This Danish software developer provides portfolio management systems to asset managers and owners and possesses several virtues that we appreciate as investors. The industry is evolving in a stable and predictable manner, the cash flows are high, the return on invested capital is impressive, and, on top of this, there is huge unexploited potential that is pursued by the highly competent management team day in and day out.
With a market share of 15 percent, SimCorp is a global market leader in the development and selling of portfolio management software. The systems allow asset managers and asset owners to constantly monitor their portfolios, whether for the purpose of portfolio management decision, risk analysis, reporting and so forth. These insights, and the continual updates to the software, are meant to make it easier to work with portfolio management, both in terms of making the right investments as well as reporting to clients.
Portfolio management software is a niche market with long and profitable customer relationships that creates a stable and predictable development in the free cash flows. Winning new customers can be a long-term endeavour as the decision-making processes among the potential clients can take a long time. Thus, gaining market share takes place incrementally and with great effort – yet, this stickiness adds to the stability of to the industry, and thus the attractiveness of the business model.
SimCorp has a development department with almost 600 software developers headed by Georg Hetrodt, who continually develops, fine tunes, and improves the flagship product, SimCorp Dimension, and the smaller presentation module, Coric, which makes it easier to prepare presentations for things such as internal meetings, investor meetings, or sales meetings. SimCorp employs a total of 1,650 people.
Generally speaking, SimCorp Dimension can handle all the tasks that an asset manager or owner may need. Almost no customers start out buying the full range of modules for the system, however. Instead, they buy certain parts of the system, and as time goes by, SimCorp tries to sell additional modules or user licences for the customer’s business with SimCorp to keep growing.
If competitor products are used in parts of the client’s work, this may lead to communication issues with the modules from SimCorp’s system. The highly competitive SimCorp Dimension product has been developed for many years and in collaboration with customers – thus, SimCorp can use as a selling point the argument that data processing will be more stable and correct, if the customer uses SimCorp products for a larger proportion of their systems.
10 new contracts are a satisfactory year
As mentioned, the market for portfolio management systems is a small niche market, where SimCorp has an estimated market of addressable clients of approximately 1,300, of which SimCorp is currently the supplier to 190 of them. The management has for a long time assessed that the potential long-term run-rate of annual tender processes is around 40-50 per year. Since the financial crisis, however, this figure has been overstating the potential, and for the last three years there has been less than 20 new contracts on the market per year.
SimCorp has won over half of these, and in 2016, 2017, and 2018 it added, respectively, 12, 8, and 10 new customers to SimCorp Dimension. The size of the contracts has been increasing, so even if the number of clients has not grown, the order flow has increased. We are glad to see that half of the new customers in 2018 were on the important American market, where SimCorp’s market share is less than it is globally, but the number of potential customers the highest.
SimCorp’s greatest challenge is assessed as being that the potential customers choose not to buy a new portfolio management system but instead keep using their legacy software. A large proportion of the potential market is still believed to be using in-house developed legacy systems, and this can lead to complications as new regulations impose new demands on the large asset managers. The number of suppliers of portfolio management systems has been decreasing due to a consolidation among SimCorp’s competitors. We view this consolidation as a positive factor as it should benefit the overall size of the profit pool, and we see SimCorp as being in a strong position with an attractive product range and a large development budget.
The sales processes are lengthy, often taking more than a year, which is partly due to the fact that buying a new portfolio management system is a large investment. Not only in terms of the paid price, but it further requires organisational resources to implement, and then workflows, processes, and other things also need to be thoroughly examined before a decision is made. Over the last few years, the trend has been for the sales processes to lengthen.
A subscription model has unsettled the stock market
Back in 2016, the management of SimCorp decided to change how the contracts were designed when selling the SimCorp Dimension product. Previously, buying the products involved significant upfront payments when the contract was signed, but today, these have been replaced by subscription-based payment models. In other words, SimCorp receives less money when the deal is signed as the payments are distributed over the contract period. The contract period was expected to average around five years, but the majority of contracts have turned out to be for seven- or eight-year periods. From SimCorp’s perspective, one of the advantages of this subscription-based model would be that the lower annual payments would not necessarily have to be approved by the top levels of management among its clients – at least, it would happen less frequently than with the single large up-front payment model with the previous perpetual licenses.
