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Under the Radar Report (UTTR) Editor Richard Hemming discusses the case to invest in small caps and the company's investment and analysis process.
Scroll down to read UTTR's contrarian stock call on Hansen Technologies.
CONTRARIAN STOCK CALL: HANSEN TECHNOLOGIES
|Radar Rating: SPEC BUY|
|ASX Code: HSN|
|Market cap: $582 million|
|Net debt: $1 million|
|Dividend yield: 2.0%*|
*FY 19 forecast
The global billing software specialist would be a good edition to any portfolio because of its defensive qualities: long customer relationships; a strong balance sheet; high recurring revenues; and dividends. After its 35% decline in the past nine months we think that it’s also good value.
Hansen Technologies: one-year chart
Hansen Technologies provides proprietary billing software for the energy, water, pay TV and telecommunications sectors around the world. The stock is good value trading at a forecast EV/EBITDA multiple of just under 11 times, which is well below the 17 times where ASX technology stocks are trading. Although Hansen is not a high growth stock it does have good defensive attributes. Having declined 35% in the past nine months we think it is worth adding a small position to your portfolio. It’s important to point out that the stock is very illiquid given around 56% of stock is tied up with the Hansen family and institutional funds.
The company’s 1H19 result didn’t shoot the lights out but highlighted that this business can keep churning out the profits in any economic conditions. Revenues and EBITDA fell 5% and 16% to $112.4m and $28.5m respectively due to reduced one-off licence fees. The performance compared to the 2H18 was better with revenues held flat and EBITDA up 11% reflecting lower costs. The balance sheet improved with virtually no net debt on the books, which gives us confidence in the group’s ability to absorb any future acquisitions. The interim divided was held at 3 cents.
Hansen stands out having been around for almost 50 years and because its customers are firmly locked in due to high switching costs. This is a very good business model and we have been waiting for the opportunity for its shares to fall to showcase just why.
The company is run by Andrew Hanson whose father founded the billing software specialist and his family has retained an 18% sake. One of the keys to the company’s ongoing success is the steady stewardship that has positioned it as a leading provider of billing software in multiple markets.
This has delivered long-term revenue growth of 5% a year and double-digit profit growth. Even after recent price weakness, the dividend yield is relatively low, but we expect it to be maintained.
Billing software and its associated services of customer care and data management are products and services that are universally needed. Hansen’s revenues are even more defensive given the industries it services, which are (in order of importance): energy, telecommunications, pay TV and water.
The average term of a contract is around five years but the client relationships are closer to 10 years given the very high client retention rate. Changing billing and customer management software providers brings high risk for a client. A client would have to be very unhappy and/or expect significant benefits to want to change. On the flip side this makes it harder to secure new clients. It takes compelling events such as changes in regulation, deregulation, outgrowing their current systems for a client to have to change software providers.
We like businesses with annuity type revenues and around two thirds of Hansen’s revenues are recurring in nature, generated from licence, support and maintenance fees. The balance of revenues are non-recurring, coming from project work predominantly for existing clients. This can be lumpy but with over 500 clients work is relatively constant over time as clients need software upgrades to meet latest regulations and changes to enable new product rollouts.
Because of the difficulty in expanding the sales line and due to Hansen’s strong balance sheet, we envisage more acquisitions, which have been central to the company’s growth.
In mid-2017 Hansen acquired Enoro, a Norwegian software company for $95m, which gave it access the new market of data analytics and placed it in a leading position in the Nordic energy market. It also provides a good platform for growth into the broader European energy market and built Hansen’s existing position in the European telecommunications market. But this will take time, as it is a slow process to win new clients and then implement a new system. The company aims to increase the EBITDA margin for Enoro driven by this and other initiatives from around 16% to above 25% over time.
A key risk is disruption from new technology, but we like the fact the over 80% of Hansen’s staff are in development, which demonstrates its commitment and product development and implementation capabilities.
Acquisitions also bring risks, but the company has a good track record in this regard. Some of this risk is mitigated by the fact it buys similar businesses and does its own due diligence.
Keep in mind though that about a third of revenues are non-recurring that can be lumpy. Also currency risk comes from having over 80% of revenues coming from offshore.
The underlying reason for our belief in the long-term potential of Hansen is that its fundamentals are very strong. Hansen closed 31 December 2018 with $0.6m in net debt (gross debt of $22.7m and cash of $22.2m). The business generates good free cash flow allowing it to fund capital expenditure and product development, reduce debt and pay dividends. It is not a dividend stock though. The company keeps its powder dry for acquisitions and then aims to pay down debt.