businesses increasingly rely on it to improve their operations. Data stands at the foundation of digital transformation (digital economy) and aids companies with innovating and personalizing their services. Exasol enjoys massive tailwinds from both increasing volumes in data and the shift towards the cloud. An IDC white paper expects the summation of all Global data to increase with 27% annually from 2018-2025. Simultaneously, estimates are that 49% of the world's stored data will reside in the public cloud (up from approximately 30% today) with 90% of the fortune 1000 having a multi-cloud strategy in 2024.

Statista estimated the Global Data Analytics Market to be worth $169B in 2018, of which 25%-30% consisted of DBMS ($42B to $50B). This is not far from Marketwatch's $30B+ for the Data Warehouse space or Gartner's $54B for DBMS in 2019 (+18% YoY). Anyhow, Exasol experiences a fast-growing global trend with a large TAM. AI, ML and BI form core pillars for future growth opportunities. Also, the industry is currently still filled with legacy database architectures that aren't built for today's data requirements. These legacy solutions often lack scalability, have capacity constraints and aren't designed for cloud adoption. Hence, Exasol is well-positioned to continue taking market share from outdated incumbents (e.g. SAP, IBM and Oracle) while competing with other more modern solutions (e.g. Amazon, Databricks, Google, Microsoft and Snowflake).

Management & Ownership

Exasol, which initially started as a university project, was founded in 2000 by Michael Gutzmann and his student Falko Mattasch. They were one of the first to develop in-memory database solutions before it became a more wide-spread concept. After developing the product for years, the duo made significant progress in creating an uncontested leader in the database market. Nevertheless, management was incapable of properly selling the product to the market. Following Mattasch's words in an interview: "[...] we made the typical mistake of a German firm by putting a lot of effort into engineering and not into marketing".

This led to an organizational change with Michael Gutzmann leaving as CEO in 2008 and an increased focused on commercialization. From then on the company improved its sales pipeline and continuously managed to add new customers. However, Exasol has over the years been incapable of raising capital to boost company sales. From what I've been told, this was partly due to co-founder Falko Mattasch being extremely risk-averse. Nevertheless, this has changed with Exasol's IPO in May 2020 during which the co-founder got bought out. The company also raised additional capital through a heavily oversubscribed private placement last December at €19.50 a share. It's clear that the company is steering in a new and more aggressive direction.

Current CEO Aaron Auld has been at Exasol for close to 15 years and been the CEO since July 2013. Auld has prior experience at other technology companies and a master's degree in law from St. Gallen. Mathias Golombek has been the CTO since 2014 and has worked at Exasol for 17 years (!), starting as a software developer and climbing his way up to head of R&D in 2007. It's positive to see that the CTO has such great experience at the company and been involved with the product development. CFO and COO Michael Konrad joined Exasol in 2015 and previously worked as CFO and CEO at Asknet AG.

I currently see two negatives with the management team. Firstly, the management team in my opinion lacks a strong track-record. While they have adequate backgrounds, it does not scream world-class. One certainly needs top-notch management when competing against the best companies in the space, for example Snowflake, led by the very successful CEO Frank Slootman. Exasol is relatively small and has just started its aggressive growth journey, which requires an extremely competent management team in order to successfully execute the new strategy. Secondly, management does not include any founders and the current team has basically no skin in the game. All three officers mentioned earlier have less than 0.1% stake each in the company. Exasol does have high insider ownership though with the supervisory board owning close to 31% of the company. This is mainly derived from Dr. Knud Klingler, who owns a 25% stake and has been member of the board since 2008. The company also holds an additional 2.7% in their treasury.