Transitioning to this new kind of contract has created unnecessary noise around the company’s financial statements, and varying contract lengths have made it harder to read and assess the financial figures and the orders that are signed on an ongoing basis. However, it has also resulted in an unnecessary degree of uncertainty and volatility in the stock market’s perception of SimCorp’s long-term intrinsic value. That being said, the impact on the company’s cash conversion has been more significant than both we and the management expected when this transition began.
In addition to this, several other changes to the accounting rules have made it harder to compare newer figures with those from prior years. However, this does not have any impact on the company’s free cash flow, which is ultimately what constitutes the long-term value in SimCorp, and which creates the foundation for the assessment of the potential return of investing in SimCorp.
The stability of SimCorp is based on not only initial or additional licenses that generate earnings and cash flows – around 85 percent of the annual revenue is from clients who were also clients at the start of the year. On top of this, SimCorp receives ongoing payments from the number of user licenses on the system, which is a very stable and profitable source of income. If more modules or functions need to be added, SimCorp can sub-contract consultants to clients to perform this work. The development in the sale of additional licences was disappointing in 2018, as there was an organic decrease of 10 percent compared to a growth rate of 35 percent in 2017. In total, the received order flow of SimCorp lived fully up to our expectations.
The orders amounted to more than 100 million euro in 2018, which was the first time that the orders reached the nine-figure milestone. This was a growth rate of 23 percent compared to 2017, and it will help support the revenue growth in 2019. The organic revenue growth was just under 10 percent in 2018 and hence within the management’s target for the year – and in allignment with the long-term objective of double-digit growth in revenue and increasing operating margins. The operating margin was 27 percent in 2018, and as mentioned, we expect this to increase over time. We see no reason why SimCorp should not be able to have margins of more than 30 percent as seen with other market-leading software suppliers. The return on invested capital is more than 100 percent, which clearly demonstrates the software developer’s ability to create value.
Sales in the United States are picking up
In late 2016, SimCorp won its at-the-time largest new customer, the Italian insurance giant, Generali. Since then, a large number of consultants have been working to implement SimCorp Dimension at Generali in 2017 and 2018. The growth in consultancy services was slightly less in the last year but still at around seven percent. SimCorp is seeing more demand for its consultancy services in the places where the customers have outsourced the management of parts or all the SimCorp Dimension operations. The earnings for this part of SimCorp are not at the same high attractive levels as for selling new licences where the incremental earnings are close to the incremental revenue, but the consultancy activities are still a good source of earnings.
While SimCorp holds significant market shares in Scandinavia and Northern Europe, their share of the North American market is only six percent. Fortunately, five of the ten contracts signed in 2018 were with American clients, and slightly more than half of the new customers gained in the last three years were American as well. Through historically sizeable and continuous investments in software development, SimCorp has created a strong product range, and this is expected to be a crucial factor in the battle for a higher market share in North America, supported by a growing understanding of the market, more references and a strengthened sales organisation.
James Corrigan is the country manager in the United States, and he has added new energy into the business since he assumed his role in 2014. In 2018, the American market grew by an impressive 38 percent – and all without having to hire new people. This high revenue growth is a reflection of the significant client growth that SimCorp has seen in the last few years, as half of the company’s 31 North American clients have been gained since 2016.
