MYOB Calculates Better Future Without Reckon

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ACCC concerns regarding the transaction with Reckon have likely led to MYOB deciding, instead, in favour of investing in its own product and client development.

-MYOB will opt for an $80m investment in R&D and sales & marketing
-Near-term positive catalysts difficult to envisage
-Opportunity to win clients from Reckon but also risk of losing clients to Xero
 

By Eva Brocklehurst

MYOB ((MYO)) has opted for organic development rather than the acquisition of Reckon's ((RKN)) accountant group assets and will not proceed with the transaction.

The proposed acquisition made strategic sense, although brokers suggest the competition regulator, ACCC, had several issues which were proving insurmountable and likely to have been the main reason behind the decision.

It was evident to Credit Suisse that the proposed acquisition was being used to mask a necessary step change in investment in product development and sales & marketing, now proven to be the case.

MYOB will spend the money intended for the deal, and more, and the broker calculates the planned investment will drop a reported operating earnings (EBITDA) margin to around 40% in 2019/20, versus 46% in 2017.

Credit Suisse downgrades, to Neutral from Outperform, and lowers operating earnings forecasts by -15% because of the reduction in margins and absence of Reckon revenue. The broker finds near-term positive catalysts difficult to envisage and believes investors will remain cautious.

Ord Minnett accepts the reasons for deciding in favour of an $80m investment in R&D and sales & marketing but also questions longer-term revenue growth expectations.

Risks

Near-term delivery risks have increased and the broker's FY22 free cash flow forecast is around -$15m below the company's long-term guidance of over $200m.

Ord Minnet struggles to anticipate why investors would increase positions until free cash flow has either bottomed, in FY19, or there is more evidence about improved returns, and downgrades to Hold from Buy.

UBS was always cautious because of the risk that higher R&D and marketing costs were not been priced in if the Reckon deal fell through. As the stock has fallen more than -8% this concern has faded, somewhat.

The company has an opportunity to win clients away from Reckon, which may struggle to adequately invest in its product as a stand-alone entity, yet Credit Suisse believes this is more than offset by the risk of losing existing clients to Xero ((XRO)) at the lower end, or global operators such as Salesforce and Microsoft at the top end.

Deutsche Bank is not surprised the company is going ahead with elevated expenditure but questions the quantum and downgrades net profit estimates for FY18-20 by -7-21%, to reflect capitalisation of the R&D investment as well as higher interest expenses.

The broker believes the company is pursuing the right strategy, although acknowledges there is a significant level of trust attached to the targets, particularly given they are up to five years away.

Deutsche Bank maintains a Buy rating on valuation but, given the impact of the downgrades on the growth profile and the "trust me" factor, as well as the Bain overhang, suspects it may be hard to witness any near-term outperformance.

Investment

Specifically, the company will invest $50m in R&D over the next two years on new online adviser and SME solutions and bring forward its online platform for accountants, as well as increase adviser sales & marketing by $30m to grow direct SME sales.

The incremental R&D investment will be capitalised and the incremental sales & marketing will be expensed. UBS incorporates higher capitalised R&D into its expenditure forecasts, driving downgrades to free cash flow estimates. The net result is a -14-15% downgrade to FY19-21 net profit estimates.

The broker considers the stock fairly priced on a free cash flow yield basis and, from a risk/reward perspective, remains incrementally positive because the significant re-investment is now priced in.

Upside risks include accretive M&A and further revenue benefits from the re-investment. On the downside the broker envisages loss of share and further marketing cost pressures because of competition, as well as lower cloud penetration in the longer term.

There is one Buy rating (Deutsche Bank) and four Hold on FNArena's database. The consensus target is $3.31, suggesting 18.1% upside to the last share price. The dividend yield on FY18 and FY19 forecasts is 4.4% and 4.5% respectively.

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