The logical thesis at play here is one we’ve seen before (and I have invested in and will be monitoring again here) being the cloud-based subscription transition.
Growth from the wrong vertical: The issue at the moment is that ~67% of revenue comes from the less predictable, lower margin ‘services’ vertical.
The more sticky saas revenue that the market loves applying massive multiples to is only growing at 27% in comparison to 44% for services. The glass half-full take on the increased services revenue is that companies are investing time and money to integrate Fineos and thus TCV will increase significantly as new customers become 15+ year customers. By contrast, the bear take would be to suggest that services revenue could (and has) fall off a COVID-looking cliff and leave FCL significantly cash flow negative for the short term.
Cash in itself isn’t an issue for FCL as their recent IPO has left them financially quite secure. The drop in cash flow from operations would simply dampen investor sentiment.
Concentration Risk: There is also a small concentration risk. The 3 largest customers contributed 51% of HY20 revenue. I say small because these three customers have been with Fineos for 16, 9 and 1-year respectively. You don’t uproot your mission critical software suite after ten years for no reason. Nonetheless, churn at this end of the revenue spectrum would be disastrous.
Accounting: On an accounting side, FCL loves to capitalise significant portions of their R&D spend. They have been on a 5-year binge of spending 20+million per year on R&D and almost 50% of this has found its way into the intangible assets line. I am also not a fan of them separating ‘delivery’ expenses from the COS. I feel that it artificially inflates gross margins.