Morningstar empieza finalmente a cubir $TYL Tyler Technologies, empresa que creo que puede ser del agrado de los contertulios habituales de este hilo:
Analyst Note | by Dan Romanoff Updated May 21, 2019
We are initiating coverage of Tyler Technologies with a wide moat rating, stable moat trend rating, and a $247 fair value estimate, and we view the shares as modestly undervalued today. We see Tyler as the clear leader in a slow-moving and underserved niche market of government operational software. We believe there is a decadelong runway for 10%-plus revenue growth at Tyler, given the need to modernize local governments’ legacy enterprise resource planning systems and the firm’s strong position in this market. Scaling software-as-a-service revenue should also help drive margin expansion over time, even if it pressures near-term profitability. The shares have gradually rerated since the 2008 downturn as local governments slowly normalized after the recession, subscription revenue has grown in the mix, e-filing has rapidly materialized into a significant opportunity, and deal sizes have grown.
Tyler addresses the needs of cities, counties, schools, courts, and other local government entities. Its two core products are Munis, which is the core ERP system, and Odyssey, which is the court management system; together they constitute two thirds of revenue. These systems enable normal operations of governmental institutions, including financial management, human resources, revenue management, tax billing, and asset management. Per management, existing core systems at customer sites are at least 20 years old and running on ancient software code where there is no next wave of incoming COBOL- and Fortran-fluent programmers to keep these systems running. We believe extending the life of these legacy systems is no longer tenable.
Business Strategy and Outlook | by Dan Romanoff Updated May 20, 2019
We view Tyler Technologies as the clear leader in a slow-moving and underserved niche market of government operational software. We believe there is a decadelong runway for 10%-plus growth at Tyler, given the need to modernize local governments’ legacy enterprise resource planning systems and the firm’s strong position in this market.
The company’s two core products are Munis, which is the core ERP system, and Odyssey, which is the court management system. These systems enable normal operations of governmental units, including financial management, human resources, revenue management, tax billing, and asset management. Tyler addresses the needs of cities, counties, schools, courts, and other local government entities. Per management, existing core systems at customer sites are at least 20 years old and running on ancient software code where there is no next wave of incoming, fluent programmers to keep these systems running. We believe extending the life of these legacy systems is no longer tenable.
While the company used to fight for every $100,000 deal, it now has established enough of a reputation in the government market that it is called upon in most relevant government system searches. The potential clients have certainly grown larger, as evidenced by statewide e-filing deals in Texas and statewide court management system deals that can be worth tens of millions of dollars annually. Further, Tyler benefits from a fragmented market that includes no companies at anywhere near its size or scale that are focused on the local public institution market.
We also believe that while upselling may not be as critical for the company as it is for other software stories, Tyler’s product depth and leadership should ultimately drive upselling on a larger scale. For example, once a large city adopts a Munis ERP, over time this should ultimately drive the central school district, court system, police system, jail system, and property tax appraisal to select Tyler as well. The 2018 Socrata acquisition for data and analytics has introduced federal customers to Tyler and is an obvious upselling opportunity across the entire portfolio.
Economic Moat | by Dan Romanoff Updated May 20, 2019
We assign a wide moat rating to Tyler Technologies, driven by higher customer switching costs and, to a lesser extent, intangible assets. Our position is that switching costs for software are driven by several factors. The most obvious of these is the direct time and expense of implementing a new software package while maintaining the existing platform. There are indirect costs along those same lines, mainly lost productivity as employees move up a learning curve on the new system and the distraction of employees involved in the function where the change is occurring. Perhaps most important, there is the operational risk, including loss of data during the changeover, project execution, and potential operational disruption. The more critical the function and the more touch points across an organization a software vendor has, the higher the switching costs will be.
Given that Tyler provides the core systems that enable normal operations of governmental units, including financial management, human resources, revenue management, tax billing, and asset management, coupled with an extremely slow-moving customer base and the typical long-tail investment in such core software systems, we believe customer retention will be extremely high and excess returns will more likely than not remain for at least 20 years. Critically, software companies tend to have low capital intensity and generate high free cash flow margins, which supports our contention for excess returns over a prolonged period. Further, high perceived friction from changing core systems is not theoretical, as Tyler enjoys among the highest retention in the entire software industry. This last point is important in that Tyler does not risk losing customers to M&A.
Per management, existing core systems at customer sites are at least 20 years old. Many customers are still operating on green screens with 50-year old Fortran and COBOL-derived custom solutions. In these instances, the employees who have maintained these aging systems are retiring and there is no next wave of programmers who are fluent in languages, like Fortran, that are no longer used. Even what might have been a smaller glitch could develop into a catastrophic system failure without proper maintenance and support. We believe as many as half of the company’s wins are replacing such systems. Given that a vertical ERP solution is mission critical, we believe extending the life of legacy systems is no longer tenable. Tyler’s solutions are developed on Microsoft’s .NET platform using modern techniques, the interface is clean and simple, much of the functionality is available through mobile devices, residents can access the local website and complete certain transactions, and the products are easier and cheaper to maintain than the legacy systems they replace.