Financials

Some key financial highlights:

• Revenue: 24% CAGR (2015-2019)

• Gross Margin: 90%

• Positive OCF from 2015-2019

• Annual churn: 4.8% (3-year average)

• LTV/CAC: 21.3x (17.7x 3-year average)

• Net Cash Position

As said before, Exasol has started a new growth trajectory by raising capital and investing heavily in its sales team (+70% from H1 2020 to H2 2020). Revenues only grew 9% in 2020 due to the company switching from a licensing model to subscription services. The company achieved a 37% growth in ARR in 2020 and guides for >45% growth in 2021. It should be noted that Exasol has 9+ months sales cycles, hence the recently made investments won't be fully reflected in the current and 2021 numbers. Exasol has been profitable in the past on an adjusted EBITDA basis (~15% margins), but is not expected to be so for the next few years due to its growth strategy.

Since Exasol has high gross margins, the majority of the company's expenses come from personnel and other operating expenses (incl. travel & marketing). These expenses have ballooned over the last years due to strong increases in headcount and significant one-off items such as IPO costs and share-based payments. Furthermore, looking at the graph below indicating the expenses as % of revenues also provides a slightly false picture due to the earlier mentioned switch in revenue model and lower revenue growth rate for 2020. Nevertheless, expenses are extremely high and Exasol has to scale the business model in the future since these proportions aren't sustainable. I have no doubt about the company's scalability potential, however I do not expect significant movements towards profitability in the upcoming years.

Exasol currently has a solid balance sheet, partially due to its recent IPO where the company raised €48.5 million in cash. The company only had €88.6 thousand of debt in H1 2020, hence a strong net cash position. From the cash flow statement we can furthermore conclude that the company experiences negative changes in working capital (excl. cash), therefore higher cash flow margins.

Valuation

With regards to valuation I take two (very simplified) approaches. The first and more easier way is to just value Exasol based on EV/ARR, forecasting it a couple of years out and then discount it back to today's value using peer multiples as a reference point. The table below provides an overview of software peer valuations in both Germany and international markets. No definitive conclusions can be drawn due to the significant differences in business models, growth rates and margins. However, we can see that Exasol belongs to the group with the fastest growth and highest gross margins. Nevertheless, Exasol is also the most unprofitable and trades at a relative premium compared to its peers.

I use a very quick & dirty approach for my valuation, mainly due to time constraints, laziness and the current opportunity not being intriguing enough to really make a deep dive. For my forecast estimations, I assume Exasol to beat its guidance for 2021 and grow ARR at a 32% CAGR until 2025. Moreover, I expect free cash flows to turn positive in the final year. The figure below shows that using these assumptions one can expect a 9% annual return when exiting at a 10x EV/ARR. Given the risks of the business (loss making, competition and management) I find this way too low. So either my estimates are way off or investors see the business as less risky than I do. Anyhow, an ideal target price for me would be more around €16, or a 38% draw down. While this isn't uncommon for high-growth tech stocks, it might be too low of a target according to the market right now.

The second way of valuing Exasol follows a similar approach, but includes free cash flow estimates looking further out in the future (at least 10 years) and then value it based on an expected free cash flow yield. In this case I use a 21% top line CAGR until 2030 and assume 30% free cash flow margins at maturity. Applying a 10% discount rate and a 5% FCF yield exit multiple provides me with a fair value of €17,90 per share. Looking at both methods and sensitivity tweaks on discount rates and exit multiples, I would argue that the €16 to €20 range looks attractive with current information and my estimates. As always, valuation is an art, not a science, so don't take my target prices as true fair values.

Conclusion

All in all, Exasol is an interesting German small cap with lots of potential. The company enjoys massive tailwinds from growth in the DBMS market and the transition to the cloud. Exasol's customer base and external reviews confirm the high quality of Exasol's services, providing customers with one of (if not) the fastest analytical database out there. The company's growth strategy sounds very exciting with significant expansions in the sales force and stronger focus on the US market. Exasol switched from a licensing model to subscription services, leading to high growth rates in ARR which is expected to continue for the upcoming years. The company furthermore carries high gross margins allowing for strong profitability in the future. Nevertheless, Exasol in my opinion carries substantial risks. Firstly, the company is very unprofitable right now due to its growth strategy. Secondly, the company experiences strong competition from tech giants (Snowflake, Amazon, Google etc.) who have much more resources and talent. Third and lastly, I'm not totally convinced by the management team yet as they don't hold significant stakes in the company and do not possess track-records of comparable quality. Therefore, I do not consider Exasol an attractive investment at current prices. Moreover, I would not consider any purchasing until the price drops in the €16-€20 range.

