Its rare to see Morningstar get so bullish in a SaaS valuation:

Updated Aug 27, 2024

We maintain our AUD 10 per share fair value estimate for narrow-moat SiteMinder. The company released fourth-quarter results last month, so the full-year result included limited new information. The shares screen as materially undervalued. The market does not seem to fully appreciate how the company’s scale-based advantages translate into the high winnability of a large market opportunity.

SiteMinder showed operating leverage as the business scales and broadens its product offering. For the past two years, the company increased the number of subscribed properties—which is the closest reported metric to customer count—by around 25%, which helped boost subscription gross margins by around 4 points. Given that SiteMinder works with around twice as many hotels as its closest competitors, we expect its superior scale to allow it to more efficiently translate revenue into gross profit, which the company can then reinvest into the business to make further gains relative to competitors.

SiteMinder is also demonstrating increased leverage from these investments. Despite increasing average subscription revenue per user by 14% over the past two years—which, all else equal, should lower conversion—customer conversion efficiency is improving, as measured by customer acquisition costs per customer decreasing 30% over the last two years. The company cites the use of artificial intelligence across operations, product, and engineering as contributing to the improvement.

Business Strategy and Outlook | by Roy Van Keulen Updated Aug 27, 2024

We expect SiteMinder’s strategy to be wide-ranging, including a focus on attracting new customers, increasing penetration of its current product suite, and developing and launching new products. We view SiteMinder’s strategy as appropriate, despite its wide-ranging nature, as all three focus areas provide large and highly winnable opportunities.

We expect SiteMinder to take significant market share within the hotels industry. SiteMinder’s market share among hotels currently sits in the midsingle digits, yet SiteMinder is the leader in its space, and has twice the market share of its closest competitor. We expect scale-based cost advantages to drive consolidation in the channel manager industry, as subscale players are pushed out of the market and scaled providers, like SiteMinder, take share. Specifically, we expect SiteMinder to take dominant market share in larger single-location hotels, and in hotel chains outside of the largest chains. 

We also expect SiteMinder to increase its take rate through increased penetration of its existing product suite, especially through adoption of its transaction-based products. We estimate transaction-based revenue currently makes up around 10 basis points of the gross booking value, or GBV, of SiteMinder’s customers. For comparison, SiteMinder Pay has a take rate of around 2%-3% of payments that are processed through a hotel’s website or, from fiscal 2025, also on payments processed at a hotel’s premises. Similarly, SiteMinder Demand Plus has a take rate of 15% on incremental demand generated through search engine optimization. 

Finally, we expect SiteMinder’s new products to be significant growth drivers, especially Channels Plus. We expect Channels Plus, which aggregates several smaller channels into a single channel, will see rapid adoption among SiteMinder’s existing customers, and help attract new customers. Although the take rate of this product is like that of payments, we expect its uptake to be much higher, due to its more differentiated nature, as well as the clear value it provides. 

Economic Moat | by Roy Van Keulen Updated Aug 27, 2024

We assign SiteMinder a narrow economic moat based on switching costs, cost advantages, and nascent network effects. 

Over 40,000 small and midsize accommodation businesses use SiteMinder’s e-commerce software to increase their room utilization, rates, and profitability, which is around twice as many accommodation businesses as use the products of its closest competitors. SiteMinder is principally a channel manager, meaning it provides the infrastructure for hotels to connect to travel channels—such as Booking.com and Expedia.com. Secondary tools include software for direct bookings, search engine optimization, corporate travel channel management, payments, and analytics.

We consider SiteMinder’s economic moat to be widest in its channel manager product. Like with other software-as-a-service, or SaaS, companies, SiteMinder’s products benefit from switching costs. These switching costs principally arise from the mission-critical nature of the products and the risks related to switching vendors—companies switching vendors risks core channels of customer demand temporarily not working or not working as well as they had previously. Additionally, there is direct time and expense involved with setting up channel managers. As customers adopt more products from SiteMinder’s suite, these switching costs increase commensurately. 

SiteMinder’s customer retention metrics reflect its switching cost-based economic moat. Monthly revenue churn—which the company defines as the value of monthly recurring revenue attributed to subscribers who terminate their contract in a specific month—is about 1%, which implies about 12% churn on an annual basis. We consider this to be in line with other moated SaaS companies that have customers of comparably low quality and therefore also have a relatively high base churn rate due to the higher business failure risk inherent in their respective industries. We estimate business failure in the hotel industry, when adjusted for the size and maturity of SiteMinder’s customers, is around 9%. We believe business failure rates for SiteMinder customers are around 7%-8%, meaning its customers slightly outperform the industry average, which hints at utility-based switching costs. Of the remaining customers, the largest share switch because they have outgrown SiteMinder’s product geared toward very small hotels, Little Hotelier, not because they switch to a competing vendor.

