Description

Crayon Holdings (CRAYN.NO) is a Nordic software and services company that plays in the Software Asset Management (SAM) market.  This market is forecast to grow at an 18% CAGR from 2021 to 2028.  In the SAM market, players manage the software estates of customers to optimize their use of software licenses.  Historically this business focused on Microsoft licenses which have complicated pricing structures but has more recently included cloud offerings managing both the use of cloud resources as well as SaaS (Software as a Service) licenses from various vendors.  As corporate digital transformations continue, software usage will become increasingly prevalent and tools to monitor this usage will become even more important.  There are a limited number of players in this field, including Crayon and its wholly owned subsidiary Anglepoint, SoftwareOne out of Switzerland, and Deloitte Consulting.  Crayon focuses on smaller and mid-size customers (although it is moving up the stack) while Anglepoint focuses on the very large customers.  In its 2022 Magic Quadrant for Software Asset Management Managed Services, Gartner placed Anglepoint in its Leaders quadrant and Crayon in its Visionary quadrant. 

This past quarter margins came in slightly below analyst expectations, hammering the stock and creating an opportunity for investors.  A large factor in the miss is that Microsoft is trying to smooth out its quarter-to-quarter seasonality.  Microsoft’s goal was to have a stronger Q3 (March) and weaker Q4 (June).  This led to a stronger Q1 for Crayon and a weaker Q2 and was not well telegraphed by the company and caught the analysts by surprise.  Crayon did keep its annual forecast intact so that this is more of a change in seasonality than a change in business fundamentals.   

A smaller factor was a temporary slowdown in US sales.  Growth in the US came in at 25% with the help of the strong dollar (as Crayon reports in NOK the strong dollar helps sales translated from USD) and was 12% on a constant currency basis.  Anglepoint does have some foreign business but up until this year it was not material, so all Anglepoint revenue was counted as US revenue.  This year the foreign Anglepoint revenue is material, so it is split out to the correct geographies rendering the Anglepoint comp in the US not apples-to-apples.  On a pure US versus US basis and at constant currencies, Crayon grew 18% in the quarter.  This was a letdown from the 25-30% growth Crayon had seen in the US in prior periods and there is a reason for that.  At the end of last year Crayon made some management changes in US sales and the new leader churned some sales reps and brought in some new ones.  This caused a temporary downtick in US business but now the new sales team is engaged, and the pipeline is showing a likely return to former heady growth rates there.  

Last year Crayon made a significant acquisition ($285m deal size) of a company called rhipe which focuses on the APAC region with a big presence in Australia.  Rhipe had a similar business model to Crayon and was a good fit as Crayon did not have much traction in APAC previously. 

In terms of product direction, Crayon is focusing on improving its cloud offering with a new FinOps platform which will be generally available in Q4.  This platform will automate many of the functions needed to track and budget cloud spend which is very important to customers.  This FinOps offering has already been sold to a few select customers. Earlier this week Crayon press released a win with a Germany-based global automotive supplier (BMW?  Mercedes?) for software asset management, FinOps, and technology-related strategic advisory over a three-year period.  Data and AI is also a new product direction for the company.  This group already has 80 employees working on a data and AI platform that can help customers with their data and AI needs.  Security is also a new product initiative at the company where it will advise clients on security of their cloud environments.

Even at a $1 billion market cap, Crayon is not well known in the United States and has very few US investors.  I think there is an opportunity here as Crayon’s slight disappointment in its last earnings release has hammered its stock since, but the mid- and long-term thesis remains intact.  The company has critical mass in the Nordic region and operates here at a 30% EBITDA to gross profit ratio with mid-teens organic revenue growth.  The company is investing heavily in other geographies and growing more quickly there but with lower margins due to the front-loaded ongoing investment.  My thesis (while the company agrees with) is that over time the other regions can get to the 30% margin mark as well and the company’s valuation at that point will be extremely low.  For example, the company is predicting EBITDA margins in the 21-22% range this year which results in a 2022E EV/EBITDA valuation of 11.7x.  Corporate organic growth in the 20% range has been the historical norm and I think can continue into the future.  At this pace, by 2025 EBITDA margins will be approach the asymptote of 30% of gross profit and the EV/EBITDA valuation will be at 4.8x.  This is an untenable valuation and at a 20x multiple the stock would be at a 517 NOK share price or 353% above where it is today.

What are the risks to an investment in Crayon?  A recession could slow sales if tech spending slows but I do not think this is a high probability event.  Companies are focused on efficiency through digital transformation and software spend is a key component of that.  As such, this creates a tailwind for SAM players such as Crayon.  As the company addresses smaller customers, there could be some churn risk if these customers go out of business in a long and deep recession.  Finally, there is an overhang issue with the stock as SoftwareOne, a competitor owns a 7.5% stake in Crayon’s shares.  It bought at the time of Crayon’s IPO thinking that there might be a business combination down the line but that seems more remote today.  As such, SoftwareOne sold 40% of its stake in March 2022 and the 90-day lockup period has expired so it can come to the market at any time.  From conversations with SoftwareOne I think it wants to maximize the value of its Crayon stake and will not sell at these depressed prices.      

Catalyst

Steady margin improvements and robust sales growth will combine to increase the share prices as quarters ensue.