Disclaimer: I’ve no position in Exasol at the time of writing this blog post. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.

• The stock is down signficantly from its ATH as the Covid-19 pandemic appears to have longer lasting impacts on Admicom’s customer base than expected, tempering growth expectations. However, I expect this issue to resolve itself when economies recover and the industry returns to normalized levels from H2 2021/H1 2022.

• Admicom still has plenty of growth opportunities left including product extensions, business line expansion, entrance to international markets and M&A options.

• Admicom is a small cap stock with low analyst coverage (only 1 currently), which I expect to increase now that the company has started to also report in English.

The Business

Admicom provides a comprehensive Enterprise Resource Planning (ERP) system called Adminet to SME’s within the Finnish construction industry. The ERP system integrates operational and financial management solutions with a strong focus on automation. Admicom offers its customers functionalities such as invoicing, project management, product control, supplier price listings, information management (CRM), accounting and payroll services. Admicom’s value proposition is that customers no longer need to spend time behind the computer fixing administrative tasks in Excel or a legacy software service, but instead focus on their work in the field. Customers save a lot of money by avoiding routine office tasks and cutting administrative costs.

Admicom’s system is provided as a Software as a Service (SaaS) that charges its customer on a monthly basis. On top of that, the ERP system is 100% cloud-based, meaning that customers can easily access the system from anywhere and on any device, as long as they have an internet connection. It furthermore offers customers real-time insights into their business, which aids strategic decision making and operational control. Another benefit of the SaaS and cloud model is that it is easily deployable and scalable for customers. In contrast to legacy ERP systems with long deployment periods, Admicom’s offering only takes a few months to get implemented.

Admicom’s revenue streams can be divided into three segments. The SaaS solution constitutes approximately 72% of revenues, accounting services 21%, and consulting, education and other services make up the remaining 7%. In total, 91% of Admicom’s revenues are recurring. The pricing of the system is flexible, adjusted each month depending on the customer’s usage volume and annually based on the customer’s revenues. For its main SaaS offering Adminet, I estimate income per customer (note: not user) to be in the area of €1500 per month, based on 90% of the 91% recurring revenues being derived from this service and >1000 deployed Adminet ERP systems.

Target Markets

Admicom’s target market consists of Finnish SMEs with the majority employing >10 people and having annual revenues in the range of €1M-€5M. However, over the last years Admicom has increased its attention for both smaller and larger clients through new product offerings and acquisitions (i.e. Tocoman). For example, in 2018 Admicom introduced Adminet Lite, a limited version of Adminet for their smaller customer segment (<€1M in annual revenues). The most basic version of Adminet lite can already be implemented for €45 p/m + €10 per additional user. For a more comprehensive lite version also including payroll, accounting and mobile services, a customer pays €85 p/m + €20 per additional user.

Besides targeting SMEs, Admicom currently focuses on customers in three main industries. The first industry is that of building services (engineering and installations), which is Admicom’s main market with approximately 24% market share and the market where the company started its operations in 2010. Companies within this industry are focused on services such as heating, ventilation and air conditioning (HVAC), electricity and plumbing.

The second industry Admicom focuses on is that of pure construction, including building projects, painting, roofing, renovating, infrastructure plans and civil engineering projects. Admicom currently has a lower penetration in this industry (10%), while the opportunity is twice the size of that of building services. Through the recent acquisition of Tocoman, Admicom aims to strengthen its position within the construction industry with the aid of Tocoman’s cost accounting and production management solutions (e.g. Building Information Modelling (BIM)). This development will further enhance future growth opportunities from the networks and partnerships obtained through the acquisition, as well as the launch of new cloud-based products. For example, the cost accounting software has recently also been launched as a cloud solution. In addition to that, the acquisition enables Admicom to obtain a stronger footprint with larger customer bases (>€5M in annual revenues).