Emmanuel Colson remains the head of SimCorp’s efforts to gain ground on the French market as he has done since 2013. Over the past few years, both Corrigan and Colson have delivered strong results, including a licence agreement with the insurance giant AXA’s asset management unit. We expect that they will continue to achieve positive results for the company. SimCorp has not previously had a presence on the Italian nor Spanish markets, but nevertheless managed to win orders with leading asset managers on both these markets in 2016. Italy’s largest insurance company, Generali, signed the largest order in SimCorp’s history just before Christmas 2016. The management’s clear strategy is to strive for contracts with a top-three player in a market that SimCorp is trying to break into. SimCorp’s market share in Southern Europe is only currently at seven percent, however.
As part of its increased focus on the Italian market, SimCorp acquired the Italian company APL Italiana in 2017 for 35 million euro, financed through a combination of equity and cash. It is a good thing when our companies are able to use their capital to expand their business through value-creating investments. Our assessment is that the acquisition of APL Italiana was made at a very attractive valuation of less than 7.5 times the Italian company’s annual operating income. APL Italiana, which had not actually been for sale, provides SimCorp a strong platform in Southern Europe.
In 2018, SimCorp opened an office in Japan, which will take advantage of the experiences that SimCorp’s employees in Singapore has from previous roles. Japan is estimated as being a very significant and long-term opportunity, but it will take time before this market has a noticeable influence on the value creation in SimCorp.
Impressive work has been done by the chairman
SimCorp has no debt, and in fact, it has cash holdings of 48 million euro. The recurring free cash flows are generally distributed to the shareholders in the form of both dividends and share buybacks. We appreciate that SimCorp will be repurchasing shares again in 2019, and it is our assessment that there should be an opportunity for this year’s buybacks to exceed the initially reported amount of 25 million euro, or 1 percent of the market value. In addition, SimCorp pays a dividend of 6.75 Danish kroner per share, equivalent to a direct yield of around 1 percent.
Klaus Holse Andersen has been the CEO of SimCorp since 2012, and he came with a solid background in sales from major successful American IT
organisations such as Microsoft and Oracle. It is our perception that he has contributed with a strong, results-oriented approach and a long-term focus. In 2018, he was joined by Michael Rosenvold, who became the new CFO. Prior to SimCorp, Rosenvold worked at the successful project management consultancy, Rambøll.
The chairman of the board, Jesper Brandgaard, will step down after 2018, following 11 years as chairman and 12 years on the board. When Jesper Brandgaard became chairman in 2008, SimCorp’s revenue was 175 million euro and the operating income was 38 million euro. At the end of 2018, the revenue was at 383 million euro and the operating income was 103 million euro. The revenue has thus been growing by more than 8 percent per year, and the earnings have grown by more than 10 percent despite a financial crisis during his term as chairman. We are sorry that the conventional wisdom on “good” corporate governance does not allow Jesper Brandgaard to continue as independent chairman.
However, we have great faith in Peter Schütze, who was previously the CEO of Unibank and Nordea Danmark, to contribute with deep insights and a strong professional background in his role as the new chairman, and we also believe that he will maintain the strategy that he has helped form during his six years as vice chairman. Our assessment is that SimCorp’s board is able to contribute with strategic insight regarding the company’s long-term value creation, which Holse and Rosenvold will work together to achieve through the company’s day-to-day operations.
The market-leading SimCorp Dimension is built on major investments in development. The company invests approximately 17 percent of its revenue in development, equivalent to around 520 million Danish kroner, increasing the absolute investment by about 7 percent annually for the past five years.
If, as we expect, the company meets its growth targets, these investments should make up a decreasing percentage of sales going forward. Increasing regulatory requirements for asset managers and asset owners and the subsequent increase in complexity should be a beneficial factor when it comes to opportunities for gaining new customers who are abandoning their legacy software. The legacy software is, in many cases, solutions that have been built in-house, and they might make it difficult to properly report to the authorities or customers due to missing functions, lack of documented processes etc.
While regulation and documentation requirements relating to business procedures in certain industries and companies are seen as an impediment for investment managers, who will require more resources for their operations, this helps drive growth opportunities for SimCorp. Over time, this should lead to significant increases in free cash flows and thus benefit us as co-owners through increased shareholder distributions. The future looks bright.