I finally caught up with the $PME Spotlight recording, and consider the debate and exploration of key issues really got to the main points about what you have to believe to defend a valuation of $95 versus a valuation of $165. I was sorry not to be able to attend and participate, but thank those StrawPeople who accurately reflected my views on this business. The discussion was of a very high quality and I got a lot out of it.
You'd definitely have to put me in the camp of those shareholders who Claude Walker describes as having watched $PME for years and, having been unable to justify its value for years, finally now see value given that its SP has fallen almost two-thirds from its eye-watering highs. However, as I think we can conclude from the Spotlight discussion and various valuations on this forum, $PME is at best a great company at a fair price, and hardly a bargain - irrespective of your time horizon.
I am somewhat torn over my own valuation scenarios. On the one hand, I do assume across all scenarios, that $PME sustains high margins that would have it remain one of the, if not THE highest net margin enterprise software firm in the world for decades. If fact, I see continuing operating leverage expanding margins further.
That is a brave - and arguably foolhardly - assumption. I struggle to find any businesses (other than Versign and Visa) that have sustained such high margins for so long. And so, I have to concede that @DrPete has an excellent point here. Such a performance, i.e., sustaining high margins c. 50% over the long term - is pretty much unprecedented in the history of operating businesses - the club is small: Verisign and Visa.
Given that $PME's premium pricing is predicated on enabling radiologist productivity - a profession in the US where staff numbers have consistently failed to meet surging demand - what happens when AI-enhances productivity to the point where there are sufficient "humans-in-the-loop" to do the required work? The Spotlight discussion rightly considered this.
Let's say that's happens 5-10 years out into the future. At that point, both Sectra and $PME have global market shares of 15% - 20%. (There are plenty of markets where a #1 and #2 carve up the lion's share of the market, and if both continue to invest in their products to maintain market leadership, I don't see any issue there from a market structure perspective.) If both can deeply embed the AI capability within their platforms, does the basis of premium pricing move from radiologist workflow productivity to the clinical value-add of the software doing the heavy-lifting of the detection/diagnosis? That is my assumption. However, this assumes that other platforms don't beat them to the AI game. And here we have to keep an eye on the hyperscalers, who are looking at how they can play, given the vast imaging datasets we've spoken about. Can the value of AI-analysis be delivered outside of the workflow? I don't know for sure.
No investment is without uncertainty or risk, and I think there are some clear measures to track for $PME into the future:
- Contract wins and renewals/upgrades - tracking both $PME and Sectra. (When do we see a Trinity follow-on?)
- As part of this, do we see more European wins: does Heidelburg represent a breakthrough logo? (an excellent point by the StrawPerson who spoke to this. Sectra are strong in Europe primarily due to their origins and longevity in the market. $PME has chased the money and rightly focused on the US. However, more premium Europe logos would underscore $PME's competitiveness outside the US.)
- Margin evolution - particularly how R&D and S&M evolve as a % of revenue as the offering broadens in scope
- Who else makes significant AI moves? Don't be spooked by headlines,... there have been AI-in-medical-imaging stories for decades ... but don't ignore it.
- Succession management - they will have to start talking about this at some stage. (Keep an eye on the CFO turned COO.)
Anyway, those are my reflections on the Spotlight. Thanks to all.
Disc: Held