The third and final industry is that of industrial manufacturing, which is the most recent market Admicom has entered. The market opportunity is slightly below that of construction, but the current penetration rate is also much lower (2%). Hence, Admicom still has plenty of growth opportunities here by establishing a more dominant market position. It will be interesting to see which other markets Admicom will enter in the future and whether they will remain within the scope of the construction industry.

A commonality among all Admicom’s core markets is that the level of digitization remains very low. The construction industry is one of the largest in the world ($10T -> $14T in 2025), however the rate of technological adoption is one of the lowest. Following the McKinsey report, the construction industry lags behind all other major sectors with regards to digitization, except for agriculture and hunting. Intense competition and the need for increased labor productivity are strong drivers for implementing new technologies such as Admicom’s services. Especially the transition of companies from legacy software to SaaS solutions represents an obvious tailwind for Admicom. Other tailwinds include growing population, urbanization and the need for ongoing maintenance and repairs. The Covid-19 pandemic has provided a major headwind in the form of less office constructions due to the Work From Home (WFH) trend, but also tailwinds with people investing more into home renovation projects and infrastructure stimulus plans. Nevertheless, the construction industry is highly cyclical, which has a considerable impact on the growth outlooks for both the industry and Admicom. In conclusion, I believe Admicom is well-positioned and has substantial growth opportunities in their current markets, but I would like to see the company expand both internationally and to other business lines in the future to support long-term growth rates.

Competition

Admicom themselves have stated to be the market leading solution within the building services industry, while also having a dominant position within the construction market (partly due to the Tocoman acquisition). Admicom’s edge is commonly described as it being the only company to provide a comprehensive ERP system for SMEs that is both SaaS- and cloud-based. Furthermore, Admicom has an extensive focus on automation and offers in-house financial management services. Switching costs for ERP systems are also relatively high, which provides Admicom a strong position within their own customer base. In my opinion, Admicom faces three types of competition:

1. Direct

2. Indirect

3. Legacy

Direct competition forms the main threat to Admicom’s operations and consists of several software companies also providing ERP systems, including those focused on the construction industry niches. With regards to building services, Admicom faces mainly competition from Pajadata, Visma L7 and Ecom. For construction the main competitors are Jydacom (owned by TietoEVRY) and Lemonsoft, while for manufacturing competition consists mostly of Oscar Software, Visma Nova and CGI (C9000). Comparing these competitors to Admicom, it becomes apparent that the competitors often do not offer the same comprehensive package that Admicom provides. The majority either lacks specific features (e.g. accounting and payroll services) or are not available through the cloud. Nevertheless, some competitors state working towards this or already offering almost identical services (e.g. Visma L7 or Oscar Software). Besides these competitors that are also more focused on SMEs, Admicom faces tougher competition with larger customers. In this segment it is not uncommon to compete with services such as Microsoft Dynamics and SAP. While these tech giants are obviously hard to beat, I do not expect them to go after Admicom’s SMEs markets, mostly because the opportunity is probably not lucrative enough to them. Additionally, as mentioned before, SMEs often do not require extensive ERP systems, but require something that can be more easily deployed, such as Admicom’s Adminet. Looking at direct competitors in neighboring countries, Admicom might face future competition from companies like Jeeves, Monitor and Rambase, whom are all based and operational in Scandinavia.

Indirect competition mostly consists of companies offering partial solutions of the ERP systems, such as Talenom for accounting and payroll services. I believe Admicom holds a strong advantage over these competitors by being able to offer similar services plus more. Admicom’s niche focus should also be beneficial here to acquire customers. While companies such as Talenom, Heeros and Visma’s Netvisor pose for indirect competition in Finland, Admicom should also be aware of international indirect competitors, such as Fortnox (accounting).

