Investing in software services companies can be difficult because you have to really know what a business is doing and how it plans to expand within a highly competitive industry. Among successful companies are those that link up with major businesses or government organisations, embedding their service and products into the daily routine and functioning of the client.
Those connections can become long-term relationships and repeated contract awards, because clients can't afford to change many times without disrupting their own business.
Investors might be familiar with names like Computershare (ASX: CPU) or IRESS (ASX: IRE), but what do some of the smaller software service providers have to offer?
One is GBST (ASX: GBT), which provides financial securities transactions and fund administration software services.
It operates internationally with about 39% of total revenue generated overseas in Europe, the U.S and Middle East. Its wealth management platform, GBST Composer, increased sales in 2013 by 30% in the UK, and is now the top provider of direct-to-consumer technology for distribution of tax incentivised products there.
Its GBST Syn financial market back-office securities system is being rolled out in the U.S with its first sale, adding to the global agreement it has with HSBC, one of the world's largest banks, for middle-office services.
Over the past three years, NPAT before abnormals has risen from $3.1 million to $5.9 million, getting back to earnings levels it had back in 2005-2006. Its shares were heavily sold-off during the GFC, staying in a low range until last November when the progress of its business and future earnings became more apparent.
In the past 12 months, the share price has risen from about $1 to $2.93. Due to its connection with financial markets and wealth management, the company has stronger prospects for further growth, as the world economy improves and economic regions recover from the GFC.
Domestically, it will also benefit from the growing SMSF industry that now makes up about one-third of all superannuation funds. In November it was announced that GBST together with Super IP, owner of SMSF software Class Super, have made Class Super the first "SuperStream Ready" software provider in Australia.
SuperStream is one of the reforms made by the government to the superannuation industry. The Class Super software service will be ready for a key May deadline for Trustee sign-up and 1 July super contributions processing.
Another plus will be a weaker Aussie dollar, helping add to overseas earnings once converted back from foreign currency. International revenue increased by 14% in 2013.
Foolish takeaway
Having the capacity to tap into world financial markets while growing domestically allows for stronger income streams with diversification. We did see how a severe bear market can affect business and earnings, as it did many other financial services companies, so investors must keep this in mind when considering short and mid-term earnings expectations.
In following the company's story, note the major contracts it wins and how it can become an integral part of a bank or fund manager's business. Changes in government legislation can also require system upgrades. So those contracts can also be very rewarding.
