2Q19 Quarterly Business Update and Appendix 4C.
Our FY20 revenue estimates of $53.8m remains unchanged and our EBITDA estimate decreases marginally to -$3.5m ($3.5m loss) from -$3.1m ($3.1m loss).
We think ELMO remains on track to meet its FY20 revenue guidance of $53m to $55m with growth typically weighted to the second half. We think the increasing ARPU reflects that ELMO is realizing the cross-selling opportunity of the wider platform given that an increasing portion of new customers will be from the lower mid-market (50-200 FTE organisations).
The strong investment into sales & marketing and development remains ongoing with an additional 91 staff added in 1H20, with the flexibility to invest supported by the $78m cash balance following the recent equity raise. With the high level of investment, our FY20 EBITDA of -$3.5m remains slightly below guidance of -$1m to -$3m.
We believe ELO is trading close to fair value at 6.5x EV/FY21 Sales.
Our target price increases marginally to $7.42 (prev: $7.14) as we roll our DCF forward and update for a re-rating in comparable peer multiples and we maintain our Hold rating.
Disclosure: I did hold ELO but sold after doing further research and realising that they do have significant competition in the space from both here in Australia and online businesses that are mostly based in the USA and dominate the HR software suite area. I don't mind competition, but I failed to see a clear differentiator between Elmo's suite of HR software solutions and those of others. I also noted that in online forums where people rate such software, there was a number of complaints about Elmo not having a "remuneration module" and about some functionality issues and limitations concerning their existing modules. One example of such a forum is: https://www.capterra.com/p/161821/ELMO-Talent-Management/
Scroll down and you get lists of pros and cons from people who have used Elmo's software.
In summary, I think they need to do more work to close the loop - to ensure they have a full suite of modules for their chosen area of the market, and then work to be recognised as the best option available for Australian and New Zealand small to medium businesses (Elmo's chosen demographic). I would also like them to become profitable. I understand that these SaaS businesses are relatively capital light in their mature years but require a fair amount of capital to be sunk in the early years - you only need to look at Xero (XRO) as an example of where that business model (reinvest back into the businesses at the expense of profits in the early years to build a bigger and better business for future years) has worked very well, but I'm concerned that ELO might be too early in their journey thus far for me to jump back onboard. I think they need to show why they are going to be the eventual winners in their chosen space, and I don't think they've done that yet. Just my thoughts, FWIW.
ELMO has reported its 1H20 results which were in line with expectations given ARR of $52m (+42.9% yoy) & Revenue of $23.6m (+30.3%) were prereported. EBITDA losses widened to -$2.6m (1H19: -$1.9m) with NPAT of $8.5m (+6.7% vs MOEe: -$9.1m).
Key operational metrics demonstrated strong execution across cross-selling into existing customers and selling the wider integrated, modular platform into new customers.
Acquisition of Vocam, HR & safety video e-learning content provider for $3.5m consideration, based on $1.5m revenue (2.3x EV/sales) and EBITDA neutral.
Guidance has been updated to include Vocam, with organic guidance unchanged. FY20 guidance now sits at ARR of $62.5m to $64.5m, Revenue of $53.3m to $55.3m and EBITDA of -$1.0m to -$3.0m.
We raise our FY20/FY21/FY22 revenue estimates by 0.4%/2.8%/2.0% to $54.0m/$71.4m/$89.6m which primarily reflects the impact of the Vocam acquisition.
We also increase our EV/FY21e Sales multiple valuation to 7.0x from 6.5x which reflects a re-rating in peer multiples.
Our target price increases to $7.72 (prev: $7.42) as a result of the changes.
We believe ELMO is executing well through cross-selling into existing customers and selling the selling the wider platform into new customers. While we like the ELMO story and believe there is a strong opportunity for the company to capitalise on its positioning as a cloud-based HR & Payroll software platform in the mid-market, ELMO is trading close to our fair value estimate at 7.2x EV/FY21e Sales given that FY21e organic revenue growth of 32% is being generated with an effective free cash flow margin of -30%.
Maintain Hold, $7.72 target price.
Disclosure: I no longer hold ELO, as explained in a previous straw. Note that ELO is not yet profitable, with minus signs ("-") in front of important numbers such as their EBITDA and cash flow margin. This is a fairly standard business model - of reinvesting heavilly into the business (at the expense of early profits) to grow market share and relevance in the marketplace in the early years, and can be very successful (look at XRO for a great example of where the strategy worked very well), but if the company has strong competition (as Elmo does) and does NOT have strong and clear competitive advantages and differentiators over their competition (and Elmo MIGHT, but I fail to grasp those at this point), then expecting them to eventually become the leaders in their chosen space is probably more about faith and hope than research and logic. Xero (XRO) DID have clear competitive advantages and they were different. Their customers loved the software and found it easy to use. Even accountants loved it. It was at the forefront of the migration to the cloud with accounting, billing, etc., and this added to its rapid adoption - and ease of use, from any device, anywhere that has internet. All of Elmo's serious competition play in the same space - with pretty much the same advantages. They are all cloud-based SaaS companies, and many have a more complete set of modules than Elmo do (as I have mentioned in a previous straw). Elmo state that being Australian-based with their servers and data centre here in Australia is a competitive advantage when companies prefer to have their data stored locally rather than on the other side of the world, but Elmo is not alone there either. There are other small Australian companies (some are private - rather than listed) that do exactly the same thing with respect to local storage and servers. I'm not saying that Elmo will NOT be the eventual winners here - I'm just saying that I don't see much compelling evidence that suggests that they are the frontrunners to win the majority of the market share in their chosen space, and that is in stark contrast to a company like XRO - which ALWAYS looked like they were going to be the eventual winners. With XRO, it was the nosebleed valuations that usually kept me away. With ELO it's just that I don't see enough to make me a believer - yet.
24 October 2019: In the Livewire Article ("wire") linked to below, after a pretty long preamble about market trends and themes, winners over time (how the makeup of our top stocks has evolved), the need for innovation, value versus growth, different ways to "value" a business, and the traits of a "Quality" growth business (Capital Light, Intangible Assets, Low Churn, High Margins, High Free Cash Flow, and Sacrificing Profitability for Growth), Michael Wayne from Medallion Financial Group discusses Elmo Software, and he makes a pretty good case.
You can read it all here: https://www.livewiremarkets.com/wires/a-fast-growing-asx-tech-stock-flying-well-under-the-radar
Disclosure: I don't hold (yet), but I'm getting interested.
26 July 2019: The following link will take you to a broker report from Moelis Australia on Elmo Software (ELO) that they released today, titled, "Strong Finish To FY19":
They've just increased their TP for ELO from $6.37 to $7.54, being about 3% above the $7.32 level that ELO closed at this afternoon (Friday 26 July 2019).
Moelis say that their Target Price increase primarily reflects an expansion in peer multiples. However, they have reduced their rating to HOLD following the recent share price appreciation.
They like the ELMO story and believe there is a strong opportunity for the company to capitalise on its positioning as a comprehensive, cloud-based HR & Payroll software platform in the mid-market to win new customers and upsell its expanded modular suite into its customer base. However, they believe the current valuation is challenging at 8.4x EV/FY20 Sales and have moved to a neutral rating accordingly.
Disclosure: I don't hold ELO shares.