Lastly, Admicom also competes with legacy solutions, such as Excel. It is not uncommon for especially small entrepreneurs to still be working with spreadsheets. This is why Adminet Lite proposes such a strong value proposition, as it enables the conversion of the smallest target markets.

Management & Ownership

Admicom was founded in 2004 by Matti Häll, who together with his team performed six years of R&D before launching the product to the market. Prior to starting Admicom, Matti Häll founded a software company called Liinos, which he sold to Visma in 2004. Häll has been the CEO of Admicom until his resignation in 2016, after which he continued to function as the chairman of the board. However, he also resigned from this position February 2021, where he got replaced by Timo Häll, the previous vice chairman.

Antti Seppä has been the CEO and president of Admicom since 2016, but he will also be resigning at the end of 2021 after serving a tenure of 5 years. The reasoning behind his departure has been communicated as the company requiring a new management team that can implement the company’s new organizational model (matrix à line) and strategies for the upcoming years. Obviously, the true reasoning might be something else, but it will nevertheless be interesting to see who the company hires.

Last August Admicom already hired former sell-side analyst Petri Aho as the new CFO, who has significant experience as an equity analyst on the construction and software sector. Anna-Maija Ijäs has been appointed as the managing director (CEO) of Admicom Finland in January 2021. She has several years of sales experience within Admicom, which I see as a positive as she has been in close contact with clients. Simon Villa is the current director of product development and has been so since its foundation, while previously having worked at Visma. It is a good indication that the person highly involved with the origin of the product still being involved with the product development today.

Admicom has a high insider share ownership, but this is mostly derived from the founder Matti Häll owning 30.7% of the company. CEO Antti Seppä owns approximately 3.7%, while the rest of the management team do not own any noteworthy stakes except for Matti Häll’s granddaughter and Adminet Lite director Mia Häll, who owns around 1.6%. Apart from insiders, the company is mostly owned by Nordic institutions, especially those focused on small caps. An interesting fund owning Admicom is TIN fonder (~4,5%), a Swedish fund focused on technology companies that has shown signs of activism in the past. Last January they for example publicized a statement regarding Admicom where they actively promote internalization and growth ambitions.

All in all, in the near future I expect some insider selling from both Matti Häll and Antti Seppä since they are losing their connection with the company. Furthermore, I suspect Matti Häll being the reasoning as to why Admicom currently provides a juicy dividend to its shareholder (>50% of earnings). According to my calculations, his stake provided over one million euros in dividends in 2020 alone. Hard to blame the guy in retirement enjoying the benefits of his success. Note that this is heavy speculation from my side and does therefore not equate to the truth, but the distributions of dividends for a strong growing SaaS company is highly unusual. Preferably I would like to see the company removing the dividends and focus on reinvestments instead, which I will further touch upon later on. Admicom currently only has one sell-side coverage, namely Inderes Oy (the CFO’s former workplace), but I also expect this to increase as Admicom started to report in English, possibly also attracting more international institutions.

Opportunities

Before diving into the quantitative aspect, I want to discuss the opportunities and risks Admicom currently faces. I believe Admicom has plenty of growth opportunities left that can help maintaining long-term top line growth:

• Increasing Market Share (%): Admicom clearly still has plenty of room left to grow organically in their core markets in Finland. Especially appealing to larger customers can be beneficial for future endeavors, while both the construction and manufacturing markets have the most room left for growth.

• Up- and cross-selling: Admicom still has opportunities left to enhance their current product offering by introducing new features and modules. This allows for growth from within the current customer base. Adminet lite has been a good example of locking in customers with a simplified solution from which one can upgrade. New modules enable cross-selling, consequently enhancing the monthly revenues derived from one customer (increases ARPU).

