Australia | May 26 2021
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TechnologyOne has signalled an annual recurring revenue target of $500m by FY26, supported by the transition to software-as-a-service and a decline in legacy licence fees
-TechnologyOne's FY21 profit guidance likely to be met
-SaaS revenue to grow at 15% or more once legacy business winds down
-Renewed interest in technology stocks likely as cyclical recovery passes
By Eva Brocklehurst
TechnologyOne ((TNE)) has provided a steady outlook, signalling revenue growth plans are intact out to FY26 and the decline in annual licence fees has been met with an acceleration in the transition to software-as-a-service (SaaS).
The company delivered maiden FY21 profit guidance of $94.3-98.6m and expects expenses to be broadly in line. From this, Credit Suisse increases margin assumptions which drives 5% upgrades to operating earnings forecasts, and assesses the main building blocks of the guidance are not overly ambitious.
The broker also considers TechnologyOne's $500m annual recurring revenue (ARR) target in FY26 achievable, supported by transitions to SaaS and penetration of the company's products. Further detail is expected regarding new products at the FY21 result and evidence of significant progress could imply upside to the return target.
Wilsons liked the result, given the continued decline in on-premises sources of income. Management has reiterated its targets for recurring revenue to be more than 95% of total revenue by FY27.
The main negative was cash flow generation, in Macquarie's view. Cash flow generation is expected to be around 80% of net profit through to FY24 after which the amortisation of capitalised development should catch up and cash flow return to around 100%. While agreeing the main negative was the weak operating cash flow, Bell Potter reflects that this is not unusual in the first half.
Still, Credit Suisse remains cautious about increased competition from best-of-breed solutions and believes the FY22 PE (price/earnings) ratio of 36x adequately covers the risk/reward profile.
Credit Suisse forecasts 9.2% growth in SaaS and continuing business revenue which compares to management's forecast of 10%. This forecast comprises strong growth in service fees offset by declining annual licence fees. The broker assumes a -$8bn headwind from the scaling down of the legacy licence business.
Legacy Licence Fees
Annual licence fees declined -18% in the first half while on-premises initial licence fees were down -35%, signalling a strong transition of existing customers. There were 37 new customers transitioned from legacy business to SaaS during the half. TechnologyOne expects SaaS and continuing business revenue to grow at 15% or more once the legacy fee business is completely wound down.
Morgans points out, as recurring revenue increases and the mix improves, double-digit revenue growth from higher quality business will become increasingly obvious. Additional modules and next-generation initiatives such as the digital experience app, DXP, should also support growth.
The broker highlights one positive aspect of the pandemic (although it made life difficult for many customers) was the prompting of many to move to digital platforms earlier than originally planned. The broker rates TechnologyOne highly, given defensive earnings, a long-term track record and impressive financials.
While conscious that technology stocks are trading on elevated multiples and have become funding sources for cyclical recovery stocks, Morgans expects interest will return once the cyclical recovery passes. Should this prove incorrect and the rotation to cyclical stocks become a more long-term trend then the broker acknowledges there is downside risk to TechnologyOne's share price.
Morgans asserts that investors need to be aware the changing interest rates and investor sentiment can swing the value materially for growth stocks. Still, TechnologyOne is around 90% of the way through its transition to SaaS and should emerge with a higher percentage of recurring revenue and earnings, justifying a higher trading multiple.
TechnologyOne gained a Australian federal government contract during the half, beating its major competitor SAP. The company pointed out it is the only global SaaS ERP (enterprise resource planning) provider to be certified IRAP, which should mean further ability to increase conversion rates from tenders.
The IRAP initiative from the Australian Signals Directorate aims to ensure high levels of care in the processing and managing of client information. Macquarie points out a recent procurement framework with the New Zealand Ministry of Business Innovation & Employment provides for 23 NZ government agencies to move to modern and secure SaaS environments, although there is no detail as yet.
Wilsons forecasts a net cash balance of $130m in FY21, potentially being deployed in selective M&A or paid as a special dividend to shareholders. The broker points out that between 2017-19, TechnologyOne paid a special dividend while still managing to increase its cash balance.
Among the stockbrokers that are not monitored daily on the FNArena database, Wilsons has a Market Weight rating and $9.89 target while Bell Potter maintains a Hold rating with a $9.75 target. The database has two Buy ratings and two Hold. The consensus target is $9.46, suggesting 3.1% upside to the last share price.
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