Investing in Sage, ideas, opinions?

[TheMotorcycleBoy]

Hi everyone,

Mel and I were considering making a purchase of shares in Sage. I do recall that a few months ago they issued a profit warning:

https://www.sharesmagazine.co.uk/news/s ... -to-happen

but we wondering whether, seeing as their price seems quite low, they might be worth investigating.

I had planned on downloading their last few year's annual reports and having a browse over them tomorrow, but thought I'd ask here first for any opinions. Have any people here topped-up/bought since the April announcement? What's people's generally view as Sage as a company?

many thanks
Matt and Mel

[dspp]

I avoid them.

They struggle in USA, and on the continent, and so are weak in any takeover valuation. They struggle building up and bulking up abroad. Meanwhile the trend weakens them vs existing peers and emerging competitors.

Users here in the UK don't see the full picture because they are the category killer for most UK SME. But that's not the whole world.

It is thoughts like this that mean I don't even bother assessing their accounts. Why try to value a company based on the accounts, when you think it is not a stable business.

just my 2euc,
dspp

[TheMotorcycleBoy]

I avoid them.

just my 2euc,

Yes, thanks, appreciate your view. Mel's and I conclusion was that they have probably had their day. Back in the 90s perhaps this was all people had in accounting software. Now not only are things different, but they are lots of potential rivals - I'd imagine their profitability will suffer.

I did put years 2014-2017 into my spreadsheet, and saw falling ROCE and rising debt. With their div yield only just around UK rate of inflation, and further organic growth looking next to impossible, we have knocked this one the head I think.

M&M

[Topidiotboy]

I would offer a counterpoint to this view.

Their Capital Marjets Day presentation is well worth a look. (https://edge.media-server.com/m6/p/waecbfi4)

It illustrates the strategy for moving into the cloud and the revenue opportunities it bring. Not only does it bring revenue opportunities, it beings in better quality revenue as customers become even more sticky. Recurring revenues are currently 77% and expected to grow to 90%. It also addresses the previous posters concerns about Sage in the US.

My view is that the current share price is a fantastic entry point. The key reason for the depressed share price in my view is that expectations of an unrealistic growth target are unravelling, and the share price has suffered disproportionately.

However, if you step away from management targets, this is a business that can grow revenue and improve margins, and has done so for decades. Whether it grows at 7% a year going forward or 10% a year going forward I would not try and predict, but I am willing to bet 6% of my portfolio that it will certainly keep growing.

[simoan]

Have to say, I agree with TopIdiotboy. Like many software companies Sage is undergoing a transition from licensed sales with maintenance to the SaaS model and that has hit revenue and margins in the short-term. However, in the long-term the SaaS model will provide a higher quality and stickier recurring revenue stream.

Sage is a top quality company with 5yr average ROCE and Operating margins around 20% to illustrate this. Net debt has gone up due to some large acquisitions in the past few years but is still less than 3x Net Profit which is my line in the sand. I expect debt to reduce quickly in the next couple of years (barring any further acquisitions) given the excellent free cashflow metrics. I held until the profit warning in the Spring. I am waiting for the trading update which should be out sometime in the next week to see if the situation has changed and will likely re-open a position if things have not worsened with regard to margins.

All the best, Si

[dspp]

Thank you both for considered rebuttals of my view.

Do we agree that studying the fine print of sage acts in isolation will not yield an answer? Studying them vs their peers around the world may be helpful, but not alone.

Regards, dspp

[simoan]

Thank you both for considered rebuttals of my view.

Do we agree that studying the fine print of sage acts in isolation will not yield an answer? Studying them vs their peers around the world may be helpful, but not alone.

Regards, dspp

I don't have a view on where they stand with regard to competition but the margins alone tell me competition is not a big problem currently. If there was lots of competition they would end up in a race to the bottom on pricing and margins would reduce more quickly. There are no current signs of that and instead margin issues are more to do with the change of business model.

Who are the competition? Intuit? Compared to them Sage look very cheap!!

All the best, Si

[torata]

Who are the competition? Intuit?

In the SME space, Xero immediately comes to mind, publicly quoted in OZ - ASX:XRO

Accounting / ERP software is inherently sticky and margins should be good, especially moving to SaaS model.
However, echoing dspp, considered on a global basis, unfortunately, I don't see growth from Sage.

torata

[TheMotorcycleBoy]

Yes, Sage are trying to market "cloud accounting".

But surely others will be able to do this. I've been in software for 25 years. All sage will be doing is changing where they host the service/data, as far as I can gauge. Wrapping an old product up in new clothes.

Won't others be able to do this, more competitively, driving prices down?