• Business Line Expansion: While I believe Admicom should continue to focus on the construction industry, it is not illogical to think that the company can expand to other industries in the future. Following an Inderes report, industry segments of interest could be security, locks or real estate. Specifically the latter could in my opinion be a great expansion that should be relatively easier to adopt to.

• International Growth: This might be both the hardest, but potentially also the most lucrative opportunity that Admicom faces. International expansion is hard and requires especially for SMEs a lot of localization. However, the total addressable market (TAM) is significantly larger beyond the Finnish borders. The number of enterprises in the broad construction sector in Finland totaled 82.470 in 2016, whereas neighboring country Sweden totaled 213.434, which is more than double that of Finland. Hence, expanding operations abroad could significantly enlarge Admicom’s TAM. Admicom has remained rather conservative in the past on international expansion, but the company did include international markets as an inorganic growth opportunity for their 2021-2023 strategy.

• M&A: In 2020 Admicom acquired Tocoman to enhance their services for the construction market, while also appealing to customers with larger turnovers. I expect Admicom to continue seizing inorganic growth opportunities through acquisitions, utilizing this strategy to either establish more dominant positions in already entered markets (e.g. manufacturing), enhance their current product offerings, expand to new business lines (e.g. real estate) or expand abroad (e.g. Scandinavia). Admicom has positive cashflows, plenty of cash, no debt and can easily raise additional capital to engage in more M&A activities.

Risks

Apart from opportunities, Admicom obviously also faces considerable risks. The following three main risks were identified:

• Cyclical customer base: The construction industry is highly cyclical, which includes a lot of instability during downcycles with many customers struggling financially or going bankrupt. Even though Admicom functions as a relatively stable SaaS business, churn rates and new customer acquisitions deteriorate in poor economic environments. The recent Covid-19 pandemic has provided a great illustration of this, with organic growth declining significantly, adjustment fees rising less and higher churn rates. Churn rates have historically been relatively low (~2%), but have increased in 2020 (<5%). It should be noted that the majority of the churn stems from customers going bankrupt or being acquired by larger companies, rather than switching to competitors. 2021 projections for the industry do not seem rosy, so Admicom faces tough comps for the current fiscal year.

• Emerging competition: With SaaS and cloud solutions rising in popularity, it is not unreasonable to expect emerging competition from new technological companies in Admicom’s industry. Nevertheless, Admicom serves a special niche with already established players, consequently making it harder for new companies to enter. Furthermore, Admicom spent 6 years on developing their initial product, so it requires substantial effort and resources to produce a superior offering.

• Management Execution: With all the recent changes in management and the new growth strategy, the major risk I believe Admicom faces is management execution. Whether the new management team can pull off the previously mentioned growth opportunities remains to be seen. M&A integration, business line expansions and entering international markets are no easy tasks to fulfill. The appointment of a new competent CEO might ease down some of these risks.

Financials

It’s difficult to not fall in love with Admicom’s financials. The company operates at 95%+ gross margins and has seen its top line grow organically 30%+ annually over the last couple of years. 2020 has been an exception, partially due to the Covid-19 pandemic. While revenue grew with 40%, organic growth only accounted for approximately half of this. However, Admicom has at the same time proven the scalability of the business model. EBITDA margins have improved significantly over the recent years, increasing from approximately 22.7% in 2015 to 45.4% in 2020 (55,1% incremental on average).

The majority of Admicom’s expenses can be derived from personnel costs, which have decreased substantially as part of revenues (46.5% in 2016 to 37.4% in 2020). Of the total number of staff, 31% works with accounting services, 19% in product development, 18% in implementation services, 16% in sales and marketing, and 8% in customer support and administration each. Other operating expenses, such as rent and auditing fees, are the second biggest cost item and have ranged between 12%-14% of revenues. Depreciation and amortization (D&A) commonly range between 3%-6% and the company pays around a 20% tax rate (= Finnish corporate tax rate).

