*Numbers in NZD*

Serko is raising up to $55m via a $45m institutional placement and $10m share purchase plan. The placement is underwritten at a floor price of $4.35.

The COVID pandemic has been difficult for Serko, with booking volumes and revenues down by up to 80% in calendar 2020. However, it is also presenting significant opportunities to accelerate growth and take market share while other competitors are struggling. Travel management companies (and their corporate customers) are increasingly using this ‘down’ period to accelerate the shift to Serko’s booking software. This demand has exceeded Serko’s expectations.

Although its current cash balance of ~$33m is likely sufficient to see it through the next 12-24 months, Serko moving from defence to offence and is raising additional capital to take advantage of these opportunities. It will use the funds to:

• Accelerate the development and global roll-out of its software platform;
• Continue to expand the platform’s capabilities and content channels across all markets, responding to new and changing business traveller needs;
• Fund small M&A opportunities (noting that Serko has been receiving a number of offers to acquire smaller travel related companies).

Interestingly, in the capital raising presentation, Serko notes that it is currently in negotiation for a large direct contract with a US Fortune 500 company. Previously, almost all of Serko’s bookings are done via travel management companies / booking agencies.

Generally, I’m not a fan of capital raisings because they dilute existing shareholders and indicate a business’ inability to fund its own operations. However, this raising appears to be in response to increasing demand for Serko’s booking tools and opportunities within the global travel market – Serko is on the attack. I am likely to participate in the SPP.

Serko has been busy during COVID lockdown, with the highlights being:

—   New resellers agreements: Serko has signed new reseller agreements with LUXE Travel Management (July), Acendas Travel (July) and Ovation Travel Group (August). This is great traction for Serko in the North American market. These agreements have been made under Serko’s Community Program – which incentivises resellers to take up Serko’s software platform by accelerating their on-boarding process, deferring implementation fees and not requiring minimum bookings until 2021.

—   Awards: Serko was named the New Zealand Hi-Tech Company of the Year 2020. Serko had been nominated as a finalist 8 times before this year, but was yet to win the award. This award has previously been won by Xero (2013, 2015) and Pushpay (2019).

A couple of quotes from travel booking companies that have signed up with Serko:

—   LUXE: “Everyone who participated in the testing absolutely loved Zeno compared to the other tools on the market… We also found that Zeno was the platform that was most ready to handle New Distribution Capability (NDC) content. That was important because we all have to prepare for NDC and prepare our travellers for it, too.”

—   Acendas Travel: “Zeno is a ground-breaking product that finally gives all parties what they need, whether that’s ease of use for the traveller, control and visibility for the travel manager or rich merchandising for the supplier,” said Acendas SVP, Corporate Travel Joe Curtis. “Particularly with the Zeno expense offering, we foresee this agreement as a way for us to better compete — both in customer retention and acquisition — in competitive bid situations. To top it all off, working with the Serko team has been an incredibly positive experience.”

—   Ovation Travel Group: “The level of flexibility and customization available through Zeno is impressive,” said Michael Steiner, Executive Vice President at Ovation. “Because our team at Ovation takes immense pride in providing highly personalized, top-of-the-line service to our clients, offering the Zeno booking and expense solution felt like a natural fit. Zeno’s fresh, user-friendly interface appeals to modern travelers and travel arrangers and at the same time, it’s programmable and flexible enough to meet each client’s unique needs.”

