This is the third article in a three-part series featuring high quality ASX listed software businesses. In parts one and two, I wrote about Objective Corporation Limited (ASX: OCL) and Integrated Research Limited (ASX: IRI), two companies with bright prospects that are punching above their weight thanks to market-leading products.
GBST Holdings Limited (ASX: GBT) is a third such company. Founded in 1984, the company develops software to serve the financial services industry and has two key products. GBST Syn~ is used to process equities, derivatives and fixed income products on the capital markets and GBST Composer is administration software for the wealth management industry.
In 2015, international revenue surpassed domestic revenue for the first time, representing 55% of total turnover. This was due to strong uptake of GBST Composer in Europe, although the result was also assisted by favourable currency movements.
The downside to sticky customers
Whilst "mission critical" software providers like GBST generally benefit from a sticky customer base, this can make it difficult for them to win market share even when they have the best product. Often a fundamental shift in the industry is required to stimulate demand. For example, in the case of accounting software the switch to cloud computing has provided XERO FPO NZ (ASX: XRO) with a golden opportunity.
Somewhat counter intuitively, for GBST this catalyst takes the form of regulatory change in the financial industry. For example, a recent upheaval in the UK pension sector forced many providers to replace their software platforms, opening the door for GBST Composer. Sales of GBST Composer into Europe are now the group's main growth division and contributed $50.1 million of $114.3 million of total revenue in 2015.
GBST is hoping it can pull off something similar with GBST Syn~ in the US, which has the largest capital markets industry in the world. Many US participants use out of date software and there are signs that tighter regulations might be on the way. These include the proposed switch to T+2 settlement, requiring settlement of financial transactions within two days.
Financials & valuation
GBST posted a disappointing set of numbers for the first half of the year. Revenue rose 2% to $56.7 million but earnings before interest, tax, depreciation and amortisation (EBITDA) fell 51% to $6 million.
These results include $2.5 million of one-off costs related to a restructure after the company changed both its CEO and chairman in the last year. Profits were further suppressed by higher operating costs in anticipation of future overseas sales growth.
Management has guided a return to growth with operating EBITDA projected to be $12 million to $14 million in the second half of the year. If this can be maintained, I estimate that GBST can deliver adjusted net profit after tax (NPAT) of at least $16.1 million in 2017. Adjusted NPAT excludes around $4 million of annual amortisation charges related to past acquisitions.
It could be argued that recent management changes add to the risk of GBST failing to achieve this result. However, recently appointed CEO, Robert De Dominicis, is well credentialed having formerly led the wealth management business where revenues grew from $22.8 million in 2010 to $69.1 million in 2015. Furthermore, GBST has a solid track record, having grown cash earnings-per-share (EPS) by 90% over the past five years.
In a show of confidence, for the first half of 2016 the board elected to maintain the 5.5 cent dividend from the second half of 2015. Assuming the same for the second half of 2016, GBST currently offers a 2.6% dividend yield.
With $4.5 million in cash and no debt as at 31 December 2015, GBST has an enterprise value of $278 million. Based on my 2017 financial year forecast, the stock trades on a reasonable enterprise value-to-earnings multiple (EV/E) of 17.