Going into 2021, management expects revenue growth to be between 10%-20% because of higher forecast uncertainties (Covid-19), more bankruptcies and lower adjustment fees (remember Admicom adjusts prices annually based on turnover etc.). EBITDA margins are guided to be between 40%-50%. Admicom reported 2021 Q1 numbers of 21% revenue growth and 45% EBITDA margins. The stock took a short nose dive as the company indicated that it expects to end up in the lower range of the guided revenue growth for 2021. It is furthermore expected that Q2 will be the worst quarter in terms of growth. Admicom’s strategic forecast for 2021-2023 targets a 20%+ revenue CAGR, including a stronger emphasis on inorganic growth opportunities, with similar EBITDA margins as guided for 2021.

Admicom has a robust balance sheet with no long-term interest-bearing liabilities and over €13.8M in cash. The company furthermore operates with a negative net working capital, demonstrating its ability to generate cash quickly through its asset-light business model. Return on equity (ROE) and assets (ROA) have consistently been above ~30%+ over the recent years, they have however been trending downwards.

Valuation

At a price of €92, Admicom is trading at around 19x EV/Sales and 41x EV/EBITDA, which is not necessarily cheap but slightly below the 2-year historic median (46x EV/EBITDA). Nevertheless, looking forward five years, I believe this is not a bad area to start considering the accumulation of shares. For my assumptions I remain relatively conservative by following the company’s guidance on growth and margins. Furthermore, I expect Admicom’s TAM to remain stable for 2021, after which I estimate a 5% CAGR until 2025 based on factors such as population growth, urbanization, and digitization trends. For the whole 5-year period I expect a 17.3% revenue CAGR, leading to 21% market share on 2025 numbers. The majority of this growth should be derived from increasing market shares in especially the construction and manufacturing industries plus strong Adminet Lite development. Moreover, I expect EBITDA margins to improve following the 5-year average incremental EBITDA margin of 55.1%, hence reaching 50.4% in 2025. Further scalability of the business model should come from decreasing SG&A expenses as part of revenues. Lastly, I expect the FCF conversion rate to remain stable at 75% as the upwards changes in net working capital compensate the convergence of D&A and capex expenses.

Discounting the cash flows and utilizing a 25x EV/EBITDA exit multiple, I estimate the stock to provide a 10% IRR for the next 5 years at €90.34. Obviously, a higher exit multiple leads to a higher IRR and vice versa. My estimations do not include any of the potential growth opportunities, such as M&A, international expansion or new business lines. Therefore, I see a strong optionality in the stock of accelerated top line growth by engaging in the aforementioned growth opportunities. Preferably I would like to see Admicom to stop distributing dividends and potentially even sacrifice margins temporarily to support growth rates and establish a more dominant market position.

For a bear case scenario, I assume a 10% revenue CAGR for the 2021-2025 period and a 15x EV/EBITDA exit multiple. The new exit multiple alone would already imply the stock to be flat for the next 5 years, whereas it in combination with the lower growth rate would provide severe negative returns. As a consequence, management execution regarding Admicom’s growth strategy forms a substantial risk to the whole investment case.

Conclusion

I believe Admicom to be a great business with high insider ownership and a market leading position within their niche. The company provides a valuable and comprehensive ERP system with several competitive advantages. Admicom experiences favorable industry tailwinds with the construction industry being both huge and ripe for more digitization. Like most SaaS- and cloud-based companies, Admicom’s business model is extremely profitable and highly scalable. The company has no long-term debt obligations and plenty of cash on the balance sheet. On top of that, I identify several growth opportunities that can enhance long-term growth rates and function as a strong optionality to push the stock much higher in the upcoming years. Furthermore, I expect the stock to attract more attention from investors as the company has started to provide information in English. Nevertheless, Admicom faces some temporary industry headwinds and contains several risk factors that should be taken into careful consideration. In my opinion, management execution to realize strong continuous growth rates forms the biggest risk to the investment thesis. Based on some simplified calculations, I consider the low €90’s an attractive area to buy shares.

Disclaimer: I’m long Admicom. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.