We think that local governments are inherently different than typical enterprise software users in that they are not trying to attract new customers or drive profitability. Core systems are relied upon to fulfill their intended function. In that regard, if there are no problems, the systems are largely ignored. Further, governments in general have been wary of software as a service. Five years ago, enterprise buyers had clearly already accepted the SaaS model and have since come to prefer it. By contrast, Tyler customers who have had SaaS or on-premises options available to them have generally opted for on-premises versions and continue to do so. SaaS is trending up in the company’s revenue mix, but we do not see a tipping point on the horizon where SaaS becomes the preferred model for local governments.
Our view is that the life of an ERP system is typically 12-15 years, which would typically include two major version upgrades. Around the third major upgrade is when the enterprise user might think about a different system. Often, the customer might simply elect to undertake another major version upgrade. We believe that local governments and similar agencies are even more reluctant to change core systems, and that the life could be double that of a typical ERP decision path, or two to three decades. Governments are resource-constrained in terms of money and people, so a yearlong disruptive period of package implementation is delayed as long as possible. We therefore think such customers will not change their nature once a core Tyler suite has been implemented, and the company will in turn benefit from a similarly long-tail relationship.
Tyler operates in a highly fragmented market that features local, regional, and national vertical software providers as well as international horizontal vendors. Many vendors are highly localized and serve only a small number of customers with outdated solutions or are no longer even in business. Gartner estimates the market for Tyler is $30 billion, growing at 7% annually, while Tyler pegs the total addressable market at $18 billion. This consists of more than 88,000 cities, towns, local agencies, school districts, and counties in the U.S., representing more than 450,000 potential system implementations. Management estimates that two thirds of system instances are based on home-grown, unsupported, or green screen technology. The company is the largest pure play focused on the local and regional government market and has become the clear leader over time. The company’s success has shown up in strong revenue growth, compounding at 13% annually over the last decade–nearly twice the market growth. As a bonus, in 2015 Tyler acquired New World Systems, which not only brought a public safety (police department) solution into the fold but also eliminated one of the largest local government ERP system competitors.
As it relates to intangible assets, we posit that Tyler benefits from building up a portfolio of software that would be difficult for a startup, or even an established software vendor without government expertise, to replicate. Further, we think Tyler has established a strong reputation for an underserved and unique set of customers. Local governments are inherently different than enterprise buyers. Government operations differ in important ways from commercial operations. For example, the accounting is dramatically different (GASB versus FASB), and there is no push to attract new customers for local governments, unlike at traditional enterprise clients. The request for proposal process is longer and more intricate. Funding sources could be different for an on-premises installation compared with a SaaS implementation. SaaS is overwhelming preferred by enterprise buyers, whereas government buyers overwhelmingly prefer on-premises perpetual licenses. An on-premises deal might involve a municipality’s capital budget, where a SaaS deal might be an ongoing operating expense. Additionally, given the uniquely risk-averse nature of local government and public institutions, deals require a variety of reference accounts–and Tyler company has spent more than two decades building a roster of clients, beginning with small local institutions, building over time to major cities and even statewide deals.
Historically, pricing is more critical for government customers, as sole-source contracts have been frowned upon. Increasingly, we believe government buyers are mimicking enterprise customers in a search for best-in-class functionality and more sophisticated total cost of ownership considerations rather than strict price comparisons. The combination of these factors represents a barrier, in our view, and while it is possible to replicate, it would be expensive and time-consuming. Further, now that Tyler has established itself throughout the U.S. and is moving toward state and even federal deals, especially after the Socrata acquisition, we believe it is inching toward representing the path of least resistance to prospective customers. We view the company’s name and solutions as an intangible asset that captures a proven ability to serve public institutions, which we consider a secondary moat source.
Fair Value and Profit Drivers | by Dan Romanoff Updated May 20, 2019
Our fair value estimate is $247 per share, which implies a fiscal 2019 enterprise value/sales multiple of 9 times, adjusted price/earnings multiple of 46 times, and a 3% free cash flow yield.
Our forecast includes a gradual shift to subscriptions from maintenance, license, and software services revenue. We model total revenue growth of 15% in 2019, decelerating to 11% in 2023, representing a five-year compound annual growth rate of 12%. We see subscription revenue at a 24% CAGR, with maintenance at a 7% CAGR and license at a 5% CAGR over that same time horizon. In our view, revenue growth will be driven by new customers and increasing deal sizes. We think deal sizes are growing more because of increasingly larger customer sizes–that is, moving from small municipal governments to countywide and statewide deals. While an ever-broadening portfolio makes upselling possible and even likely, we do not view this as a significant driver of revenue growth over the next several years.
We believe the underlying market is substantial and growing. According to Gartner, the software market for local and regional government and K-12 software is $25 billion and growing at 7% annually. While Tyler currently does not meaningfully serve the federal government or higher education, these markets represent another $26 billion opportunity growing at approximately the same 7%.
