Up 700% in 5 years: Where to next for Integrated Research Limited?

Australian tech-wreck survivor, Integrated Research Limited (ASX: IRI), has taken on the world in IP telephony services and returned investors more than 700% over the last five years.

The company’s enterprise software has infiltrated over 1,000 businesses globally, and its resume of customers reads like a ‘who’s who’ of international commerce: a quarter of Fortune 500 companies, 4 of the world’s 10 largest companies, 9 of the top 10 US banks, 7 of the 10 biggest telcos, 4 out of 10 biggest oil and gas companies, and 6 of the 10 biggest stock exchanges.

With a market cap sitting a touch under $350 million, Integrated Research lives outside the ASX300, and under the radar of many investors. But what, exactly, does this little-known Aussie do?

Integrated Research is the leading global provider of performance monitoring and diagnostics software for business-critical computing and VoIP (voice over internet protocol) networks. Its flagship product PROGNOSIS is an integrated suite of applications that monitors and manages distributed IT infrastructure, payments systems, unified communications, and Web applications. Put more simplistically, a health monitor for business technology systems.

Communication and payments are two cornerstones of everyday life that keep rapidly evolving. Integrated Research remains brilliantly positioned to profit handsomely from both the migration to Internet Protocol Telephony networks — IPT or VoIP as it is commonly called — and the massive long-term growth in real-time payment processing.

Integrated has had a seat at the IP telephony table since the technology’s infancy in 2000. It began by monitoring Cisco’s IP systems but now supports other key VoIP providers such as Avaya, Nortel and Microsoft’s Lync and Skype.

Sales are supported by a large installed base of major customers, a strong partnership network, and a three-fold revenue model: customers pay upfront license fees to use the software (just over half of revenue), plus they pay annual maintenance fees, (typically around 20% of the license fee), for the lifetime of the customer relationship (one-third of revenue), and consulting services make up the balance.

Boring, boring software

Enterprise software slips into the ‘too boring’ basket for many investors, but Integrated’s thick 40% gross margins and 20% net profit margins are attention-grabbing. And the appeal doesn’t stop there.

Maintenance retention rates into the mid-90% range means the average life of those customers is nudging 20-plus years, so it’s easy to know where the next meal is coming from. During difficult economic times, this recurring revenue provides a safety cushion: businesses may delay a new purchase, but they’re less likely to cut maintenance expenditures.

There’s more that’ll really get your CPU racing.

The 39% return on equity is high enough to give you a nose bleed, and zero-debt balance sheet strong enough to keep you there. In fact, the company was sitting on over $15 million cash when it last reported.

And with a global A-list of customers, it should come as little surprise that 95% of revenue is earned offshore, providing easy international diversification for Australian-dominated portfolios.

The company has been on a growth tear in recent years. Last year revenue increased 32%, while profit soared 68% — thanks in part to a falling Australian dollar — but driven by the underlying strength of the business. But there may be some trouble afoot.

A recent stumble

The company’s recent half year guidance pointed to a slowing of growth, with revenue set to gain a modest 17% and net profit to disappointingly slide by a similar proportion.

Full details won’t be revealed until the company reports, but determining whether the first half of 2016 is a permanent change, or just a bump in the road, could be very rewarding.

It’s unlikely the growth will stop here. The company is sensibly reinvesting around a fifth of revenue into research and development — the pipeline for future growth. Add to that the July 2015 acquisition of US-based IQ Services, which provides a platform for next generation testing capabilities and extends the existing product line.

Shares have nosedived 25% since reaching a high of $2.80 at the three-quarter mark last year, to less than $2.00 in early 2016. Things could get particularly choppy when the company reveals the full details on 18 February.

Foolish takeaway

Combining a strong reputation and loyal customers, several of whom are among the world’s largest, with forward-thinking new solutions, is a proven model for increasing profits and margins.

Integrated Research stands to continue profiting from the VoIP tidal wave and surging real time transactions. Its high customer retention delivers solid recurring revenue, with strong and improving margins.

The company’s 3.6% partly-franked dividend yield is well supported by a rock solid balance sheet, though the mid-20s price to earnings multiple may look high to some market participants in light of recent disappointing growth guidance.

If things get rough, that may provide added opportunity for level-headed long-term investors.

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Motley Fool contributor Donny Buchanan has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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