Consensus community valuation
$3.65
Average Intrinsic Value
14.8%
Undervalued by
Active Member Straws
#Bull Case
Last edited 9 months ago

12-Apr-19:  Never heard of Serko?  Nor had I, until this morning.  Here's where I heard about them - http://www.livewiremarkets.com/wires/the-1-stock-for-offshore-growth - at the 6:48 mark in this Livewire "Buy Hold Sell" segment hosted by Jeremy Hook from TMS in which Michelle Lopez from Aberdeen and Shane Fitzgerald from Monash both disclose that they hold Serko shares - while talking about why they don't think Corporate Travel (CTD) is a "Buy".   While SKO is not the "1 stock" referred to in the segment's title, it is a very interesting company.

Here's some history:  http://www.serko.com/about-serko/

The Serko back story:

Serko is a story of technology innovation. Founders Darrin Grafton and Bob Shaw started the Serko journey with Interactive Technologies Limited in 1994. ITL was a technology company designed to help travel agents solve a number of thorny mid-office and back office system challenges.

As the internet irrevocably changed the way users searched and booked travel, the business changed direction in order to ride the wave and in 2000 Serko Online was born. Since then the company has gone from strength to strength and with an unwavering commitment to simplifying and improving the travel experience, has gone on to become a global leader in travel and expense.

In 2014 Serko acquired the assets of Incharge, a small but significant online expense management company. With travel accounting for nearly 70% of expense spending, the ability to offer a tightly integrated travel and expense management solution became a key differentiator and the integrated travel & expense proposition delivers unparalleled visibility and simplicity to users, approvers and managers.

In 2014 Serko listed on the NZX and in early 2015 Serko acquired the assets of Arnold Travel Technology, a competing OBT, from Expedia® to extend it's dominance over the Australian market. In 2018 Serko acquired InterplX, a US based expense management company to strengthen it's presence in the North American market.

 

SKO listed on the ASX in July 2018, so there is less than a single year's data available on the company via the ASX website, but the company is 25 years old (founded in 1994 as detailed above).  They own the IP and tech that is behind websites like those used by Corporate Travel (CTD), Flight Centre (FLT) and ATPI - see here.

 

The founders (Bob Shaw and Darrin Grafton) own about 37% of the company between them, so they have plenty of skin in the game.  All of the directors are shareholders.  Both of the founders still actively run the company.  Bob Shaw is the Chief Strategy Officer and an Executive Director, while Darrin Grafton is their CEO (and also an Executive Director).

 

Worth a look.   http://www.serko.com/

 

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#RiskReward
Last edited 6 months ago

Serko is a NZ based software as a service business that offers innovative, cloud-based corporate travel management software as well as expense management software to large organisations. Majority of Serko’s revenues are derived from reseller opportunities with large Travel Management Companies (TMCs) – think: $CTD or $FLT.

For the most recent financial year, Serko reported a 17% increase in booking transactions, 3% increase in average revenue per booking (ARPB). The company noted minimum volume commitments contributed revenue of $0.7m, indicative of favourable transaction contracts and a firm revenue base.

Recent full year results revealed Operating revenue of $23.4m, up 28% from prior year. Recurring revenue was $20.7m (89% of total). NPAT was $1.6m, and the business recorded $3.8m cash burn (+$3.65m from operations, -$6.81 for development costs). Notably, over the previous year Serko had increased R&D spending by 87% to $9.165m, focussing on innovation, integration and leadership of its software solution.

The company has stated that it will be strategically moving customers to its higher margin Zeno offering as a method of increasing ARPB over time. This product is also the key growth driver for the company, with plans well underway to deploy this solution en masse within the company’s North American segment. The integrated expense management platform will be rolled out via lucrative reseller agreements with well-known, existing, American distributors.

North America currently accounts for 6.3% of total revenue (AU 78%, NZ 14.7%), with revenue within this geographical segment up 222% on the prior year. NZ revenue is also growing at a rapid rate of 231% over the prior year, and this strength is expected to continue into FY20. I would expect FY20 to be a consolidation/preparation period for Serko before a sudden, large increase in the company’s scale FY21 if adoption in the US can be widely achieved. Throughout this time, I will be closely monitoring ARPB as a method of tracking Zeno’s adoption within existing customer base.

[see valuation notes for calculation]

This implies NPAT of $2.2m -$3.1m or 35% to 90% increase on FY19. At upper end, Serko currently trades at 104x forward earnings. At face value, this is highly expensive, however it is extremely well documented how capital light Software-as-a-Service (Saas) businesses such as Serko are able to scale. If Serko is able to establish some foothold on the North American market with its Zeno product, this segment should fast become the company’s largest and with a considerable share of the investment required already made upfront, the bottom-line impact of even moderate success here could be huge.

Serko impresses me greatly that it looks able to fund its grand overseas expansion plans from a position of profitability and strong operating cash flows. The company’s balance sheet is clean with just $194k borrowings, dwarfed by the current $15.7m cash balance.

To me, the opportunity here is too lucrative to model future cashflows with any great degree of confidence, and the company will likely adjust its marketing spend in accordance with its execution. A simple PE analysis is also useless due to the company’s strong growth rates and relatively insignificant earnings base. From a valuation perspective, this may be a case where it is far better to be roughly right than specifically wrong.

I am impressed by Serko’s clean balance sheet, and thus far, the income statement has turned up no surprising nasties. The company appears fully capitalised for now but has demonstrated the ability historically to raise capital with ease and on attractive terms.

At $50m rev, I think Serko can report $10-$15m NPAT. At current growth rates (circa 30%) Serko looks set to achieve this milestone FY22, implying the company currently  trades at a multiple of 22-32x FY22 earnings.

At $100m rev, we may be looking at $30m-$40m NPAT. Due to the power of compounding, achievement of this feat by FY25 would require an annual growth rate of 25.99% (in addition to the assumption above). Even if Serko were to raise an additional $30m capital, and even at only current prices, this would imply a (way, way forward) valuation of 9-12x Earnings. I find it hard to believe that a capital light, high retention software business able to grow NPAT 2-4x over in the preceding 3 years would ever trade at these multiples.

Obviously, there is much risk in the assumption that such conditions will transpire, however to me what this suggests is that the upside, if Serko is able to execute, will be multiples of the current valuation.

The opportunity that I see with Serko rests upon the longevity of the current revenue growth trajectory more so than any period of rapid acceleration. I will be closely monitoring retention rates, scalability and early signs of adoption in the US.

Serko is a wonderful business at a fair price, and I am a buyer of shares under $4 (disc: held).

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