On today’s episode, we’ve invited members of the Student Managed Investment Fund (SMIF) at The University of Western Australia back on the show to pitch for the community watchlist. Last year we heard from their Chief Investment Officer, Ben, who pitched Citadel on the podcast. SMIF operates a high conviction fund undertaking positions in ASX listed companies following the end to end analysis, due diligence and valuation of the company, all completed by UWA’s top performing students. For this pitch, Bryce and Alec talk to Forress Salekian (CIO UWA SMIF) and Phillip Nguyen (Investment Director UWA SMIF), who’ve prepared a pitch deck on Technology One (ASX: TNE). Together they delve into their investment thesis, and share the extensive research they’ve done on the company.
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BRYCE LESKE:: [00:00:40] Welcome to another episode of Equity mates, a podcast that follows our journey of investing, whether you're an absolute beginner or approaching Warren Buffett status, our aim is to help break down your barriers from beginning to the dividend. My name is Bryce and as always, I'm joined by my equity buddy Ren. How are you going? [00:00:55][15.1]
ALEC RENEHAN: [00:00:55] I'm very good price, very excited for this episode. We've got another pitch for the equity markets community watch list. Yes. Which episodes that we love because we generally find, you know, companies that we haven't heard of before or we find people that have done a lot of work on companies that can really open our eyes to what's out there. So excited to get stuck into this one. Absolutely. [00:01:17][22.1]
BRYCE LESKE:: [00:01:18] We've got some returning pitches joining us. Their last pitch was an absolute cracker. But before we get stuck in, we just want to quickly address the community watch list versus the equity markets hypothetical portfolio, if you're wondering where that has got to. We have an update on that. [00:01:35][17.2]
ALEC RENEHAN: [00:01:36] Yeah, yeah. We look where we want to expose the equity based community to as many stocks as possible. But we want to do it in a way that, you know, isn't making buy, hold or sell recommendations, isn't getting us in trouble with OPSEC. So we rather than talking about a portfolio and talking about buying things for the portfolio, just on the side of caution, we are just talking about the community watch list. And, you know, obviously you always have to do your own research, but we figure this is just the safer way to expose everyone to the companies that are out there and to, I guess, to the work that people in the equity community are doing. So if you're wondering why the name change, that's why the content hasn't really changed. It's just about how we package it all up. [00:02:26][50.0]
BRYCE LESKE:: [00:02:26] Nice. So without further ado, it is a pleasure to welcome you to the community stock pitch here on equity markets. Faraz Sawaki and Phillip Newin, who are both from the University of Western Australia, a student-managed investment fund. Boys, welcome. [00:02:42][15.5]
Faraz and Phillip: [00:02:43] A pleasure to be here. [00:02:43][0.0]
BRYCE LESKE:: [00:02:44] So if you will recall, we had been on last year who pitched Citadel based on the work that Smith had been doing. And soon after that they had a takeover offer. [00:02:56][12.3]
ALEC RENEHAN: [00:02:57] And I'm going to say it was an equity mates bump. [00:03:00][3.4]
BRYCE LESKE:: [00:03:02] But anyway, we have a Faraz and Phillip here who are going to be pitching technology one, which is a stock that they've been looking at and will get your opinion on it in a second. [00:03:14][12.3]
ALEC RENEHAN: [00:03:15] Yeah. So before we do, Faraz for you're the CEO at Smith. For people who are interested in what you guys are doing, if they're uni students that want to create something similar or if they're uni students at University of Western Australia that want to join you, can you just introduce Smith and maybe your investment philosophy? [00:03:38][23.1]
FARAZ SAWAKI: [00:03:39] The yeah, absolutely. So Steve stands for the Student Maggi Investment Fund that was founded in 2014 with the aim of providing students the ability to experience funds management equity research in a safe and controlled environment with the help of industry sponsors. So the club is split into three teams, have got the marketing team, the investment team and the economics team. So Filimonov from the investment team and what our responsibility is to manage twenty thousand dollars on behalf of our sponsor Viburnum funds. And what we do is we conduct equity research and pitches, which we then simplify and to get feedback on out on the work that we've done and ultimately decide whether or not to invest in the stock. Now, in terms of alcohol, we manage a high conviction fund of 12 stocks. So obviously we're very concentrated in our portfolio. So we need to have a lot of confidence in the businesses that we are in now in order to have a lot of conviction positions. We spend a lot of time doing deep dives on companies to make sure we know the businesses inside of out and each investment. They might spend one or two months looking at a stock before we make a decision. And that's how it looks like we'd like to invest scared to want to make sure we know everything about the companies we invest in. In terms of characteristics, Smith likes to look for high quality businesses at an attractive price that are easy to understand. So a lot of the businesses we do are quite simple. For example, John Interactive, Labasa, we find that those kinds of businesses, the information is quite easy to digest. We also look for businesses that have a sustainable local competitive advantage that allows them to generate a higher return on invested capital to drive earnings growth in the portfolio. We've got a mix of value and growth, but we do care about the price that we pay. We do spend quite a bit of time modeling in particular we do and comps just to say that we miss Price and whether the stock is undervalued. Now, often times these blessings arise from transformations that happened totally within a business or in the case of today, obviously people go into more detail, but they're shifting to more of a sass style operation. So we like to look for that. And on top of that, we like to look for stocks where there are an industry that the entire industry is growing, not just the stock itself, and that provides the stock with structural tailwinds to propel it into the future. [00:06:03][144.4]
