Iress Ltd (ASX: IRE) develops and sells software to financial institutions. It has two main divisions focusing on financial markets and wealth management solutions. A smaller third division, provides software for mortgage lenders in the UK to help them streamline their workflows.
Positives
Dominant market position
Iress enjoys an enviable position in the Australian financial markets software sector as its products are used by most of the financial community. It would therefore be difficult for a competitor to challenge Iress in this area. This business makes up 33% of the company's total revenues but is no longer growing.
Exposure to a growing industry
The wealth management industry in Australia is expected to grow strongly due to the surge in superannuation assets over coming decades. Furthermore, Iress should also benefit from the global trend towards greater regulation in this area. Revenues in the Australian segment of this division grew by 13% in 2014 reflecting these factors.
International diversification
In recent years, Iress has expanded its international operations and now has a presence in Australia, the UK, South Africa, Canada and Singapore. This provides both opportunities for growth and protects the company against weak economic conditions in Australia.
Strong cash flows
As a software company, Iress enjoys sticky recurring revenues and low capital expenditure requirements. Also, its products are highly scalable and so it earns healthy margins and generates strong free cash flows.
Negatives
Acquisition strategy
I am not a fan of growth by acquisition as a business model and over recent years, it looks as though this approach has cost shareholders of Iress. In 2010, the company made a profit of $50.5 million off revenues of $183 million. In 2014, profits were $50.7 million and revenues were $329 million. Revenues increased on the back of two large international acquisitions for a combined cost of $432 million. However during the same period, net debt has increased by over $200 million, earnings per share have fallen by 20% and return on equity has dropped by more than half. It is hard to see the benefits of spending all that money.
Price
Despite recent corporate activity, IRESS remains a strong company and based on estimated current cash flows of around $75 million, I think it is worth between $5.50 and $7.50 per share. Therefore, I'd be happy to buy under $5.50, but I don't expect to get such an opportunity any time soon.
A better alternative?
GBST Holdings Limited (ASX: GBT) is in many ways the little brother of Iress, operating in a similar area but one third of the size. Unlike Iress, the company has improved its balance sheet over recent years and is now debt free. It has also been growing its international business organically, with particular success in the UK where it has capitalised on the rapid growth of Self-Invested Personal Pensions (SIPPs).
At current prices, I am not a buyer of GBST either, but am comfortable holding for the time being. Based on estimated current free cash flows of $20 million, I would think about buying more of the stock at under $5 per share.
