Fineos (ASX: FCL) Shares Soar But Is The SPP Big Enough?

During the week, insurance software company Fineos (ASX: FCL) announced an acquisition and a capital raising, as well as disclosing its revenue had come in just above the top end of guidance, for FY 2020. For those interested in learning about the company here is our initial coverage of Fineos (ASX:FCL), by Interstellar Capital (but note that the share price is now up 60% since publication). Now, let’s unpack the recent news as quickly as possible!

First, the Fineos business has not been unduly impacted by Covid, which makes sense, since insurance would be one of the last things people would willingly cut. If we see tightening in the industry, it’s probably going to come as the recessionary environment drags on, not upfront.

Second, the company has decided to buy Limelight for about $104m. Limelight is growing its revenue quickly (at 38% in the last year) but only has about $20m in revenue — and not all of that is recurring. It makes a lot of strategic sense, because it builds out Fineos’ offering, with lots of cross-sell and up-sell opportunities. That’s a real positive, and the price seams reasonable enough, albeit not overly cheap.

Third, the company has said that “The outlook for FY21F remains positive. FINEOS is targeting standalone (excluding Limelight) revenue growth for FY21 of approximately 20%, including subscription revenue growth of approximately 30%.” That’s all positive too.

Fourth, the company will raise capital to fund this acquisition, and off the back of all this good news. Specifically, it will raise $85 million from institutional shareholders (who it will endeavour to allocate shares to on a pro-rata basis) and just $5 million for retail shareholders under a share purchase plan (SPP). This is, slightly less positive, because it suggests that retail shareholders might be diluted unfairly, unless the company makes an effort to ensure allocations are filled. Fortunately, this is a possibility, as the Fineos has said that it may expand the SPP, if it chooses to.

Personally, I will be applying to buy shares under the SPP, partially because I’m pleased with the acquisition news (while accepting it is risky) and partly because the shares are currently trading almost 20% higher than the share purchase plan price of $4.26 per share. Note that Fineos “will apply [any] scale back having regard to the size of the application and the number of CDIs held on the SPP record date.”

I believe there are four reasons why Fineos should expand the SPP in the likely event that applications exceed the $5m size they have announced:

1. Treating retail shareholders fairly enhances reputation amongst one group of shareholders (retail shareholders) without really doing any damage in the eyes of institutional shareholders (unless they think they should get unfair treatment).
2. Retail shareholders are often very sticky and are less likely to sell on valuation concerns and volatility. Many retail shareholders invest in their superannuation and do it with a long term view. Many individuals who invest do not like to trade too much and have a natural long term mindset due to many years experience. Pro Medicus is a high performing example of a larger company with a high proportion of retail shareholders relative to institutions.
3. Where individuals do sell their SPP shares, the quantum is not enough to move the share price, and a well distributed register means management is beholden to no single investor.
4. It’s the right thing to do.

I would therefore encourage any shareholders to email [email protected] and politely suggest that the board consider expanding the SPP if applications greatly exceed capacity, giving at least one reason for the suggestion.

Are Fineos Shares Undervalued At $5.10?

Ultimately, I’m now sold that this is an investible quality software company that falls squarely into the area that I like to play in. However, I note that a significant proportion of Fineos’ sales are service revenue and not necessarily recurring. That means when sales are going well, the company will record faster revenue growth than a pure SaaS company would, but when sales slow revenue can actually drop — rarely unpunished by a market obsessed with growth. For that reason, I only have a small holding in Fineos at current prices.

If FY 2021 revenue estimates of ~$140m are roughly right, then at the current share price Fineos as trading on a market capitalisation of 10 – 11 times its forecast 2021 revenue, which is growing around 20% organically. That’s not too bad but given it’s not all recurring it doesn’t jump out at me as particularly undervalued. Maybe a little.

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The author owns shares in Fineos and intends to apply for more under the SPP. This post is not intended to be financial advice, and you should click here to read our detailed disclaimer.