There will be lots of new data security concerns with this "new" idea, surely. And if it's all "up in the cloud" and accessible on generic Android and iOS platforms (i.e. all these execs mobiles and tablets), then it will be easy to switch provider, in my opinion.

Matt

[Topidiotboy]

My view on some of the points raised.

Where is the growth coming from?

If you look at the Capital Markets Day presentation, migrating the Installed base to the cloud in itself generates significant revenue opportunities. Why would customers pay more for the same service in the cloud? Easy, no local IT infrastructure to manage, and a reduced Total Cost of Ownership.

Combined with this organic growth there is also the opportunity to reduce costs and raise operating margins.

That's before we get on to the opportunity to grow its user base. This links in to the rising Net Debt and falling ROCE, which is explained by acquisitions as per Simoan's post. It should be noted that one of these acquisitions was Intacct, which is helping to drive growth in the US, and is proving by any measure to be a great acquisition. So that explains where the majority of global growth is being targeted.

Competition is a concern for any business. Let me illustrate with a general point. Until recently there were five major tobacco companies operating in the US. The competition didn't stop each of them making handsome profits. Specifically on the point of Sage, yes there is competition from Intuit, Xeros and a multitude of smaller scale companies, but like the tobacco companies the Sage profit margins tell the tale of how much of a threat the competition is. Barriers of entry are strong, knocking up a mini-ERP to meet the complex needs of SME's around the world is not the sort of thing a gang of developers can knock up overnight in their garage.

In many ways I'm repeating the message of Sage's management, and I think one should always treat management waffle with a large dose of scepticism. Why am I not doing so with Sage? Well, such is the strength of the business, and the strategy for moving it forward is so rooted in simple common sense, that its difficult to argue with management.

[TheMotorcycleBoy]

My view on some of the points raised.

Where is the growth coming from?

If you look at the Capital Markets Day presentation, migrating the Installed base to the cloud in itself generates significant revenue opportunities. Why would customers pay more for the same service in the cloud? Easy, no local IT infrastructure to manage, and a reduced Total Cost of Ownership.

Combined with this organic growth there is also the opportunity to reduce costs and raise operating margins.

That's before we get on to the opportunity to grow its user base. This links in to the rising Net Debt and falling ROCE, which is explained by acquisitions as per Simoan's post. It should be noted that one of these acquisitions was Intacct, which is helping to drive growth in the US, and is proving by any measure to be a great acquisition. So that explains where the majority of global growth is being targeted.

Competition is a concern for any business. Let me illustrate with a general point. Until recently there were five major tobacco companies operating in the US. The competition didn't stop each of them making handsome profits. Specifically on the point of Sage, yes there is competition from Intuit, Xeros and a multitude of smaller scale companies, but like the tobacco companies the Sage profit margins tell the tale of how much of a threat the competition is. Barriers of entry are strong, knocking up a mini-ERP to meet the complex needs of SME's around the world is not the sort of thing a gang of developers can knock up overnight in their garage.

In many ways I'm repeating the message of Sage's management, and I think one should always treat management waffle with a large dose of scepticism. Why am I not doing so with Sage? Well, such is the strength of the business, and the strategy for moving it forward is so rooted in simple common sense, that its difficult to argue with management.

Thanks for this - this is useful stuff. We may well come round to SGE.

M&M

[TheMotorcycleBoy]

That's before we get on to the opportunity to grow its user base. This links in to the rising Net Debt and falling ROCE, which is explained by acquisitions as per Simoan's post. It should be noted that one of these acquisitions was Intacct, which is helping to drive growth in the US....

As a member of a tech, which was acquired 4 years back (we had 3500 headcount then), we are now ~30000 in number.....

Horizontal acquistion, in my naive opinion, is very difficult (read as earnings eroding). There are huge losses, in redundancy costs, a whole tranche of added training requirements, merging/converting common facilities (report tracking, printing, IT support blah blah). What parts of the acquired are useful/or not takes much time (and money?).....integrating different subsystems.

Again, IMO, there seem only 2 ways this (horizontal acquisition) can actually add "share holder value" in the real world:

1. the acquirer is only acquiring the customer base, and then quickly sells the actual business as a going concern
2. the acquirer leaves the acquired company to it's own devices, i.e. it's brand / products / procedures aren't changes. Only the board changes.

(Of course in the case of option 2. that's rather like the parent company just stating "Our method of operation isn't as good as what we have just acquired, but we can afford to buy their operation and reap their profits". I'm not sure how many M&As actually proceed on this basis..... cars, commodities, perhaps?)