https://www.serko.com/news?submissionGuid=1f8e1506-e517-4b4b-bdc6-5d93f512dd5f

• Serko is a fast growing technology business that has developed leading travel booking software, a strong market position in Australia / New Zealand and a vast (and growing) existing reseller (TMC) network.
• It exhibits typical SaaS qualities – i.e. the technology should be highly scalable and revenues are predominantly recurring, sticky and highly predictable. Serko is currently investing heavily in product development and integration into new markets (with a focus on North America), however once the business is more mature it should be capital-light and therefore should benefit from significant operating leverage over the medium to long term.
• The global online travel industry is large and growing quickly as international travel increase and more travellers are using online solutions to book and manage their travel. Serko has estimated the Australia / NZ market at $10b, UK & Europe at $330b and North America at $338b. Pre-COVID, IBISWorld had forecast industry revenues to grow at ~10% annually for FY19 to FY24.
• After a $45m capital raising in October 2019, Serko has financial firepower to continue to invest in the platform and drive its expansion into new markets. As part of this raise, Booking Holdings, one of the largest global providers of online travel services with a listed value of US $83b, took a ~5% stake in Serko and expanded its existing agreement to offer and promote Zeno to its corporate travellers. Management expect this to have a material impact on revenues in FY21 and beyond via an uplift in ARPB. Serko has also extended its reseller agreements with other TMCs (e.g. Carlson Wagonlit Travel (CWT)), to make Zeno available to US and Canadian customers.
• Serko is not only looking to expand geographically, but also into the SME market. The Booking Holdings agreement should help drive this expansion, further Zeno has strong integration with Xero’s accounting software.
• There appears to be a clear pathway to $100m annualised revenues, with management currently guiding for 20-40% revenue growth in FY20. Serko has proven that it can be profitable (in FY19), however is instead executing a growth strategy for long term value creation.
• Serko’s leading and patented technology, plus its vast existing reseller network, represent growing competitive advantages. If it is able to achieve scale on a global level, by growing a large and loyal customer base who become accustomed to using Zeno to book and manage travel, Serko should have the ability to exert strong pricing power.
• Serko is still managed by the two co-founders, Bob Shaw (CSO) and Darrin Grafton (CEO), who developed the original technology together and both have 25 years of experience in the travel technology industry. Together, the two co-founders own ~25% of the company, even after a small sell-down in October 2019. Serko has maintained the same Board since listing on the NZX in 2014.
• Recent changes in the online booking industry, specifically the New Distribution Capability (NDC), have opened commercial opportunities for Serko’s technology to become the platform not just for booking flights but also purchasing other related services such as in-flight entertainment and meals, premium seat selection, lounge access etc.
• Ultimately, Serko’s vision is for its Zeno platform to become the preferred marketplace for travellers to connect with preferred suppliers across the 7 phases of their travel journey (i.e. fly, stay, move, eat, work, play and rest).

• One of Serko’s largest TMCs in Australia is Flight Centre. Together, Serko and Flight Centre have developed an online booking tool – “Savi” – which is widely recognised as a leading technology platform in the industry. See the below link for more info and a demonstration video.
  https://www.corporatetraveller.com.au/solutions/savi
• As part of the capital raise, Serko announced that it is in advanced commercial discussions with a global payments provider to provide a similar white label version of Serko Zeno to its SME customers, initially in Australasia, with the potential to offer in additional geographies in the future.
• In 2018, the International Air Transport Association (IATA), a global trade association for airlines, launched the New Distribution Capability (NDC), a new standard of communication between airlines, travel agents and aggregators. Previously, airlines could only provide the availability of their flights to travel agents, whereas under the NDC they are able to provide much more information such as personalised products and offers. Serko was one of the earliest level 3 certified providers under the NDC, which allows corporate customers to not only book flights on Zeno, but also purchase in-flight meals and entertainment and premium seat selection etc. and also access customised offers. Serko has a strategic alliance with Qantas and recently, Southwest Airlines in the US selected Serko as their launch partner to showcase their NDC capabilities.
• In 2018, Serko acquired business, InterplX Inc, a provider of SaaS expense management software in the US, to expand its Zeno expense capabilities and move into the US market.

• The global travel industry is highly competitive, with margins shared between airlines, TMCs / OTAs, search aggregators such as Kayak and TripAdvisor, and others (e.g. technology providers). Google has also entered the space with Google Flights, which searches for the best airline tickets, and is growing quickly.
• As with all technology companies, what is ‘the leading or preferred solution’ at any point in time is fluid and subject to change – there is the ever-present risk that a competitor will develop a superior software solution with greater commercial appeal. There are a number of TMCs that have developed or acquired their own booking software – for example, Webjet has developed Rezchain in collaboration with Microsoft, which enables users to eliminate cost discrepancies in hotel bookings. Although not in direct competition with Zeno, the point is that there are always new technologies being developed.
• Serko’s business model involves close partnerships with TMCs, including explicit revenue sharing. Subsequently, there are always risks associated with maintaining these relationships.
• Serko is currently trading on high valuation multiples, the business is not expected to be materially profitable in the short term, and will be burning through cash (~$5m per 6 months) as it invests for expansion. Any slowdown in growth will put pressure on the share price. Further, in the latest half (6 months to 30 September 2019), Serko capitalised 70% of its R&D expenditure such that it did not flow through the P&L, up from 50% in the prior corresponding half.
• The current growth strategy, including entry into new markets (i.e. North America and Europe) present significant execution risk. Serko will incur significant capital expenditures relating to product development and integration, as well as greater sales and marketing capabilities.
• Key personnel risk – Serko is highly dependent on its 2 co-founders, and if one were to leave or significantly sell-down, this would likely result in a significant share price decline.

