Technology One is an enterprise software provider focussed on enterprise resource planning systems for various organisations spanning from education and local government, to health services and private corporations. You can see all their products in the graphic below from the 2024 AGM presentation.
One of the main reasons for Technology One’s success is that it develops, sells, and integrates its products rather than selling the product but relying on a third-party consultant to integrate it.
Historically, Technology One sold a license and then charged a smaller maintenance fee. In the last decade, it transitioned all products to recurring revenue plus implementation. Now, it is including implementation costs in its new SaaS+ offering. This allows Technology One to capture the benefit from streamlining implementation, by saving on costs, which in turn incentivizes it to develop fast-integrating products, which benefits clients.
At the end of H1 FY 2025, ending in March 2025, Technology One had $511m of annualised recurring revenue.
Impressively, Technology One has very low churn, and a net retention rate over 100%, which means existing customers are generally paying more, and not leaving. This implies the existence of pricing power. You can see that these metrics are improving or steady in the H1 FY 2025 results presentation.
All this proves that Technology One occupies a very important part of it customers’ technology stack, and has thrived by vertically integrating the implementation and development of ERP software for an Australian client base. This allows it to supplant vendors like SAP, at least in Australia and New Zealand. It remains to be seen what the company can achieve in the UK, but it is at least growing faster (albeit off a low base) over there.
In H1 FY 2025, the company reported free cash flow of $24m (even excluding $43.8 million acquisition consideration). This lagged well behind profit after tax of $63 million, partly because capitalised development costs and capital expenditure of almost $45m exceeded depreciation and amortisation of about $38.8 million. While Technology One doesn’t go overboard with its acquisitions, the gap between free cash flow, even after growth expenditure, and net profits is worth noting.
If today’s growth expenditure powers profit before tax growth of 13% – 17% as planned, it will be well worthwhile. In any event, the company had cash and Investments of over $200m, so it can afford to invest in growth.
Adrian Di Marco founded in 1987 and stepped down in 2022 after 35 years leading the company. He selected his replacement as CEO Ed Chung, who started as CEO in 2017 after a decade in various senior roles with the company. As a result of board renewal in recent years, the alignment between leadership and shareholders is not as high as I would like to see.
That said, management is remunerated with regard to earnings per share growth and total shareholder return, so I do believe they are motivated to keep earnings going in the right direction.
Based on the current share price, Technology One is trading on about 80x analyst consensus estimates for the next twelve months’ profit, and about 92x historical earnings. This implies that the market thinks that Technology One will be able to maintain existing growth rates for a very long time. In essence, this means that Technology One must actually increase its competitive advantages as it grows. This is certainly possible in enterprise software, but far from guaranteed.
The main risk with Technology One is that the sociological lionizing of enterprise software businesses wanes. Alternatively, it is also possible that growth rates will fall short of the target due to increasing competition or unwise spending on failed growth initiatives. Since the market is expecting so much growth from Technology One for so long, any hit to either sentiment or actual earnings growth could hurt the share price.
Personally, my portfolio is already very skewed towards these sort of high P/E ratio software stocks, and I tend to like to buy them when they are smaller and less well known. Generally speaking, large software stocks like Technology One do get a premium multiple because, in my opinion, there are not very many available technology growth stocks on the ASX and the superannuation companies have to invest the money somewhere. This phenomenon is only getting worse with the loss of technology winners like Altium to private takeovers (at premium multiples)!
So while I do not currently own Technology One shares, I thought it was high time I published a note on it, given it is definitely one of the high-quality ‘fluffy dog’ stocks that I would like to pat one day, when the opportunity appeals.
Disclosure: The author does not own shares in TNE and will not trade TNE shares for 2 days following this article. This article is not intended to form the sole basis of an investment decision. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 276544).
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