Description

IVU Traffic Technologies AG (IVU GY)

Summary

IVU Traffic Technologies (IVU) is a high-quality, underappreciated, and attractively priced vertical software business well-positioned to benefit from ongoing tailwinds in its core markets, with upside optionality related to electrification of bus fleets, M&A, and international expansion.  In addition, IVU’s revenue mix continues to shift from services to software, which I believe will improve business quality and drive margin expansion in the years to come.  I expect IVU to compound revenue at a low double-digit rate for the next several years, with earnings growing faster.  In my base case, I believe the stock is worth EUR 28-30 (+38-48%) by 2023, with further upside possible given the intrinsic earnings power of the business, a longer-term cloud transition story, and the potential for the stock to benefit from ESG fund flows.

Business description

• IVU provides a software suite that enables public transport providers, including bus and rail operators, to manage their entire workflow from service and resource planning through to dispatch, fleet management, ticketing, passenger information systems, and financial reporting (Exhibit 1).  The key value proposition of IVU’s offering is efficiency, particularly as it relates to utilization of vehicles (buses and trains) and people (operators and dispatchers).  Customers view IVU’s software as mission-critical, and churn is rare.

• IVU generates nearly all its revenue in Europe: about 49% in Germany, 49% in the rest of Europe, and 2% in the rest of the world (Exhibit 5).  Roughly 40% of revenue derives from rail customers and 60% from bus customers.  Selected customers include Deutsche Bahn, the Berlin-Brandenberg public transport authority (VBB), Lithuanian Railways, and Swedish rail operator SJ AB.

• The sales cycle is generally tender-driven: customers will issue a public request for proposals meeting their specific requirements, and IVU and its competitors will submit proposals and bid for the business.  Deals are negotiated on a bespoke basis, but broadly speaking, contract values are correlated with the size of the customer fleet, the number of users, and the software modules involved.

• A typical customer engagement begins with project work (42% of 2020 revenues), which includes implementation services and the sale of hardware.  IVU subsequently generates software revenue from the customer in a typical license-and-maintenance model whereby the company sells a perpetual software license and contracts for annually recurring maintenance revenue over a multi-year period.  A small (MSD) and growing share of revenue derives from cloud hosting.  IVU’s customer relationships are deep and long-lasting, and it is typical for IVU to up-sell additional modules into an existing customer or cross-sell to a different division within a given customer over time.

• The nature of this model is that project revenues have been roughly flat (~2% CAGR) over the last six years while the revenue mix has shifted toward software.  License revenues are lumpy and have CAGR’d at 21% over the same period, while maintenance and hosting revenues have grown monotonically (17% CAGR).  Overall, software revenue has increased from 39.5% of total revenue in 2015 to 57.7% in 2020, of which 34.4% is recurring maintenance and hosting revenue and the balance license revenue.

Thesis/overview

• IVU’s core markets are healthy and growing, and IVU is gaining share.

• At a high level, in public transit, IT spend is correlated with the broader level of infrastructure investment.  Per one industry expert, the expected CAGR for public transport spend in Europe is 5-7% over the next several years, with IT spend growing in tandem.  A different expert indicated that the light-rail segment of public transit should grow at an accelerated rate totalling 20-30% over the next three to five years as many European cities invest in their light-rail systems.

• In general, European governments are prioritizing investment into public transit in an effort to meet various environmental goals that serve as a broad tailwind.  Examples include:

• Lawmakers in France recently voted to abolish domestic flights on routes that can be covered by train in under two-and-a-half hours.

• Germany’s Federal Transport Minister is trying to shift freight transport from trucks to rail.  Currently, 19% of freight is transported by rail, and the minister is targeting 25% by 2030.  While this is not strictly public transit, IVU does have a cargo business that could benefit from this sort of mix shift.

• Deutsche Bahn, an IVU customer, is partnering with Lufthansa and with the German government to work toward reducing or abolishing domestic flights in Germany.