BRYCE LESKE:: [00:06:04] Nice. So a pretty good philosophy there and interested to see how it plays out with this pitch. So Philip let's start at the top. We're going to be chatting about technology. One, the ticker is T and A. Can you tell us about technology one and what it does? [00:06:21][17.0]
Phillip Newin: [00:06:23] Yeah, so, yeah, technology one is the ASX listed the global technology company and they offer enterprise resource planning software services across the entire enterprise of their clients. So it is essentially a software system that caters to the core processes which exist in almost every business. So things like human resources, payroll management, accounting and financials, and inventory management. And because of the agnosticism of these backbone processes in that almost all businesses, irrespective of which industry they operate in Atum, what we found is that Teyana operates across a broad range of verticals, so they mainly target local governments and that comprises over a third of their revenues. But they've also got a sizable presence in the education, state and national governments, and health and infrastructure industries. And then in terms of market capitalization, they're at around three point three billion dollars, which is actually quite high for what Smith usually looks at. But given the high quality nature of the business, we we kind of overlooked this a bit. And we found that overall the company had a combination of really attractive defensive qualities. And they've also got some good growth opportunities, which we'll touch on later. But unfortunately, we found the valuations to be a bit too high for our liking right now. So as you said earlier, we we did decide to put it on our fund's watchlist. [00:07:46][83.5]
ALEC RENEHAN: [00:07:47] So just in terms of setting the scene, it's an Australian listed company. What geographies does the business operate in [00:07:55][7.5]
FARAZ SAWAKI: [00:07:55] the majority of its revenues right now? It comes from Australia and New Zealand, but it has been expanding into the United Kingdom. And right now the UK makes up around four percent of its revenues. [00:08:06][11.1]
ALEC RENEHAN: [00:08:08] And is now, Faraz, in your introduction that you mentioned that the business model was changing. So can you just talk us through, I guess, that evolution, what technology one's old business model was and what it has transitioned to? [00:08:25][17.6]
FARAZ SAWAKI: [00:08:28] Yeah, so, yeah, so that was actually one of our main theses points. So yeah, as far as I was saying before, one of management's digitization strategies is actually to divest their company's business away from these outdated legacy operations is what they're called legacy operations, that basically software that it fits the purpose for their clients right now, but it's actually incapable of updating to meet the changing needs and the shifting over to SASO software as a service operations whereby they're developing the software and installing it in-house. And they also give their clients to contractually promised updates each year. And yet we just think that this strategy is really prudent for them because it's mutually beneficial. So for the company, it's a high. Sassy's is a high margin business because they can build a standardized product in-house and install it in-house, which reduces costs to them. And then for their clients as well, such as local councils. We did a lot of research into a case, studies of their local councils, and we found that the current legacy systems just simply don't meet their needs anymore. And they don't want to be spending more money to replace it by having to pay these legacy annual fees every year. So they'd rather just the staff contracts alternative, which gives them these great updates every year free of charge. [00:09:45][77.5]
ALEC RENEHAN: [00:09:46] So let's take a step back. We're really fascinated when we speak to people pitching stocks or to expert investors about the process of researching companies and finding these gems. So, Philip, can you talk us through your research and filtering process, both how you first discovered Tanay and then I guess the due diligence you did on the company before making a recommendation to hold it? [00:10:15][28.8]