We anticipate that GAAP gross margins will rise from 47% in 2018 to 50% in fiscal 2023, driven mainly by improving scale in subscription revenue. We think gross margins for larger SaaS companies should ultimately be 75%-85%. That said, we see Tyler embarking on a journey toward true SaaS that will extend well beyond a decade. We model GAAP operating margins increasing from 16% in 2018 to 20% in fiscal 2023. Beyond improving services gross margin, we model modest improvements in various other segment-level gross margin lines, as well as some operating leverage in selling, general, and administrative expenses. Historically, the company has targeted at least 100 basis points of margin expansion annually. In fact, the company has a long-term non-GAAP operating margin target in excess of 35%. In 2028, our non-GAAP operating margin only reaches 30%, which we believe skews conservative.
Risk and Uncertainty | by Dan Romanoff Updated May 20, 2019
We assign Tyler a medium fair value uncertainty rating. The company generally trades at high multiples relative to peers, which is exacerbated by the fact it is expected to grow only near the median of the software group over the next few years.
While competition is always a risk, we believe industry competition is unusual for Tyler in that local governments and public institutions have continued to push off investing in new systems as long as possible. Continuing to maintain existing legacy systems is often no longer an option. The competitive landscape is highly fragmented, with many hyperlocal competitors. As Tyler continues to benefit from larger deals, we believe it will bump into the larger horizontal software companies more frequently.
Now that governments and public institutions of all sizes are increasingly open to SaaS delivery and public cloud environments, we believe the sales cycle could lengthen. On-premises sales were a more defined transaction for customers that tend to have strict procedural purchasing. With SaaS deals increasingly possible, we believe potential buyers might want to explore data security and legal responsibilities more thoroughly.
Despite impressive growth and a revenue base that we expect to be well in excess of $1 billion in 2019, Tyler is still predominantly selling perpetual license deals. Such deals can get pushed out or pulled in. Since the company does increasingly larger deals, it is possible that a couple of large deals leaking into the next several quarters could cause a quarterly miss.
Lastly, Tyler made 19 acquisitions for $590 million in aggregate between 2009 and 2018. The largest of these was for NWS in 2015 for $338 million. The integration of these deals has not always been as quick or smooth as anticipated. We believe the company will continue to make acquisitions and will occasionally do a larger deal that might be disruptive over the course of a year.
Stewardship | by Dan Romanoff Updated May 20, 2019
We assign Tyler a Standard stewardship rating. We see no material governance issues. The company has grown from small-cap to mid-cap, with the shares significantly outperforming the S&P 500 over the last five years. Revenue has grown to $935 million, and we look for revenue growth of more than 10% annually over the next five years. Given management’s record of driving margins higher each year, we expect additional margin expansion throughout our explicit discounted cash flow forecast.
Lynn Moore was named president in 2017 and CEO and chairman of the board in May 2018. He has been with the firm since 1998, when he joined as general counsel, and has been an executive vice president since 2008. Moore took over from John Marr, who had been CEO since 2004 and remains on the board as executive chairman. Marr was instrumental in the growth of Tyler over the years. Moore has been with the company for approximately two decades and is well versed in the operations of the firm. His approach thus far has generally been a continuation of the execution and product strategy that made Tyler the company that it is today. CFO Brian Miller has been with the company since 1997, when he joined as chief accounting officer. He has been CFO since 2008. We have met Miller many times over the years and find him to be more than capable in his role as CFO and good with the investment community. Management compensation skews heavily toward an incentive-based equity component and are based on common metrics such as revenue and EPS growth. We have reviewed management compensation plans, including the absolute dollar and equity component levels, and found nothing unusual.
Tyler’s board of directors consists of eight members, including insiders Moore, Miller, and Marr. The remaining five are independent and possess a variety of backgrounds from privately held software executive to investment fund manager.
Tyler does not pay a dividend, nor would we expect a company of this size or growth trajectory to do so. Tyler has repurchased stock in the past to either offset dilution from the exercise of stock options or drive the share count down. Our model contemplates near-term share count guidance as issued by management and longer term assumes a flat share count.
The company has been acquisitive over the years. Such activity has typically been small, feature-driven deals in the $5 million-$10 million range. More recently, management has directed investors to expect deals in the $15 million-$50 million range. Tyler has completed two larger deals since 2007: NWS for $338 million in 2015 and Socrata for $148 million in 2018. The company also announced the pending acquisition of MicroPact in early 2019 for $185 million. Most acquisitions have been small and have gone smoothly. The NWS deal is the largest management has executed and had some speed bumps. The product itself needed unanticipated investment from the software engineering side as well as in customer service. The investment phase of NWS is behind the company now. Some of the small deals have been enormously successful. For example, the 2010 Wiznet acquisition for less than $10 million became Tyler’s e-filing business, which exited 2018 on a $54 million annual revenue run rate. Our model contemplates $25 million in annual acquisitions.
