Adding up MYOB’s numbers (Part 2 of 2)

In this post, we’ll look at MYOB’s competitive landscape to ascertain what its future may look like.

MYOB’s core SME offering Account Right Live is a hybrid “desktop + cloud” product with an archaic architecture but still caters to a rather large legacy customer user base.  It has been described by some as “basically a technological dinosaur – a slow, crash-prone non-server backend with a limit of 3 years of data and idiosyncratic user-interface which hasn’t changed much”.

All SME accounting will eventually be cloud based.  The only question is the rate of this transition.  The accountants (as the greatest influencers in the space) are pushing hard for the transition as it makes their lives a lot easier.

MYOB obviously recognises this transition to cloud but its own cloud offering was late to the game and is generally regarded as still a fair way behind Xero.

So MYOB has some catching-up to do.  Let’s look at what their competitors are doing.

Both Xero and Intuit clearly sets out the quantum of their R&D expenditure in their respective financial statements.  Xero spent NZD$67.5m on Product Design and Development in the last financial year.  Intuit spent US$217m in R&D expenses over the last quarter alone (being the US$28bn behemoth).

On the other hand, MYOB has kept its R&D expenditure fairly vague in its IPO prospectus aside from headline statements such as “MYOB spent over $100m in R&D over the last three years.” (which only got them to this point today – still significantly behind their competitors in cloud).

Even if we were to take these numbers at face value (as an example, FY2014 statutory accounts shows capitalised R&D spend of only $12.3m?), MYOB appears to have underspent compared to its competitors. Furthermore, MYOB has 8 legacy products to maintain while Xero maintains essentially 1 single product.

R&D recognised as operating expenditures is not broken out in the financial statements, but we can see a clear trend in both MYOB’s staff expenses and G&A expenses (where R&D recognised as operating expenditure would be embedded) as MYOB heads towards its IPO:

Product Development and Sales & Marketing expenditure are investments into the future (which is why they are sometimes capitalised).  You may be able to reduce them in the short run with no immediate impact on your revenues, but they will catch up to you over the medium to long run.  This underpins the concept of “maintenance capex”, the minimum amount of capex that will keep your business running “as is”. Benchmarked against competitors, MYOB appears to have been starved of maintenance capex.

Let’s then look at capital structure.  MYOB carries a net debt load of c. $435m and has promised its institutional shareholders c. 3% dividends (at IPO price).  This means close to $80m of cash generated by the business is spoken for as interest + dividends expected by its debt and equity holders.  Additionally, its leverage coverage ratio is set at 4.0x, decreasing to 3.75x in 18 months time which equates to minimum EBITDA expected of at least $110m (increasing to $116m in 18 months time).  MYOB is not in a position to increase its R&D or Sales & Marketing expenditure aggressively even if it wants to.

It is facing off against Xero, sitting on NZD$285m of cash, with supportive venture capital funds as significant shareholders who have not only injected significant amounts of cash into the company, but actively encourages the company to take short term losses to aggressively grow and take market share.

In other words, would you invest into a company that has been transitioned through 2 successive private equity consortiums and masterfully “prepped” for a highly profitable exit (twice!) or, as an alternative (if you really need exposure into this sector), invest alongside venture capital funds at a 25% valuation discount?

I believe that MYOB is essentially a highly cash-generative legacy product in run-off mode sold to the capital markets as a growth business.  To facilitate the IPO, net present value (i.e. future cashflow) was sacrificed to boost short term earnings.

MYOB currently trades at a valuation of 22x net profit after tax.

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.