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Investors who jumped on board the Afterpay train will be looking forward to a very “festive” festive season. From a low of $8.90 at the heights of the Covid-19 market meltdown in late March, Afterpay now trades around $100 and will shortly be added to the index that tracks Australia’s 50 biggest listed companies.
The obvious question is: “who is the next Afterpay?”
One candidate is cloud HR and payroll company ELMO Software (ASX: ELO). It was nominated by my colleague Peter Switzer in his ZEET list of stocks (Zip, Elmo and EML Payments), a possible replacement for the high flying WAAAX stocks (WiseTech, Afterpay, Appen, Altium and Xero). ELMO presented this week at the Switzer Small Cap Virtual Investor Day. Let’s see whether it fits the bill.
Founded in 2002, ELMO is a leading provider of cloud HR, payroll, rostering/time & attendance software. Across the 5 areas of ‘pay’, ‘engage’, ‘hire’, ‘retain’ and ‘develop’, it offers customers a configurable solution of up to 15 product modules (or revenue streams to ELMO).
ELMO targets mid-market customers in Australia, New Zealand and the UK, employers with typically 50 to 200 employees, and estimates that its 1,692 customers gives it about a 7% share of the Australasian market and less than 1% in the UK. Recently, it acquired breathe, a UK HR SaaS platform that is designed for small businesses (less than 50 employees).
The company’s organic growth strategy is to continue to acquire customers in existing markets; launch breathe to small business customers in ANZ; upsell existing customers to buy additional modules (the average customer has 2.7 modules whereas new customers are signing up for 3.9 modules); add new modules to breathe; and develop new modules/enhance functionality. Complementing the organic strategy are further selective acquisitions, where the company has demonstrated a strong record of execution.
With the breathe acquisition, ELMO says that its total addressable market has increased to $11.4bn (ELMO’s revenue in FY21 is forecast to be $72.5m – $78.5m).
Similar to other SaaS business models which are readily scalable, ELMO boast some fairly impressive operational metrics. 97.6% of revenue is subscription revenue, a gross profit margin of 85.3%, a customer retention rate of 90.2% and average revenue per customer of $32,700.
Revenue has grown from an annualised run rate of $31.1m in FY18 to $55.1m in FY20, a compound annual growth rate of 33%. For FY21, the company is forecasting this to grow to $72.5m- $78.5m, up from the breathe adjusted pro-forma of $61.6m (growth of 18% to 27%). EBITDA is guided to be a loss of $3.5m to $7.5m.
On the ASX, it has been a mixed year for ELMO. It slid to a low of $3.66 in the Covid 19 meltdown, before rapidly rebounding to $8.06. A $72.8m capital raising at $7.00 per share in late May took the heat out of the price, and it has largely traded sideways since then. Covid-19 has been a net negative, with employers reluctant to consider new expenditure. Yesterday, the shares closed at $6.32.
ELMO Software (ELO) – last 12 months
The only major broker who tracks the stock is Morgan Stanley. According to FN Arena, they have an “overweight” recommendation and a target price of $9.30, 47.2% higher than yesterday’s close. Commenting after the breathe acquisition, Morgan Stanley said that: “it saw the reaffirmation of organic growth guidance as a key positive” and that “it believes ELMO can upsell breathe’s core HR platform with other modules and can take breathe into new markets like ANZ”.
I’m not ready to label ELMO as the next Afterpay, but there are a number of things to like about the business:
My concerns relate mainly to competition and customer acquisition. At the enterprise end of the market (major corporates, Government etc), it is extremely competitive with global players such as SAP, Workday and others. ELMO is targeting the levels down, but there are always areas of overlap. In the small business market, there are several SaaS competitors and this market can be very price sensitive.
On valuation, this is always a difficult question for a business that it is investing and is not yet profitable. Looking at ELMO’s enterprise value to sales ratio, it is presently trading on a multiple of approximately 7 times. This is not high by market standards for a SaaS business.
Subject to the competition concerns, I think it’s a stock to consider buying.