• The International Association of Public Transport has requested the European Commission to invest in the public transport sector as part of the “Connecting Europe Facility,” with a focus on improving public transport infrastructure in suburbs and rural areas.  The details still need to be worked out, but it has already been decided that this will lead to investments in the triple-digit billion range; in Germany alone, an estimated EUR 10 to 12B in annual financing is thought to be needed, as per Init SE’s 2020 annual report.

• IVU has not provided revenue growth targets beyond 2021.  As one point of reference, Init SE (IXX GY), which also serves public transit customers but is not all that comparable to IVU given differences in geographic and product mix, has set a target for “continued sustainable annual growth of 15% on average.”  Over the past seven years, IVU’s and IXX’s growth rates have averaged 11.9% and 8.7%, respectively.  Clearly, if IVU can come close to achieving Init’s revenue growth goal, that bodes well even relative to my high case assumptions (13% CAGR).

• In 2020, IVU’s personnel capacity increased by 15.3% y/y (vs. 8.3% in 2019), its fastest growth rate in the last several years, in part reflecting management’s assessment of the company’s near-term revenue growth prospects.  Management guided 2021E revenue growth to at least 8.7%, the fastest rate it has guided in several years; over the last five years, IVU’s actual revenue growth rate has exceeded its guided revenue growth rate by an average of 900 bps (Exhibit 7).

• With respect to market share dynamics:

• Within rail, IVU has a market share in the mid-80s in Germany and the mid-40s in the rest of Europe.  Its win rate in the rest of Europe is 70-80%, and the company has not lost a large tender within the last few years.  Accordingly, we expect that its market share will continue to trend higher particularly in Europe outside Germany. 

• Within bus, the market is more fragmented, and it is harder to determine IVU’s market share and win rates.  Management cites growth from existing customers and growth in new customers as key drivers.  One IVU former told me that IVU has limited its bus aspirations to Europe because that opportunity is sufficiently large.

• In my research, multiple former employees from Trapeze Software, one of IVU’s largest competitors, have indicated that Trapeze is losing share to IVU for reasons discussed later.

• Overall, my view is that with a market backdrop of MSD to HSD growth and continued share gains on top of that, an 11% revenue CAGR for IVU through 2024E is a reasonable base case (2015-2020 CAGR: 10%).

• Model is inexorably shifting to software, which will increase margins and improve business quality over time.

• As discussed, the mix shift to software has been underway for years, with software increasing from less than 40% of revenue in 2015 to nearly 60% in 2020.  

• It is important to understand that the company’s shift to cloud is different from other cloud transitions investors may be familiar with in the US (e.g., MSFT, ADBE).  While an increasing proportion of customers are opting for IVU to provide hosting, the underlying revenue model largely remains license-and-maintenance.  IVU simply charges an additional recurring fee for hosting (2020: 7.9% of total revenue) rather than bundling software and hosting together into a subscription package.  As such, hosting is immediately accretive to revenue (unlike a traditional cloud transition that trades upfront license revenue for ratably recognized subscription revenue).  A key caveat is that management has indicated that hosting today generates little to no margin; it seems to be largely a pass-through to AWS, IVU’s cloud provider.  IVU expects to be able to increase hosting gross margin in the future given the customer value created.  Although hosting itself is not yet a material profit generator, it is worth noting that deployments in IVU’s cloud actually benefit maintenance gross margins because it is much easier for the company to support those customers than those with on-prem hardware.  A tiny percentage of contract volume is pure subscription SaaS today, and that could pick up over time, but it’s still very nascent.

