MYOB was taken private by Archer Capital and Harbourvest Partners for AUD$487m in October 2008. It was then on-sold to Bain Capital for AUD$1.2bn in August 2011 and re-listed on the ASX in May 2015 at an enterprise valuation of $2.6bn. Two billion dollars of incremental value was created in less than 7 years.
Over this same period, the accounting software market has evolved from the “buy shrink wrapped box with CD-ROM sold by Harvey Norman” model (MYOB’s bread and butter) to the sexier software-as-a-service (“SaaS”) model. Xero has stormed the market and gained significant market share in both Australia and New Zealand (invoking the type of passion for accounting software usually reserved for Apple products). Intuit, the US$28bn American juggernaut has also entered the Australasian market in a big way with its own cloud offering.
Meanwhile, the market size (i.e. the number of SMEs in Australasia) has grown at a rate that’s on par with inflation at best. Xero has now acquired a user base in excess of 200,000 users in Australia (roughly 10% of Australia’s SMEs, possibly 20%-30% of the addressable market) including 100,000 users in the last year. So where did all these additional users come from?
MYOB, despite its claims of significant investment into “cloud”, is widely regarded by the accounting community as an inferior product to both Xero and Intuit (just do a quick Google search).
So how did MYOB’s two successive private equity owners manage to increase MYOB’s revenue from AUD$181m to AUD$299m (including about $51m of acquisitions) and its value 5-folds?
I believe MYOB’s growth has been achieved primarily through price increases amidst flat (most likely declining) user numbers.
Let’s look at the numbers.
On the surface, pro-forma revenue growth rates of 7% and 12% over FY2013 and FY2014 look solid and respectable.
However, let’s consider that MYOB had implemented price increases in the magnitude of between 8.5% and 31% during this same period (these price increases would have been carefully segmented, so not across the board, but it does give you an indication of the magnitude). Mathematically, if the rate of your price increase is greater than your rate of revenue growth, then your number of customers must be declining.
Interestingly though, according to MYOB’s IPO prospectus, its number of “Paying Users” (defined as all cloud users and those desktop users that make additional maintenance payments (including MYOB BankLink users)) is not decreasing at all. In fact it grew by a nice round 50,000 users per year.
How does this make sense? Well there happens to be a bit of general vagueness around the definition of “Paying Users”. We know that MYOB includes all its acquired Banklink users as “Paying Users” and we know that Banklink had 325,000 users at acquisition. Ignoring the fact that some Banklink users are also MYOB users, it then infers that MYOB had approx. 125,000 standalone users (ex Banklink) in FY2014.
Note that Banklink users are substantially lower value (ARPU of approx. $104 per year).
A separate back-of-the-envelope cross check (using disclosed revenue numbers and average pricing) yields us approximately the same number of Paying Users that are not on Banklink nor on Cloud.
To be fair, finessing operating metrics to support a story is the norm rather than the exception in selling documents (e.g. Prospectuses and Information Memorandums). It does show that the nice upwards trajectory of MYOB’s Paying Users numbers need to be viewed under a set of skeptical lens.
Price increases are actually a great weapon in business. If your business has a “moat”, then price increases should be exploited as every dollar of price increase flows directly down to your bottom line.
However, when you increase your price so aggressively (up to 31% in a year), while offering what is regarded as an inferior product with extremely aggressive and capable competitors hot on your heels, it’s hard to see it being sustainable going forward without significant customer backlash (already happening) and attrition.
To be clear, as long as MYOB can achieve a rate of price increase greater than its rate of customer attrition, MYOB’s top and bottom line will continue to grow. This appears to be MYOB’s “secret to success” over the last couple of years and actually demonstrates the value of having a “moat” (in MYOB’s case, high switching costs).
However, is this moat sustainable (are switching costs really that high?) and is MYOB in a position to defend against the siege weapons of its very capable and aggressive competitors? We’ll explore this further in Part 2.
Note: The above blog post constitutes the author’s personal views only and is not to be construed as investment advice. Being obviously passionate about the art of investing, the author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this blog post.
Good analysis re the underlying business.
My thoughts now jump to the question of how, if at all, to act in light of these apparent weakness in the underlying product and business.
My first question, as always, is price vs value, in seeking to understand if a serious dislocation occurs between the two as is often the case when a PE fund is a seller on the public markets.
