GBST Holdings Limited (ASX: GBT) develops and sells wealth management and capital markets software to the global finance industry. Among other things, the software helps GBST's clients with regulatory compliance, risk management and reporting.
What you pay
At current prices of around $5.30, the market capitalisation of GBST is about $360 million.
What you get
I expect free cash flows this year to come in at around $20 million. Having recently paid off all debt, the enterprise value to free cash flow ratio is roughly 18.
However, what really counts is what free cash flows will look like in ten years' time. Is GBST the kind of business that can produce ever-increasing profits?
Environment
There are various worldwide trends occurring in the financial industry that should benefit GBST.
- Ever changing and increasingly stringent regulation
- More financial products that are growing in complexity
- Demand for improved visibility and service for retail investors
- Globalisation of financial products
Furthermore, it is not easy for new competitors to enter GBST's market because it has spent decades developing its software that is tailored to the needs of customers. It would therefore take a long time for a new entrant to build similar quality products and customer relationships.
Business Model
GBST receives an up-front service fee for system implementation and then recurring license fees for maintenance and upgrades. In this way, service revenues act as a lead indicator for future license fees.
It is expensive and time consuming for companies to replace the kind of software that GBST provides since it is deeply ingrained in their workflows. Therefore, once acquired, customers are unlikely to leave.
Like most software companies, GBST is not a capital intensive business and so thanks to its recurring revenue model, it generates lots of free cash flow. This means that the company can afford to pay a high proportion of its profits as dividends whilst simultaneously growing the business.
Management
GBST is consistently the first to market with product upgrades after regulatory changes, and this is an indication of effective management.
For example, the company has quickly become a market leader in the UK wealth management industry since the Retail Distribution Review was implemented there in 2012.
Similarly, it speedily incorporated the EU's new Financial Transaction Tax into its capital markets software last year.
The main reason that GBST is able to respond more quickly than the competition is that management is committed to research and development. It reinvests 10% of revenues in this way and just opened a dedicated development centre in Vietnam.
The company wins many industry awards for its technology and this is further evidence that the strategy of heavily investing in research and development works.
Outlook
GBST paid off the remainder of its debt last half, and this may lead to management increasing dividends in the near term.
Looking further ahead, the international business offers huge growth prospects. GBST is already growing strongly in the UK wealth management industry, but its entry into America last year along with recent successes in Asia, present a massive opportunity. There is no reason that its award winning wealth management and capital markets products cannot continue to win market share overseas for years to come.
Currently margins in the overseas division are much lower than those in Australia, but this will change if the company achieves sufficient scale abroad, providing a further potential boost to profits.
Foolish takeaway
GBST is a company with world class products, exposed to favourable industry trends and run by able management. Furthermore, it is a scalable, highly cash generative business with plenty of room to grow off its small base. In my view, 18 times free cash flows is a reasonable price for such a business.