Faraz and Phillip: [00:10:17] Yeah. So in terms of looking at these companies, there are many key factors that we look at. So I think Fasel will on them a little bit more that just in terms of technology in itself, we the research process for us was looking at kind of the specific aspects of technology businesses that really made them stand out compared to their competitors. In the case of SAS business, it's things like customer retention rate, their ability to generate recurring revenue. But debt in terms of the entire research process and looking at it, I think Faraz can speak a bit more to that. Yeah. So normally what we do if we use quantitative screens to actually filter through stocks and find these gems, so normally screens would have a number of different metrics, including market cap. We like to look for microcaps and small caps anywhere between 15 and 30 to do all the metrics include things like return on invested capital, whether the company's cash flow, positive or not, and all the metrics that we think can help us. Now, the universe of stocks tell because the philosophy, but in practice, it doesn't always happen. So you might remember Ben saying that he found Silverdale through the equity community. We actually found DNA as a result of the Citadel pitch. So that team that was working on Citadel was looking for competitive companies and one of them was technology born. And what they found was that they met pretty much all of our criteria in terms of having a sustainable long term track record of operations and profitability. And it really fit into and aligned with our philosophy. And although it might have been outside our market cap range, we thought it'd be good to dig deeper a little bit more about startup businesses and have a look at technology. One, and if there was a significant drop in price, we thought we might pick it up and put it in the portfolio. [00:12:06][109.4]
BRYCE LESKE:: [00:12:07] So there's no doubt that the software as a service industry is providing plenty of opportunities for investment and is is is growing at pretty accelerating rates. Where does technology one within its landscape of competitors and what are some of their major competitors? [00:12:23][16.3]
Phillip Newin: [00:12:24] So Technology one actually operates in the Australian market with really large kind of large scale, globally acclaimed competitors. So we're talking about the likes of Sage, Oracle, Infl and Microsoft's. So all of these have their own enterprise resource planning segments of the business. But the thing that we're seeing with technology, one is that especially here in Australia, they're able to sustain their competitive positioning as a result of their security certifications. So our analysis shows that out of those competitors, they have the highest number of security certifications. And we think that this is really important considering the climate that we live in right now, where the shoot to online as a result of carbon 19 is meant has been this probably never been a greater demand for good and secure data management. And yeah, I think the success of their competitive positioning when compared to Oracle and Microsoft is seen in the fact that they actually. And able to take clients away from their competitors, so, for example, in NY 20, they took more than 30 clients from Oracle and Microsoft. And for that, we do think that they are definitely holding themselves well in the industry. And, yeah, it is an industry that, as you said, is primed for growth. And we think that these competitive advantages and the barriers to entry give them a real edge to grow their business. [00:13:53][88.7]
BRYCE LESKE:: [00:13:54] Before we move on, we're just going to take a quick break and hear from our sponsors. [00:13:58][3.8]
ALEC RENEHAN: [00:14:00] So I'm going to assume and please correct me if I'm wrong, but I'm going to assume that SAP is the biggest ERP software company in the world. And I think a lot of people who work in big businesses will be familiar with SAP. And I think I guess software as a general proposition is characterized by longer sales cycles. And, you know, I guess difficulty to take, you know, to transition businesses from one software platform from another just because of all the complexity that comes with that transition. So you mentioned that they're taking customers off Oracle. I assume they're also taking customers off SAP. What are some of the key selling points for technology one's ERP system? You mentioned security, but are there any others that are really driving this, these customers to change? [00:14:53][53.5]
FARAZ SAWAKI: [00:14:54] Yes. So that's the security certification is usually the main one of them, especially considering that they've consistently improved their certifications, for example, with Esau's, an IRA case over the past few years. But we do think that they've also got a strong network effects just as a result of how long they've been operating and the quality of their clients as well. So we're talking about blue chip clients, as well as national and state government agencies and then other public institutions like universities and hospitals as well. So it's that network effect that also drives the competitive positioning, especially considering that, as I was saying before, their revenues are dominated in Australia and New Zealand. And then I guess another thing that you kind of touched on before as well is the high switching costs. So businesses that have partnered with Technology One are more likely to be reluctant to switch over to competitors just because there are so many costs involved with transferring large quantities of data and the vulnerabilities that exist in terms of cyber attacks, in transitioning this data, and also considering that the company enters into longer term contracts with these businesses, they're more likely to stick with technology just because of how much they've already invested in these longer term contracts. [00:16:19][85.3]
ALEC RENEHAN: [00:16:20] Yeah, yeah. That's that cyber security point is is a critical one. You know, Bryce and I aren't working at our corporate jobs anymore, but just the increase in the amount of emails and reminders and all that stuff we got about cyber security. So if you can offer a more secure platform, I can see how that would be incredibly attractive. So we've touched on what the company does, how you found it, the industry. Now, let's get into, I guess, the the positives in the negatives of the company as an investment option. So for Smith, you didn't pitch it as a buy, you pitched it as a hold. So let's start with the positives. What do you like about technology, one as a company and an investment? [00:17:06][45.9]