1. Price
Mkt Cap = $2.015bn
Net Debt = $435m
EV = $2.4bn
2. Value
I have tried to work out what their enduring earnings power/cash generation could be:
FY2015 (Page 66 of Prospectus)
Revenue = $323m (vs $323m Pro Forma FY15)
Cogs = $24m (vs $24m “”)
Staff = $117m (vs $111.7m “”)
Marketing = $11m (vs $8.5m “”)
G/A = $46m* (vs $28.4m “”)
Total Opex = $198m (vs $172.4m “”)
EBITDA = $125.4m
D/A** = $70m
EBIT** = $55m
Interest*** = $16m
PBT***** = $39m
Stated dividend**** = $60m (This is highly unlikely that it can be paid)
*The normalisations and note in prospectus seem quite odd on this line – general & admin expenses – and they make up the bulk of the EBIT differential between pro forma and statutory accounts. Note 1 on page 67 reads that $0.3m of transaction costs attributable to the offer were normalised out of the line, also $19.4m of transactional costs not attributable to the offer were also normalised out. I’d love to see what these were and to what extent they are non-recurring. I have assumed that as they are captured in G/A Expenses they are both recurring and necessary.
**Depreciation = $5m
Ammortisation = $8
Ammortisation of acquired intangibles = $56.3m
Total D/A = $70m
Note that on Page 73 of the prospectus, the Cash Flow statements advise that Cash Capex (excluding acquisitions are $17.5m), if they were to maintain this run rate of cash capex it could mean one of four things:
a. They overpaid for previous acquisitions (a distinct possibility)
b. There will be $50m surplus cash flow above my calculations
c. The quality of the business product is in a slow liquidation
d. This projection is well below what is required for MYOB to build and maintain a decent product in this space and they will need to increase this spend.
***I have deducted an interest charge of 3.8% on $435m – new net debt figure. The prospectus provides an interest charge of $16. This implies 2% BBSW + 1.8% margin. Every 1% move in interest rates adds $4.3m to interest cost. Plus the interest margin is calculated on total leverage ratios which aren’t disclosed.
****3% yield on midpoint listing price of $3.50 = $0.104 cents per share as per guidance in the prospectus, page 5.
*****I am reticent to add back the DA and use it as a proxy for free cash in this instance as these guys are now in a dog fight with some bloody good operators (Xero & Intuit), so they will at least need to be reinvesting in product development to the tune of any DA amount (especially after 7 years of PE ownership) unless of course they wish to find themselves in a slow liquidation.
Summary
The current mkt cap implies a valuation of 51x profit before tax on my workings.
Growth projections and competitive landscape
Another interesting aspect to look at in terms of their growth projections for FY2016 is:
See 4.3.4 (Page 71)
12 Month June Forecasts
Growth Projections:
SME SOLUTIONS: +12.5% ($190.2 vs $214)
Practice Mgt: +4% ($80.2 vs $83.4)
Enterprise Solutions: +9.6% ($35.6 vs $39)
Total Rev: +9.9% ($306 vs $336)
Cogs: +12.2% ($22.1 vs $24.8)
Staff: -3.3% ($117.4 vs $113.5)
Marketing: -34.1% ($13.2 vs $8.7)
G/A: -43.2% ($50.9 vs $28.9)
Conclusion
It would take quite a remarkable business to:
a. Grow heavily post-private equity ownership
b. At the same time find significant cost savings post-private equity ownership
c. Grow whilst also slashing their marketing efforts (all the while being in a hyper competitive industry against two very formidable competitors – Xero & Reckon)
Thank you for the excellent deep-dive analysis into the numbers.
It’s interesting to note the quantum of normalisation adjustments that have been made (and I too query whether things like “business transformation one-off costs” and “other non-recurring adjustments” are in fact truly one-off and non-recurring. (“costs associated with a pilot campaign to test the effectiveness of brand advertising” – is this not just a direct marketing cost?)
The incongruence lies in the fact that the MYOB prospectus has included a bare bone cost structure and capex profile – while selling it to investors as a growth company.
The reality is – growth by price increases do not require any R&D or marketing dollars – but is it sustainable going forward? Should MYOB be more viewed in context of a cash cow that’s in run-off mode?
I believe this is clearly a case where, in order to facilitate a good IPO, the net present value (i.e. the future cash generating capacity of the company) has been sacrificed to boost short-term earnings.
[…] a follow-up to the work I’ve done to-date on MYOB, I’ve collated further samples of actual customer price increases (off various […]