TNE - the largest enterprise resource planning (ERP) software as a service (SaaS) company in Australia –provides integrated solutions to more than 1,300 leading corporations, universities and local government agencies across Australia, New Zealand and the UK. The company has successfully transitioned from its traditional consulting business (7% of revenue currently) to annual recurring revenue (ARR) over the years, which has improved revenue growth and customer retention. Founded in 1987 and headquartered in Brisbane, Australia, it has been profitable since 1992. TNE is strongly committed to research and development (R&D) to enhance and upgrade its products, ensuring it remains ahead of competition. This has culminated in a strong and loyal customer base, with an above 99% customer retention rate.

Likelihood of sustained technology edge given healthy R&D spending and high-quality SaaS products

The SaaS industry has found increasing favour among corporations given the flexibility, scalability and cost efficiency of its solutions. Besides, the COVID-19 pandemic has hastened the migration of workflow online or to the cloud to remain relevant and competitive, benefiting companies such as TNE.

TNE makes significant R&D investments (21-26% of annual sales) to maintain its technological superiority over competitors and expects R&D investments to remain at 20-25% of sales. The company has 19 products (compared to 11 in 2008) with around 500+ licensable modules. R&D investments in platforms, including SaaS+, App Builder and Digital Experience Platform, are an integral part of the company's long-term strategy. Thanks to its extensive SaaS product portfolio, the company has received a steady stream of orders in recent years. Recent new customers include city councils in Australia and New Zealand as well as established UK educational institutions. This is due to its scalable and unique customization solutions for customers looking for efficiencies and ways to expand their digital and cloud presence. More than 1,300 customers use the company’s software products and services, with the average ARR per customer in FY24 (ending September 2024) at AUD400K, compared to less than AUD200K in FY19.

Possibility of improvement in medium-term profitability on solid ARR and net retention rate

TNE has performed strongly since the pandemic eased – revenue increased to A$507mn in FY24 from A$285mn in FY19, EBIT margin expanded 265 basis point (bps)` to 29% and FCF reached AUD87.9mn from A$1.8mn. In FY24, the company reported the 8th consecutive year of record full year revenue, profit and SaaS fees. It also saw ARR growth of 20% YoY to A$470mn driven by SaaS revenue growth from new and existing customers. Net retention rate (NRR) stood at 117%, above its 115% target, and was the best-in-class (considered between 115% and 120%) in the ERP market. This was due mainly to existing clients’ purchase of additional SaaS products and modules.

TNE generated 90.5% revenue from SaaS and recurring fees in FY24, while the traditional and legacy business contributed approximately 7.5% and other revenue constituted 2.0%. By region, APAC makes up around 83.4% of group revenue, followed by New Zealand 9.2% and the UK around 7.4%.

TNE upgraded its 1HFY25 ARR guidance, management now expects ARR to be over AUD500mn (from earlier over AUD500mn in FY25), driven by strong FY25 sales pipeline. Additionally, the company provided a new long-term ARR target of over AUD1bn by FY30. The company expects global SaaS ERP solution and SaaS+ offering continue to drive future success.

Favorable dividend policy and good shareholders returns over past few years

TNE has a strong balance sheet, with cash and investment holdings at AUD279mn and zero debt at end-FY24, which we believe would provide significant financial flexibility to reward shareholders and fund future expansion plans. TNE consistently paid dividends since 1996, which has advanced at a CAGR of 15% since FY20. The company has revised its dividend policy from 8-10% annual increase to a payout ratio of 60-65%. In FY24, it paid dividend of AUD22.45 cents per share, up 15% YoY, with a payout ratio of 62%. Investors can expect the dividend trend to continue in the future given positive forecasts and the company’s strong fundamentals. Encouragingly, the company’s return on equity has exceeded 34% over the last five years and it has also more than tripled investor wealth, with share price up 260% over the same period.

In Conclusion, TNE has successfully transitioned from the traditional and licence software model to a SaaS model, evident in strong ARR and NRR. The company aims to improve profitability (operating margin) in the medium term. Additionally, a strong balance sheet with no debt provides TNE ample room to execute bolt-on mergers and acquisitions and expand in other regions, which could bolster the share price. TNE recently acquired CourseLoop Pty Ltd, which enhanced its education platform, adding curriculum management to its offerings. However, key risks to the company include significant competition in this space, technology disruptions, integration risk surrounding future acquisitions, regulatory challenges, and cybersecurity concerns. Additionally, valuation of the company looks expensive both on P/E and EV/EBIT basis, currently it is trading at P/E of 72x and EV/EBITDA of 38x as compared to its 10-year historical of 43x and 26x, respectively. Most of the 17 analysts covering the stock have “Hold” rating with average target price of AUD27.45. The recent surge in prices (up 98% YTD) means the target has been crossed, providing no room for upside. Any correction in the near-term should provide an opportunity to investors to revisit the stock.