• In tandem with this mix shift to software, EBIT margins have expanded modestly, though not nearly as much as I think they could have.  2015A EBIT margin was 8.4% and 2020A was 13.9%, though in my analysis (Exhibit 6), “core” EBIT margin in 2020 adjusted for the impact of cloud hosting revenue (which is largely pass-through) and the income from the sale of a non-strategic asset only reached 10.2% (2019: 12.6%).  The y/y decline in core EBIT margins in 2020 was due to aggressive hiring: FTE increased 15.3% y/y, the fastest rate in at least five years, which management attributed to the scale of the opportunity in front of the company.  For context, I note that 2019 incremental EBIT margins were 34.4%, giving some sense of the underlying earnings power in the business at maturity.  The company’s 2021E guidance implies an EBIT margin of at least 13% on an as-reported basis, 460 bps greater than the 2015A level and representing ~54% incremental EBIT margins vs. 2020 excluding the gain-on-sale.

• As Exhibit 6 shows, core gross margins backing out the dilutive impact of hosting revenue have improved from 69.1% in 2015 to 78.2% in 2020, reflecting the impact of the revenue mix shift toward software.  

• Net, software revenues, and particularly the recurring portion thereof, will continue to grow as a percentage of total revenue over time, which should continue to drive gross and operating margin expansion despite the currently dilutive impact of hosting revenue.  I model EBIT margins on an as-reported basis reaching 15.2% in 2024E, implying 340 bps of expansion relative to 2019 EBIT margins as-reported and 220 bps of expansion relative to 2021 guidance as-reported.  I believe this level of margin expansion is reasonable given the dynamics discussed above.  While I am not modeling revenue lines separately, if I illustratively assume that 2024E base case revenues of 138.4M are 60% license-and-maintenance, 25% project, and 15% hosting, and conservatively assume that hosting and project revenue collectively generate 5% EBIT margins, then a 15.2% overall EBIT margin implies an EBIT margin from license-and-maintenance revenue of 22%.  I believe that is eminently achievable for a pure software business, and likely leaves room for further margin expansion.

• Bus electrification is a durable secular trend that is only just beginning and that will drive demand for IVU and its peers.

• Only 0.4% of all buses in Europe were electrified in 2018, with that number expected to grow by 40% by 2023, driven in large part by environment-related government initiatives which in many cases are very well-funded (e.g., the German Federal Ministry of Transport and Infrastructure is providing EUR 393M toward electrification of transport and EUR 500M toward digitization of transport systems).  IVU management notes that ”we are just at the beginning with electric mobility … in the next ten years, almost all municipal transport companies in Germany are expected to switch to electric buses.”

• The introduction of electric buses into fleets complicates workflows for operators who must build charging time into schedules, resource manage charging stations, account for weather and topography, and monitor battery health and status.  In addition, as bus fleets become electric, fleet sizes naturally increase due to shorter ranges (~150 km vs. 1000 km for diesel) and longer charging times relative to refueling.  One industry participant told me that he expects fleet sizes to increase by 20-30%.

• Accordingly, electrification of bus fleets drives demand for modern software solutions such as those provided by IVU, among a few others.  As one former executive from an IVU competitor told me, “systems of planning and dispatch are more important than in the past.”  This creates cross-sell opportunities within IVU’s existing customer base as well as increased tender activity that gives IVU a chance to win new customers.

• IVU’s strategic partnership with Daimler Buses could be key in this regard as the companies jointly develop integrated solutions for electrified public transport and promote each other’s offerings in Germany and globally.  Daimler owns 5.25% of IVU.

• IVU frequently discusses the importance of the electric bus opportunity in its filings and in the press, but has not yet quantified the potential impact on the business.  My discussions with industry participants have indicated the increase in software spend could be ~25-50%, driven by increased fleet sizes and the incremental cost of software modules specific to electric fleets. 

• IVU seems particularly well positioned within electric buses relative to its competitors (discussed in greater detail below).  Only Mentz and IVU have mature planning capabilities today specific to electric fleets.  Init is working on it, but historically planning has been a very small part of its business in general (~5% of revenue).  Optibus is an important and well-funded new entrant to monitor, but so far doesn’t appear to be a presence in IVU’s core markets.

