Fineos are generating strong SP momentum ($5.10 at the time of writing, up 119% since March lows) off the back of a seemingly solid acquisition and a (second) revenue upgrade.

FINEOS announced on the 11th of August their intent to acquire Limelight Health, Inc., a US-based provider of underwriting, rating and quoting software, for US$75M.

To fund the acquisition, Fineos raised $90M ($85 insto) at $4.26 per new security. $5M retail SPP at $4.26 still to come.

Limelight:

Limelight provides cloud-based quoting, rating and underwriting software to North America-based insurers. Its Group Benefits Suite comprises eight-core platform components catered to sales workflows and management, broker portals, risk scores, rating engine, whole-case underwriting and business intelligence.

• Importantly, Fineos have worked with Limelight in the past which gives me confidence in the quality of their product offering.
• Limelight is able to greatly improve the quote and onboarding process. A personalised initial quote would normally take 7+ days. With limelight, this now happens on the same day. I'll be keeping a keen eye on 'delivery' expenses going forward to identify the efficiency Limelight is meant to deliver.
• It's hard to argue with the theme of the acquisition. The North American market is the greatest avenue of growth for Fineos and management have been transparent in their intent to focus on this market given they recently hired a new Senior Sales Executive for their US-team.

Limelight Highlights:

• FY20 revenue up 38% on FY19
• 41.4% CAGR between FY18-FY20
• In an article released in Jan 2019, it was noted that “over the last year and a half, Limelight Health's recurring revenues per month grew 750 percent. During this same 16-month period, the company more than doubled the headcount of its team from 45 to 110 employees.”
• Limelight offers 16 product lines with the average customer utilising 6.2
• CEO and CTO are co-founders

Limelight’s SaaS Income Breakdown: 

• Smaller brokers pay them approximately $1,800 per month on average, based on annual contracts. Enterprise deals, on the other hand, range from $80k to $100k per year, with the average company signing 3-year deals and paying for the first upfront.
• As of Mar 2020, the company was doing $420k in MRR across 300 brokerage customers and 5 large enterprise customers. The investor presentation released last week had the MRR up to ~$442k. 
• Overall, they are exhibiting healthy growth and are up from $200k in MRR in Dec 2018.
• Recurring Rev makes up 33% of total revenue

Overall, 5.2x FY20 Rev seems about right for a company that is growing at 40% and offers a complimentary service in a target market. Also cannot complain with the growing trend of repeat top-line upgrades over a single reporting period.

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.