Phillip Newin: [00:17:07] I think I touched on a little bit of some of those reasons. As I was saying before, the digitization strategy, it's providing them with more recurring revenues. And we like this just because it gives them more earnings visibility and kind of stability over the medium to long run. And we also found that despite them decreasing their reliance on legacy legacy revenue, so it drops from 10 from 18 percent of their revenues in twenty nineteen to just 10 percent of their revenues in twenty twenty, they were still able to grow the overall revenues overall just as a result of the success of this transition to SAS. And then another positive thing that we found was that, as you also mentioned before, this industry is growing and we see it reaching about one hundred twenty three billion dollars over the next two years. But even within that, there are other growth opportunities within the verticals. So we'll start with the government vertical with a as I said before, drive the majority of their revenues. There's now greater demand for secure data and technology once certifications put them in a prime position to capitalize on that. But then in education, we're also expecting certain elements of online learning to persist. Post covid we should help Tourny as its education clients can use their. This awkward plot to carry out these back and administrative tasks such as tracking enrollments and admissions and like what Ben was saying last year with Citadel, we continue to see how as being one of the fastest growing sectors, and that's driven by the proliferation of Atos and the shift to processing patient records and surgical procedures online. And then I guess another key aspect of that that we found attractive about the company was the management. So what we're seeing is actually a high, highly experienced team that's deeply aligned with the company. So insider ownership in the company is quite high at 16 percent, which is high compared to similar stats and technology companies on the ASX. And this shows that management is highly incentivized to grow the business because they've got skin in the game. And it's also good to note that the founder actually still retains a seven percent stake in the business and then of moving on to their remuneration structure. We think that the system that they've got for remuneration is also really good. They track their remuneration based on net profit before tax. And on this basis, we're saying that the remuneration is actually growing really well with the net profit before tax over the past few years. And then we're also seeing that market value is actually growing faster than remuneration, which shows that the structure is serving them well because for every dollar that they spend on remuneration, they're able to actually generate more than one dollar in market value. So, yeah, we've got a really good feeling that this was a management team that really was aligned with the company. And that's always an important consideration to make in any company. And then I guess the last good point that we found, and it's perhaps the most the single most distinguishing factor that separates technology, one as a high quality business is its longevity. So it's been operating for more than 30 years since 1987. And I believe they listed on the ASX in nineteen ninety nine. And over their history, they've operated profitably for the past twenty nine years. And if you actually look at a kind of short term snapshot over the past 11 years, the company's been able to grow its profit year on year without fail at a 12 percent, up from around one hundred and sixty seven million in 2011 to almost three hundred million in twenty twenty. And what's more, they haven't kind of left their shareholders behind any specific growth, which is what we might see in some our companies. So their dividends shares also been growing at around eight percent and the earnings per share has also remained really robust. So it's growing from around 14 cents a share in twenty sixteen to almost 20 cents per share in 2013. And we're just seeing that not only are they able to achieve this profitability, but the earnings, the quality of these earnings are also really good for them. And so we use the cash conversion ratio to track that. And we're seeing that almost all of the net income is being converted into cash flow, which is really attractive for us just because not only does it give them greater liquidity, they're currently operating at a net cash balance, but it also gives them more flexibility to pursue their growth opportunities. It's just an overall, I think, a good company. But yet in terms of the negative qualities, just the main aspect was the price. Right now, we think that the valuations are a bit too high for our liking right now, especially since we are a conviction fund. And as far as I was saying before, we do really care about the price at which we enter into these positions. But yeah, we've added it to our watchlist. [00:22:05][298.6]
BRYCE LESKE:: [00:22:06] You covered it all through it with no room for questions. But I think, yeah, there's no doubt that it's a pretty compelling case given the tailwinds for the industry, you know, its digital transformation. You know, the the the trust, I guess in the platform itself, you've touched on management there and the inside ownership, which is always important thing to look for, as well as the alignment of remuneration and its business model. It sounds like it's a pretty healthy company in terms of its financials, profitability, profitability and also the quality of its earnings. So really, it sounds like it's just coming down to the valuation side of things. Are there any key, I guess, to close it out? It's obvious that it's a hold because in your view, it is too expensive. Are there any sort of key risks or headwinds that it might be facing into over the next 12 months that might lead to it coming back in price a little bit and therefore appearing in your portfolio? [00:23:18][71.9]
