Description

Background

Computer Modelling Group (CMG) is a Canadian software company currently focused on the oil & gas sector, specifically reservoir simulation and modelling.  The company orignated as a research organization under the University of Calgary, with the commercial activities (licensing its reservoir modelling software) spun-off into CMG in 1997 through an IPO (the non-profit activities were retained as Foundation CMG later renamed Energi Simulation, with no financial ties to CMG but friendly collaborations still exists).

Reservoir simulation softwares are used by O&G companies to visualize/analyze the underlying reservoirs, how the resources are trapped and expected to flow under various drilling/production scenarios, and helps predict the fluid flows and optimize drilling, risks, and economics.  CMG has ~35% market share of the reservoir simulation market, with the main commercial competitor being Schlumberger's Eclipse solution (~55% market share).  Halliburton and Baker Hughes also has their own software but seems to have became outdated and fallen out of favor with the market.  There's also upstarts like ResFrac and Eclipse copycats like Russian based Rock Flow Dynamics but they are relatively small in the market.  Inhouse solutions of big oil majors are another alternative.

The advantage of CMG comes from its Canadian roots and university roots.  The product is strong in modelling unconventional reserves, likely due to the nature of the Canadian resource base being heavy in oil sands and other unconventional resources.  As per past commentary from management, they overindex in market share for unconventional oil & gas.  

The university roots of CMG also probably helped shape their "grassroot" strategy.  CMG provides their software for free to over 100 universities around the world, including some of the most renowned pretroleum engineering schools (Texas A&M, University of Adelaide, Standford, Imperial College etc.).   This is a popular software strategy as the engineers would be schooled in CMG software, gotten used to its interface and functionality, and would transition seamlessly in the job that license the same software.

The business is also a highly technical one and with different entry barrier as you need more than codes to replicate the product.  CMG has slightly more than half of its staff in R&D, over half of those staff have PhDs, and spends ~20+% of revenue on R&D

But as expected with other O&G related business, the last few years (before the energy run up this year) has been a headwind.  CMG's revenue peaked at C$85m in 2014 and has declined to ~C$66m as clients gradually reduced budget, reduced licensing seats, or have merged/been acquired by competitors.  This roughly mirrors the decline in petroleum engineers employed (~-17.5% in US as per Bureau of Labor Statistics).  Margins declined as well but still relatively fat, went from ~50% EBIT margin to ~40%.

The important recent event is the change in management and likely change in strategic direction of CMG.  For a long time management at CMG were decent but conservative.  The company has a highly successful single product but was unable to expand into other areas (they have co-developed a production system modelling software but hasn't had much success commercializing).  One shareholder likely got impatient and pushed for change, and in 2019 Mark Miller was introduced as a new board member.  For those not familiar, Mark Miller is the COO of Constellation Software, a highly regarded acquirer of vertical market software company.  That was followed by appointment to the board of John Billowits in Jan 2021, another former executive (CFO, CEO of Vela Operating Group) of Constellation Software.  Finally in Feb 2022 Mark Miller took over Chairmanship of the board.  In May 2022 a new CEO was hired, Pramod Jain who came from the travel software sector but has experience integrating acquisitions, and most recently the hiring of a new Head of Corp Dev that's also a Constellation alumni (in the M&A department).  You can see where this is going.

Thesis

Our base thesis has nothing to do with the management change or change in strategic direction.

Everyone can see where the energy price is and where the energy market is heading towards.  We believe there's pent-up growth for CMG's existing product that will be realized in the coming years.  Oil & Gas company budgets are set the end of the year, and most of CMG's deferred revenue booking happens in calendar Q1.  That means CMG's business lags the movement in oil & gas prices, but we believe at the end of the year when company budgets are set, there will be pent-up growth for additional software licensing/seats.  CMG has also started raising prices over the last couple of years and we think pricing will further contribute in the next budget reset.  After bottoming last year, revenue growth have already started to inflect, rowing high-single-digits in the last two quarter.  We think we are paying ~15x EV to this year's FCF, and likely ~10x FCF when this pent-up growth is realized.

Then the Constellation/strategic direction change angle is just icing on the cake for the thesis (though if everything goes well the icing will likely be much bigger than the cake).  To be clear, we don't think CMG is an acquisition target of Constellation Software (at least not yet).  We do believe that Constellation Software has gotten too big for many of its acquisitions to move the needle.  That's not the case for CMG, and if the same expertise that made Constellation successful can be transplanted to CMG, then this could become quite an interesting situation.

Catalyst

End of year O&G company budget comentaries.

Acquisitions in the near term (you'll have the judge whether the acquisitions make sense, but nonethless the market will likely get excited).