Reckon loses a major contract, but may still be a buy

The business accounting software field is becoming crowded.

a woman

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Imagine you've held 30%-40% of the available market for years and have kept a reasonable relationship with the licensor of your products – and then quite suddenly, the licence is withdrawn.

This is basically what happened to Reckon (ASX: RKN), an accounting and financial software seller, when its licensor — software giant Intuit — announced it was severing the relationship from 2014. And furthermore, it intended to go into direct competition!

Once the sleepy hollow of the global software industry, accounting-related software has become a hotbed of rumour and sensation recently, like phenomenon  Xero (ASX: XRO), the only ASX-listed rival to Reckon. Although yet to turn a profit, Xero is capitalised at a massive $1.97 billion and has continued to 'buy' users like there's no tomorrow. Whether Xero's strategy of getting the users first and harvesting returns later eventually works is yet to be seen, but the current share price certainly assumes massive success.

So what is Reckon doing about all this? Well, the Intuit-owned names QuickBooks and Quicken have been changed to ReckonAccounts without any perceptible damage to sales at this early stage, and more pro-active moves are currently underway.

There has been a soft launch of Reckon One, a direct counter to Xero and the yet-to-appear range from Intuit. Both Intuit and Xero are focused on the micro-business (less than five employees) end of the market and Reckon One looks to be competitive in this field – micro businesses comprise around 50% of Australia's small business sector.

Reckon is actively working to rapidly shift the sales mix toward subscription services and online. Although lower margin, subscription services tend to generate significantly higher repeat business and client loyalty. It is also doing further fine-tuning of the professional service segment (accountants, financial planners, etc.), including an expansion of subscription services and private cloud.

The company also continues to expand the Virtual Cabinet (document manager) and Virtual Portal (online business collaboration) products. Both of these are currently UK-based.

Finally, it has acquired SynDirect, which is a product capable of transferring data from a multitude of accounting systems, and Xcede Professional Accounting module, a report writer for professional accountants. Both of these products can be deployed in the cloud.

Judged by standard financial metrics, Reckon is in a healthy position – net debt of 19%, reasonable cash flow (allowing for some development expenditure not being expensed), first half net profit up 10%  and earnings per share up 11% (due to ongoing share buyback). Given the relative depth of the product and service range, it isn't hard to come to a basic valuation of $2.60 for this stock (currently trading at $2.18).

Foolish takeaway

You can't put a patent on the calculations involved in financial accounting and so products are likely to be judged more on ease of access, familiarity and, of course, price. Reckon already has the advantage of being a long established provider and its current client base is reasonably secure as people generally stick to what they're used to.

However, definite risks with software companies include the need to spend approximately 15% of revenues on product development, margin pressure if competitors move into the same space and a likely increase in marketing costs. Although Reckon is currently attractive, I would prefer to see a price below $1.80 before any consideration.

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Motley Fool contributor Peter Andersen doesn't own shares in companies mentioned in this article

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