Phillip Newin: [00:23:21] Yeah, so I think the main risk that our team discussed and we found was that covid integration risk. So during the height of the pandemic and even now we're seeing a flurry of activity in terms of companies trying to move their operations as much online as possible just to facilitate working from our as well as in-person personnel. And what we found and what this was actually what management admitted themselves was that there's a high risk that because of that, this flurry of activity, companies are going to struggle to integrate all the suspicions of all of this software that they've been using. And so if they're able if they're struggling to find kind of a synergy to help them integrate their software platforms, then this could have a material impact on the company. One technology, one's ability to service the client's needs, as well as also their ability to extend their contracts, as well as to find new clients. And then, I guess, a smaller, smaller office that we had, considering that their presence in the United Kingdom is quite small right now. Is the vaccination brisk and also to a certain extent here in Australia as well? We both countries are quite aggressively expanding the vaccination campaigns. But I think right now this general consensus is it's quite positive, especially in the United Kingdom. But there is a risk that if they are unable to fully roll out their vaccination campaign or if lockdowns and restrictions are is too early, there is certainly a risk that they would face material downside in their financials. And then I guess the final risk that we have is concentration. So in the annual report, they do say that no client makes up more than 10 percent of their revenues, I believe, or something along those lines. But we would like to see a bit more disclosure around that client concentration numbers. And then just in terms of the revenue, make up the government. So local government plus national government combined makes up more than 50 percent of their revenue. So kind of a material shift in the industry, in the government industry could potentially be bad news for them. But, yeah, just kind of the three main risks that we found nice. [00:25:51][150.5]
BRYCE LESKE:: [00:25:52] Well, if you guys have it as a hold, we will put it on the community watch list and keep track of it. And, you know, you guys have put forward a pretty compelling and detailed case. And I think you've given a pretty good insight into how you go about your investment process and develop a thesis. So I would also encourage everyone listening to just remember that this is part of the student-managed investment fund at the University of Western Australia. So they do put a lot of time and effort in to make these investment thesis and cases. If you would like to come on the show to pitch your thesis for a company on the community watch list, then please do reach out to our website or hit us up on Sociales. But don't feel put off that you need to present one in such detail. [00:26:42][49.9]
ALEC RENEHAN: [00:26:43] I was looking through that before and I'm confident that I've never put a deck together like that. So it's impressive what you guys are doing. And I think it's it's a really cool thing that you have the opportunity to do. I mean, I think about our time at uni and I would have loved to have done something like this, so. Yeah, well done. But for other people listening, don't don't be put off because of the work that these guys have done. [00:27:07][23.6]
BRYCE LESKE:: [00:27:07] Yeah. If you would like to have a look at their deck, reach out to us and we'll touch base with the boys and see if there's room to share some of their info. But otherwise, Philip and Faraz for us. It was great to have you on very much. Appreciate your time. You did. You did a great job. And we look forward to getting the Smith team back at the end of next semester [00:27:30][23.2]
Faraz and Phillip: [00:27:33] Thank you, guys. [00:27:34][0.3]
BRYCE LESKE:: [00:27:35] Nice one. Well, that brings us to the end of today's episode. Always good to chat stocks, Ren and we'll pick it up next week. [00:27:41][5.6]
ALEC RENEHAN: [00:27:41] Sounds good. [00:27:41][0.3]
Speaker 4: [00:27:43] Equity Means Investing Podcast is a product of equity meets media, all information in this podcast is for education and entertainment purposes only. [00:27:50][7.3]
ALEC RENEHAN: [00:28:43] Bryce, with three policies here at equity markets, what's number one we face we hate fees and we love brands that are finding ways to reduce fees for everyday customers. And that's why we're here today to talk about the pay. Who in twenty 20 saved Australian customers? One hundred and ten million dollars in consumer fees and interests by using after pay rather than traditional credit cards? [00:29:08][25.3]
Speaker 1: [00:29:09] That is right, Ren. It's been a great investment for me. And after pay is changing the way we pay for the better by helping us all manage our money and to take back control, [00:29:18][8.8]
ALEC RENEHAN: [00:29:18] you just had to slip the investment thing in. [00:29:20][2.1]
Speaker 1: [00:29:22] Everyone knows I love afterpay. [00:29:23][1.0]
ALEC RENEHAN: [00:29:24] Yeah, well, look, you may not be able to live off to pay as much as price, but you may love to pay because you can use it online or in-store. And it's really easy to get started. Just head to afterpay.com to sign up or download the app to pay up from your app store or pay them to choose off to pay [00:29:43][19.3]
Speaker 1: [00:29:43] late fees, transaction limits, and eligibility criteria. Apply visit afterpay.com for more details. [00:29:43][0.0]