In the case of Sage/Intacct I briefly visited https://en.wikipedia.org/wiki/Sage_Intacct

and so, perhaps, the acquisition was based mainly on option 1. - i.e. land grab of the customer base. In which case, the acquisition may be beneficial.

Matt

[simoan]

Hi Matt,

If I may be so bold... I think you're over-thinking things with regard to Sage. If you work in the same industry it is difficult to see the wood for the trees and most times this is a positive disadvantage. You sometimes need to take a step back and consider the investment unemotionally from a laypersons POV. I could create a bear case for any share you care to name with all manner of "ifs and buts" so you need to be careful you don't talk yourself out of investing in good companies by doing so - just concentrate on the numbers and almost forget what the company does if you can.

The future is uncertain and trying to predict it is a mug's game, although we all do it. As Donald Rumsfeld might say, you have to concentrate on what is known and ignore the "unknown unknowns". For sure, consider the "unknown knowns" but minimise them by researching more. Consider any "known unknowns" but your main focus should be on the "known knowns" (hard numbers in trading updates, HY and FY results, management actions etc.) as much as possible.

If competition was a serious concern then Sage would not be able to sustain such high EBIT margins and the analogy to the tobacco industry is a reasonable one. If you look at industries that are truly competitive (construction, distributors), or where the customer calls the shots (supermarket suppliers, government contractors), you will find the margins of these companies are much smaller i.e. < 5%. I rarely invest in companies with such low margins and so naturally avoid competitive problems most of the time.

All the best, Si

[flyer61]

I believe Fundsmith hold Sage...Terry Smith is not noted for buying or holding Companies he does not rate very highly. The metrics he uses I find compelling.

[TheMotorcycleBoy]

Hi Matt,

If I may be so bold...

Don't worry....I'm quite thick skinned...

I think you're over-thinking things with regard to Sage. If you work in the same industry it is difficult to see the wood for the trees and most times this is a positive disadvantage. You sometimes need to take a step back and consider the investment unemotionally from a laypersons POV.....

And furthermore, I'm actually reasonably positive about Sage. Well-ish. Like I said in my earlier post...

and so, perhaps, the acquisition was based mainly on option 1. - i.e. land grab of the customer base. In which case, the acquisition may be beneficial.

The acquisition may have been wise.

I believe that working in tech, however does give me a big advantage, in knowing what acquisitions mean in tech. The firm I'm now in was once CSR:

https://en.wikipedia.org/wiki/CSR_%28company%29

and eventually we wound up, with an acquiring CEO. (I'm guessing he thought we could *actually* enter the mobile phone CPU arena). Zoran was one acquisition too far. And we bleed through this. (The logical thing, would probably have been to have concentrated better on the existing strong bluetooth, wifi and audio suite - CPUs on the sidelines of the digital gadget portfolio).

However, once it became clear that his strategy was doomed, he sold up (and pocketed big time); yes to a smart phone chip vendor - but I let you DYOR if you are interested in finding out which one.

...I could create a bear case for any share you care to name with all manner of "ifs and buts" so you need to be careful you don't talk yourself out of investing in good companies by doing so - just concentrate on the numbers and almost forget what the company does if you can.

The future is uncertain and trying to predict it is a mug's game, although we all do it. As Donald Rumsfeld might say, you have to concentrate on what is known and ignore the "unknown unknowns". For sure, consider the "unknown knowns" but minimise them by researching more. Consider any "known unknowns" but your main focus should be on the "known knowns" (hard numbers in trading updates, HY and FY results, management actions etc.) as much as possible.

If competition was a serious concern then Sage would not be able to sustain such high EBIT margins and the analogy to the tobacco industry is a reasonable one. If you look at industries that are truly competitive (construction, distributors), or where the customer calls the shots (supermarket suppliers, government contractors), you will find the margins of these companies are much smaller i.e. < 5%. I rarely invest in companies with such low margins and so naturally avoid competitive problems most of the time.

Yeah, I kind of agree, really. But I'm glad to get a conversation started - appreciate your views. We may well buy into SGE.

I believe Fundsmith hold Sage...Terry Smith is not noted for buying or holding Companies he does not rate very highly. The metrics he uses I find compelling.

Yeah, I'm just ruminating, and as I said to Si, just good to get a chat going on this.

Matt

[dspp]

Not all industries easily support several similarly sized competitors, or a multitude of different competitors of different sizes. Some industries tend towards one company dominating, or oscillating domination shifting among just two or three. In industries like these analysing the accounts is only one part of the investment decision making process. You also need to consider the other factors that are in play, and indeed that may lead back to analysing the accounts of all of them.

