| Fundamental Thesis: | ELMO Software Limited (ASX: ELO) is a leading Human Resources software company focused primarily, at this stage, on clients located in Australia and New Zealand. It primarily targets midsized companies with 100 to 1,000 staff. It develops, sells and implements Human Resource (HR) & payroll software solutions that enable organisations to automate many of the Human Capital Management (HCM) processes and functions, efficiently managing the stages of an employee’s life cycle from “hire to retire”, including pay.
ELO has all the hallmarks of a big winner. A high quality product that saves customers time and money. A strong and growing position within a large and growing addressable market. A significant proportion of revenues generated from recurring revenues paid upfront, so it has a positive working capital position, with lock-in contract terms typically lasting a minimum of three years. Once the software is integrated into the business, customers then face significant barriers to move as the cost and hassle of replacing the software with competitor software is quite burdensome. This predictability also reduces the risk around forecasting future performance as some 88% of next year’s budgeted sales is already locked in under contract.
Furthermore, we have significant shareholder alignment with the co-founders, Danny Lessem and Manuel Garber, retaining meaningful shareholdings. Though Manuel Garber is not a manager of the company, his son Darryl Garber is an enthusiastic advocate for the business, and the head of corporate development. The chairman Jim McKerlie purchased 50,000 shares in the IPO and fellow board members (and CFO) Trevor Lonstein has a more significant holding of 420,000. On top of that, a number of senior managers also have significant shareholdings.
The company listed on the ASX in June of 2017. The primary purpose of the IPO was to raise capital for acquisitions for additional platform functions, capital investments in platform enhancements and the building out of its sales and marketing team. To date the company is hitting on all key markers and momentum within the business is strong and building.
In FY18, ELO expanded their market leading product suite from 7 to 12 modules. They now provide a unified, intuitive, user-friendly, single dashboard solution for recruitment, onboarding, performance management, learning and development, pre-built courses, succession planning, remuneration, HR surveys and employee administration (HR core). Payroll was added in February 2018 with the acquisition of Sky Payroll, unlocking a new and complementary $657 million market.
They also continued to deliver strong results financially, delivering on their upgraded guidance, with revenue of $29.8 million for the full year to 30 June 2018. This was an increase of 62.8% over the prior year. Of this, organic revenues grew by 37% compared to FY17, with acquisitions making up the rest of that growth. What makes this revenue stream so attractive is that over 93% of their revenues came from recurring subscription based sales, which are charged and booked upfront.
Customer satisfaction is also strong with customer retention in dollar terms being 119% in FY18, meaning that customers are on average spending more and using more modules after they become customers. This demonstrates the attractive utility of the software to businesses.
Over the past year the company released some 145 product enhancements, they completed a $45 million equity placement to accelerate growth, acquired PeoplePulse, Live Salary, Sky Payroll and Pivot Software, received numerous accolades including Deloitte Fast 500, SmartCompany – Smart50, and the Anthill Cool Company award. With the continuation of strong sales momentum, their customer base increased by 97% to 1,031. Some of these are outlined below.
(Source: Motley Fool, Elmo)
Customer retention is consistently high at 92% and the module penetration per customer has steadily grown to 2.56 out of a possible 12, highlighting the potential for continual cross-selling and up-selling opportunities amongst its existing customer base. In addition, the company believes that recent acquisitions have now increased its total addressable market opportunity from ~$600 million to ~$1.7 billion per annum. With ELO currently controlling about 9% of that market on customer numbers, and only 2.56 module penetration per customer, there is a very clear and significant runway for future growth.
Going forward we expect the company will continue to invest for the long term as it seeks sustainable growth through increased capabilities, headcount, sales and marketing resources, and the continued development of new technologies.
The company is guiding the market for continued strong revenue growth in FY19 to $39.5 million, but much of this will be reinvested, with EBITDA expected to be only $1.1 million. The company’s profits are suppressed largely because of the amortization of intangible assets (Goodwill from Acquisitions), but the company is operationally cash flow positive and has been for some time.
This investment opportunity fits our ‘Momentum’ investment classification, where the company is generating significant revenue growth and that growth is likely to be significant well into the future. But because it does not generate a positive net profit after adjusting for non-cash adjustments to the Profit and Loss statement, you can’t use traditional price-to-earnings or PEG ratios to determine valuation. Nor can you apply Return-on-Equity and Return-on-Asset measures to assess the company’s investment merits and profitability, quite simply because the company is still early in its growth phase and reinvesting heavily back into the business.
However, analysts are forecasting ELO to actually beat guidance in FY19 with revenue expected to hit $41 million, $56 million in FY20 and $75 million in FY21, while EBITDA is expected to increase from $1.1 million in FY19 and explode to $5.5 million in FY20 and $12.7 million in FY21. It also has about $46 million in cash thanks to a recent placement and practically no debt.
(Source: Elmo)
The company currently trades on a forecasted Price-to-Sales ratio of around 10x, which isn’t cheap, but is consistent with other hyper-growth businesses. So long as the company continues to grow sales at circa 35% per annum for the foreseeable future, which is very likely, the share price could easily rise 100% over the next three years, meeting our upside profit potential benchmark. Beyond that, though, ELO has even further significant upside potential, so it could be a company we own for quite some time. |