• Management has stated that features related to electric bus fleets are the most important thing developers are currently working on.

• The company is likely to make an acquisition in the near- to medium-term that will expand the product portfolio and/or customer base, and that could be materially accretive to revenue and earnings.

• IVU has EUR 28M in cash in addition to EUR 25M it put in a notice deposit in 2020 which it can withdraw with a notice period of three months.  As such, IVU likely has purchasing power of ~50M, ~14% of its current market cap.

• IVU has openly discussed its interest in making an acquisition that expands its product portfolio or gives it a foothold in new geographies, and is actively seeking such acquisitions today.  In particular, management has discussed interest in incorporating predictive maintenance capabilities into planning and scheduling, and also deepening capabilities within railway cargo management.

• While I cannot predict the financial profile of an acquisition that has not yet been identified, I think it’s reasonable to expect that the company could pay something like 6-12x EBIT, which would be immediately accretive and create cross-sell and/or up-sell opportunities.  Init did an acquisition in 2020 for which it paid 1x revenue and 6x EBIT and stated that normally its acquisitions are even cheaper.

• Overall, my view is that IVU presents an attractive risk/reward, with a weighted average year-end 2023 price target of EUR 28.43, an IRR of 16.0%.

• In my base case, I model a revenue CAGR of 11% through 2024E with EBIT margins reaching 15.2% that year.  As discussed, it seems that the market backdrop is MSD to HSD growth and that IVU is taking share on top of that.  I’m not explicitly accounting for the impact of bus electrification or M&A, though those factors increase my confidence in the durability of IVU’s growth.  Margins expand as a result of the continued mix shift to software, also discussed.  I believe an exit multiple of 18-19x forward EBITDA, in-line with where the stock is valued currently, is reasonable for a very sticky enterprise software business of improved quality with EBITDA growth still in the mid-teens.  This translates to a year-end 2023 target price of EUR 28-30, +38-48% from here.

• In my low case, I model a revenue CAGR of 6% through 2024E with EBIT margins reaching 12.0% that year, 100 bps below 2021E guidance of 13% EBIT margins.  This scenario contemplates IVU simply growing in-line with the expected market growth rate (i.e., no share gains, no benefit from bus electrification or M&A) while not coming close to achieving the EBIT margin management thinks the company can earn this year.  I apply an exit multiple of 12x forward EBITDA, more than one-third lower than where the stock is valued currently.  I believe that is sufficiently conservative for what even in the low case is still a sticky software business with MSD revenue and EBITDA growth.  This translates to a year-end 2023 target price of EUR 15, -26% from here.

• In my high case, I model a revenue CAGR of 13% through 2024E with EBIT margins reaching 20.1% that year.  Relative to the base case, this scenario contemplates even greater share gains and margin expansion, though still seems achievable given the various tailwinds, the presence of an industry participant that is guiding investors to a 15% sustained growth rate, and the mechanics and earnings power of IVU’s business model.  This translates to a year-end 2023 target price of EUR 42, +107% from here.

Competitive landscape

• Trapeze Software

• Trapeze, a Constellation Software company, is one of IVU’s largest competitors.

• Trapeze is most relevant in bus and light-rail, not in heavy rail.  Transport for London is an example of a large Trapeze customer.

• Multiple Trapeze formers told me that Trapeze’s planning capabilities are limited compared to IVU’s or Giro’s.  Trapeze is a share donor to IVU and Mentz.

• Trapeze is also reportedly weighed down by tech debt, whereas IVU is more agile and lean.

• According to a Trapeze former, Trapeze’s revenues have been relatively stable for the last ten years, with IVU growing much faster.

• Init SE (IXX GY)

• Init SE, a publicly traded company headquartered in Germany, is also one of IVU’s largest competitors.

• Like Trapeze, Init is most relevant in bus and light-rail, not in heavy rail.

• Geographically, Init is much more diversified than IVU.  In 2020, 26% of revenues derived from customers in Germany, 21% from customers in the rest of Europe, 42% from customers in North America, and 11% from ROW.  