We believe SiteMinder’s economic moat goes beyond switching costs. We see cost advantages from the company’s scale relative to competitors. Channel managers build the infrastructure to connect demand channels to property management systems. Given that the property management system market is highly fragmented and hotels typically only use one property management system, channel managers that integrate with a larger number of property management systems can tap into a larger base of prospective customers. Demand channels, on the other hand, are far less fragmented, with narrow-moat Booking and narrow-moat Expedia commanding the vast majority of market share. Nearly all hotels use these channels. Additional channels typically focus on niche demand, such as certain geographies, types of buyers (bulk buyer tour operators), price points (budget versus luxury) or specific use cases (last-minute and mystery bookings.) Although these channels are smaller, each incremental demand channel can help drive commensurate incremental demand and is therefore crucial to top-line and especially bottom-line performance for hotels. In addition to breadth of integrations, we believe customers also value the depth or quality of integrations, such as the number of data fields connected, and the reliability and security of connections. 

Building the infrastructure to connect demand channels and property management systems is largely a fixed cost, consisting of technical costs from mapping data fields between systems, and incorporating regulatory logic. These costs are ongoing as technical specifications and regulations will constantly change. However, like with other infrastructure, costs are largely disconnected from usage. Given that we don’t believe different channel manager providers can build this infrastructure with a higher level of efficiency than peers, we believe SiteMinder’s superior scale provides it with a cost advantage, as it can spread out the costs over a customer base that is at least twice the size of its closest competitors. 

We view SiteMinder’s scale-based economic moat as strong and don’t believe competitors have attractive options to escape their lack of scale. Competitors can try to offer similar coverage as SiteMinder, in terms of the breadth and depth of integrations, but this would reduce financial resources available for sales and marketing, or product innovation. Given high industry churn, this would see them quickly losing market share, as churned customers are not replenished at an appropriate rate. Alternatively, competitors can try to push harder on sales and marketing, while letting the product fall in quality and hoping for the market to be inefficient. However, we believe that having fewer demand channels would lead to higher business failure rates among their customer bases, thereby dampening market share gains. Focusing on product innovation also seems an unlikely solution, as SiteMinder can likely copy any innovations before they start to affect market share and do so at superior scale. Essentially, we believe that due to the cross-border nature of travel, the small and midsize segment of the hotel industry will consolidate globally toward the largest company with the broadest and deepest set of integrations. 

We see SiteMinder’s superior scale evolving into network effects. Although channel managers provide access to hundreds of demand channels, most hotels only use around half a dozen channels due to the required costs to set up each channel, both from a technical and a commercial perspective. SiteMinder, using its superior scale, is standardizing various second-tier channels—such as Trip.com, Agoda.com, and Hopper.com—so that they can be accessed as a single, first-tier channel. Although this Channels Plus product is nascent, we believe it is a natural evolution of SiteMinder’s leading market position and will prove to be a highly attractive channel for hotels due to higher leverage on setup costs. In turn, we expect more second- and third-tier demand channels to join SiteMinder’s standard to connect to a large and growing pool of hotel inventory.

Fair Value and Profit Drivers | by Roy Van Keulen Updated Aug 27, 2024

Our fair value estimate for SiteMinder is AUD 10 per share, implying an enterprise value/sales multiple of 12 on our fiscal 2025 estimates. We use a weighted average cost of capital, or WACC, of 9%, reflecting high revenue cyclicality, medium operating leverage, and low credit risk. 

We assume revenue to grow at an organic compound annual growth rate of 22% over the next decade, driven primarily by transaction-based products, including Channels Plus. We expect EBIT margins to expand to 18% by fiscal 2034, compared with negative 13% in 2024. We expect SiteMinder’s operating expenses to decline as a share of revenue over time, as it evolves from a middleware software company to a platform company. We expect this to result in lower customer acquisition costs, and integration costs with the platform increasingly being born by network participants, such as online travel agencies and hotels, rather than by SiteMinder itself.

Risk and Uncertainty | by Roy Van Keulen Updated Aug 27, 2024

We assign SiteMinder a Morningstar Uncertainty Rating of High.

We see high risk from economic cyclicality. Although most of the company’s revenue and gross profit comes from subscriptions, an increasingly large share of the company’s business will be coming from transaction-based products, which follow the highly cyclical travel industry. 

We see medium risk from competition. SiteMinder is the largest provider in an industry where scale matters. SiteMinder can charge lower prices than competitors due to its ability to fractionalize fixed technological and regulatory costs over a customer base twice the size of its closest competitor. However, SiteMinder’s scale advantage is not insurmountable and we believe the market for channel manager software is not especially efficient. We expect SiteMinder’s competitive position to improve over time as its new Channels Plus product starts creating a network effect between hotels and online travel agencies.

Finally, we see medium risk from execution. We expect SiteMinder’s Channels Plus product will be a significant driver of revenue growth, margin expansion, and help widen its economic moat. But the product is still in its early stages and adoption of the solution could miss expectations. 

Capital Allocation | by Roy Van Keulen Updated Aug 27, 2024

SiteMinder has an Exemplary Morningstar Capital Allocation rating, reflecting our assessment of a sound balance sheet, exceptional investment efficacy, and appropriate shareholder distributions.

SiteMinder’s balance sheet is sound. As of the end of June 2024, it held significant cash with no debt. 

We rate investment efficacy as exceptional. The primary contributor to our rating is SiteMinder’s investment in new, market-leading products, such as Channels Plus. We view these as contributing significantly to SiteMinder’s economic moat through the establishment of network effects. 

SiteMinder does not currently return capital to shareholders, which we view as appropriate, given that the company is currently not profitable