• All numbers in NZD (functional currency)
• At the current share price of NZD $4.80 (on the NZX), Serko has a market capitalisation of around $450m. It has $48m of cash (including $45m raised in October 2019), and minimal debt.
• For the year ended 31 March 2019, Serko generated revenues of $25m (+28% YoY), EBITDAF of $2.6m and NPAT of $1.6m. The majority of this revenue was generated in Australia (~80%), with 15% in New Zealand and the remaining 5% in the US.
• Worth noting is the increase in operating costs of +32% in FY19, as Serko invests in its global growth strategy, and in particular on product development and integration in the US. In 1H20, Serko’s R&D costs were almost 40% of revenues.
• Serko management has guided for 20-40% revenue growth for the year ended 31 March 2020, therefore we should expect revenue to be around $30-32m. In recent years, revenues have been growing at ~25%, with 80-90% being recurring revenue.
• I wouldn’t be expecting EBITDAF or NPAT to grow significantly (or even necessarily be positive) in FY20, as Serko will continue to execute on its growth strategy.
• Therefore, Serko is currently trading on a forward (FY20) Enterprise Value / Revenue ratio of ~14x, and a historical (FY19) P/E ratio of 240x. Metrics to make value investors blush.
• Serko management has set out its strategic goal of achieving $100m annualised revenues in the medium term (i.e. 3-4x current revenues). The blueprint for getting there is 5m of transactions in each of its 3 key markets – Australia and NZ, North America and UK & Europe – multiplied by an average revenue per booking (ARPB) of $7. Currently, Serko’s ARPB is closer to $6. At $100m annualised revenues, management expects EBITDAF margins of approximately 50%.
• Based on my working DCF, I have come to a valuation of $4.50-$5 per share, which is close to the current share price. This DCF assumes revenue growth of ~30% for the next few years, as well as some operating leverage, and a discount rate of 12%, indicating that there is a lot of growth already baked into the current share price.

Serko is a SaaS technology business that provides online corporate travel booking and expense management software. The company’s software products include:

• Zeno travel, an online booking tool that corporate travellers use to book flights, trains, hotels, rental cars and airport transfers in line with corporate travel policies;
• Zeno expense, a cloud based expense management solution that automates the process of corporate card and out-of-pocket expense submission, reconciliation and reimbursement;
• Serko mobile, a mobile app that gives users access to information and travel booking functionality.

Serko sells and delivers its travel booking software through a network of 50+ travel management companies (TMCs) and Online Travel Agents (OTAs), such as American Express Travel, CWT, Orbit Travel and Corporate Travel Management, who in turn provide booking services to their corporate customers incorporating Zeno. Serko then upsells its expense management software directly to these corporates. There are 1,300+ corporate customers using Serko’s software, including (among others) KPMG, PwC, NAB, Siemens, Fonterra, NSW and Queensland Governments and IAG.

Under its current business model, Serko derives revenue in a number of ways:

• Booking fees when corporate travellers make a booking via Serko’s platform (varies based on volume), paid by the TMC;
• Commissions on hotels, rental cars, airport transfers etc. booked through the platform, paid by the service provider;
• Monthly subscriptions paid by corporates using the expense management software based on the number of active users (i.e. their employees) using the platform;
• Subscription revenue when corporate travellers download and use the Serko mobile app;
• Services revenue for customisation, marketplace integration or implementation assistance requested by customers.

All revenue streams, except for services revenue, are recurring.

Serko is listed on both the ASX and NZX. The company employs ~200 people worldwide, with headquarters in New Zealand and offices across Australia, China, India and the US. Currently, over $6b of transactions are booked through Serko’s platforms.

Serko’s current strategic focuses are:

• Expansion of its Zeno platform into North America (and later on, Europe);
• Continuing to build its TMC / OTA reseller network;
• Penetrate the SME market with a self on-boarding module and non-travel resellers;
• Increasing its average revenue per booking (ARPB) by migrating users from legacy platforms to Zeno and offering increased content and functionality.