Simple accounting platforms, or more complex ERP platforms, both tend to lock-in clients. By way of a constellation of bolt-ons they also tend to create network effects. As things move to cloud offerings (which is generally an extension of SaaS) then these network effects can increase. The biggest barrier to scaling up is the multiplicity of different tax etc regimes around the world, but that is also a defensive moat as one conquers each territory.

Falling ROCE with scale rings alarm bells for me. Wasn't ROCE rising a leading indicator when Dell was winning, then ROCE falling again and indicator when it slipped. Here are a few quick search results that may help (I haven't read these links. I can't find the links I want which are to some really god HBS cases on the the topic using Dell/HP/Compaq wars as an example).
https://www.coursehero.com/tutors-probl ... atios-for/
https://www.mckinsey.com/business-funct ... erformance

When analysing situations like this there is no alternative but to understand the business of interest, in its context. That in turn may mean you need to understand all of Sage's important competitors in the accts/ERP space in this example. Just homing in on financial accts alone may well be insufficient, although that should be caveated with a comment about how long you intend to hold a share for.

Coming back to Sage, is it big enough to defend a (say) #2 position for (say) a decade against Intuit in the mid/low end space it occupies, and to do so profitably ? As a comparison that has been an unhappy place for many years for AMD vs Intel in one of the main microprocessor areas.

I don't know the answer by-the-way, and I am genuinely interested.

As a company owner/founder who has gone through a number of start-up cycles I do know that choice of software for accounting in a UK context is tricky. Many of the ERP bolt-ons that are available for Intuit/Quickbooks for mfg control in USA context are not available in UK. But if one goes with Sage then the functionality was historically extremely limited unless one went to the big-ticket Sage packages, and that brought with it a need to use £40/hr staff to do things that really one wanted to use £10/hr staff on. That gets me a downer on Sage, and at times I specialised in inventing work-arounds to use Quickbooks creatively rather than go to SAge. (Or we used MYOB or etc). But equally almost all the UK SME accountants love Sage because it is the category-killer software in the UK, and that makes their job easy. Outside the UK it has far less recognition in my experience. For my main current business I selected Sage to run the accts in, but do all the mfg ERP stuff in something else entirely, fwiw.

Regards, dspp

[TheMotorcycleBoy]

My final word on SGE for the day. I analysed their financials 2014-2017.

Year                  2014       2015     2016     2017
Operating margin      27.5%      26.5%    27.3%    27.15%
Cash conversion       106%       110%     93.2%    86.3%
ROCE                  25.33%     25.23    25.0%    20.80%

And apparently the Intacct deal happened in 2017.

http://www.sage.com/company/investors/p ... of-intacct

I'm curious as to whether or not the deal (financial transaction) had actually closed by the time the 2017 was prepared.

Yes, from the note section of the AR:


16.1 Acquisitions
Acquisitions made during the current year
Intacct Corporation
On 3 August 2017, the Group acquired 100% of the share capital of Intacct Corporation (Intacct) for total consideration of £627m. Intacct is a
leading provider of cloud Financial Management Solutions in North America and is incorporated in the USA. Acquiring Intacct strengthens
the Group’s position as a leading cloud provider to customers throughout their development from start-up to global enterprise and in the
short term provides a further platform for growth, with medium-term aspirations for geographical expansion. The combination of Sage and
Intacct’s existing product portfolio, brand, resources and partners, will put the Group in prime position to establish itself as the leading
provider of cloud Financial Management Solutions in North America in its chosen segments.

[dspp]

M&M,

We posted simultaneously. Everything I said about accts + ERP also holds true for CRM, so the net has to include saleforce.com when you are analysing cloud provision of company-wide solutions in the SME space.

Intuit turnover = $5.2bn; Sage turnover = £1.7bn; Salesforce turnover = $8.4bn

The UK market is begging for the Americans to come in and clean up. The reverse is not so.

regards,
dspp

[PinkDalek]

[Matt wrote]:

And apparently the Intacct deal happened in 2017.

http://www.sage.com/company/investors/p ... of-intacct

I'm curious as to whether or not the deal (financial transaction) had actually closed by the time the 2017 was prepared.

Yes, from the note section of the AR ...

You most likely also spotted page 170 includes:

The consolidated income statement includes revenue of £8m and a loss after tax of £6m reported by Intacct for the period since the acquisition date. The revenue of the Group for the year ended 30 September 2017 would have increased by £78m and the profit would have reduced by £17m if Intacct had been included in the Group for the whole of the year.

[flyer61]

Interestingly Fundsmith have bought Intuit this year. Another long term Company they have, is ADP, which has been a very good performer for me.

M and M here’s one to run your slide rule over .... PZ Cussons