21/07/2023

updating this straw.

It could be that the risk reward proposition is fast approaching an action point. We still have a year or two until FCF +ve and the market is really very unkeen on companies that are unprofitable and developing a SaaS business. Which is great for us if we are looking for long term compounders that haven't been recognised by the market. The days of SaaS bargains seems a long time ago, but FINEOS could well be that rare ASX company.

Just looked at a presentation from Morningstar extolling the virtues of FINEOS. I am not sure if this will work but have tried attaching the presentation.

WebPage.pdf

If it doesn't work let me know as might be behind paywall and I will do some screenshots of the major aspects of the thesis.

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knife, and put it in your pocket

save it for a rainy day.

Fineos has just fallen off a cliff.

I used to hold but am very glad I don't now.

It is, obviously not alone. It belongs to that category of growth stock that is largely out of favour, particularly it has just guided that revenue will be at the lower end of predictions.

It is also unprofitable and probably won't be FCF+ve for another couple of years.

But

It is a bit of a slow burn, solid sticky SaaS that has a great future ahead of it. (See business model straw) I am not sure when the downward vertical SP graph stops, but I am looking at re-entering at some point in the near future.

Fineos offer the mission critical SaaS product that investors like me search for at a decent price.

They are a niche player, providing software solutions to a particular subsegment of the Life insurance industry (Life, accident and Health). These companies, do not want to risk a new offering from a competitor, if their current product works well. And that's why 55% of them are still operating on legacy on-premise systems as opposed to Fineos' cloud based product. Fineos is the lead provider for this particular part of the insurance industry and is investing heavily in sales, marketing, R&D etc to build out an unassailable product suite to create a fortress. The switching costs are very high for this industry and therefore they have a significant moat (see below)

Here is a link to their most recent presentation

What is apparent is that all metrics for growth are solidly positive, and their margin is being maintained at ~65%, but on the P&L statement they are increasing their spend significantly.

I think this is one of those times where this is the correct thing to do, but at a moment in investing psychology where it is the least acceptable thing to do - creating an opportunity to buy a good solid company at a discount.

If one looks at how long their customers have used Fineos products it is quite extraordinary:  Its 10 largest customers have been with Fineos for an average of 8 years, with the oldest close to 20 years. This is validated by its mid-90s percentage retention rate, implying the life span of its customers is around 10-20 years.

They do not break out LTV:CAC (or many other metrics for that matter!) but one can safely assume it is going to a big number.

They are also offering an increasing number of modules (developed in house, and a few acquisition related). I believe that they have probably finished much of what is required for a comprehensive product suite, and that the R&D numbers will continue to decline as a percentage of revenue over the coming years, improving profitability. It currently has higher software development costs (as a percentage of revenue) than other industries (eg Xero) but I am hopeful that this should slowly improve.

The runway for growth is huge: they currently have several of the biggest insurance companies operating in this space as customers and should be able to capture a significant percentage of companies coming of legacy systems, using existing customers as references.

As such, it is not unreasonable to see a tripling in revenue over the next 2-3 years, a relatively small increase in costs and consequently a flip into increasing +ve FCF. With time the marketing and sales costs will continue to reduce, depending on how aggressive management wish to be, with a further improvement in FCF.

If they can achieve this, then one can sit back and watch the money roll in, because none of those customers are going anywhere, and any new customers are just gravy.

Not low risk in execution, but very low risk once executed.

Not held but one to watch closely.