• Init’s business is characterized by very large deals, usually associated with ticketing (45% of revenues, primarily project-based), and much more hardware-oriented (hardware is ~two-thirds of revenue vs. software at ~one-third).  Planning is only 5% of Init’s business today.

• Multiple experts have indicated that Init has problems with legacy systems that are overly complicated relative to IVU.

• Init is working on developing solutions for electric buses, and corroborates that planning is much more complex for electric fleets.

• Giro Hastus

• Giro is a privately-held Canadian company relevant in both rail and bus.

• A former Trapeze exec described the competitive dynamic in the European rail market as a two-horse race between Giro and IVU.  The expert stated that IVU’s product is better than Giro’s, albeit by a small margin, and was optimistic about IVU’s ability to expand in Europe ex-Germany.

• Giro does well in non-German speaking Europe, especially in France.  It tried to enter the German-speaking market but failed.

• Goal Systems

• Goal Systems is a privately-held Spanish company 

• One expert indicated that Goal was the biggest competitor to IVU within rail, but stated that its crew dispatching capabilities are sub-par.  The same expert stated that IVU has won more tenders than Goal in Europe in recent years, though relative to IVU, Goal has more traction outside Europe, particularly in North America.

• Mentz

• Mentz is a competitor within bus and light-rail that has historically had a solid market position in Germany.

• IVU recently won a customer in Basel from Mentz, which one expert believes could create opportunity for IVU to expand its relationship with that specific customer and also perhaps to win more customers from the competition.  It remains to be seen whether that was a one-off or start of a broader trend.

• Optibus

• Optibus is an Israeli startup that recently raised $107M in Series C financing led by Bessemer Venture Partners and Insight Partners.

• The company has built an AI-based platform to help mass transportation work more efficiently in cities around the world, including functionality related to navigation, scheduling, and driver rostering.

• Thus far, Optibus remains small in revenue scale and in terms of product capabilities and has little to no presence in IVU’s core markets.  My research indicates that to date, its share gains have come at the expense of Trapeze and Giro Hastus.

• Nonetheless, Optibus remains an important player to monitor going forward, and one that might be increasingly relevant as the electric bus opportunity develops.

Miscellaneous

• Quotes from March 2021 interview with IVU’s CEO (translated):

• “Our industry is currently more in demand than ever, which is why it will also be about IT systems for buses and trains - and our product roadmaps are packed.  In addition, I could imagine expanding into other regions as well as into related subject areas, both organically and through acquisitions.  Thanks to our high liquidity, we have a good starting position here and will continue to use it with care.”

• “We want to attract more and more users to our IVU.cloud in the next few years so that we can also use it to develop the SaaS business.  This applies to both new and existing customers.  The experiences so far have been very positive for both sides, customer satisfaction increases thanks to the all-round carefree service and, at the same time, our recurring income.”

• “With electric buses, the planning and use of vehicles in regular services will be even more complex than before.  Transport companies then suddenly also have to deal with the energy requirements of the vehicles, their range, the effects of weather and traffic, and even the loads on the power grid when they charge the vehicles.  To do this, they need solutions that we offer with our IVU.suite.”

• Asked to what extent the 2021 outlook reflects usual conservatism: “We always create our outlook based on valid figures, so we’ve done very well in recent years.  There will be no forecast from us that we do not fully support.  If our expectations change, we prefer to adjust our outlook during the year.”

• International expansion

• The company has generally limited its aspirations on the bus side of the business to German-speaking Europe, where it still sees a substantial runway for growth.  However, on the rail side, the company has stated that there are many customers for it to win worldwide.

• Clearly, to date, the company has virtually no traction outside Europe (only 2% of total revenue).  There are some early signs that the company may be making progress, including the recent announcement of a contract win with Keolis Downer in Australia.  

• In the 2020 annual report, management stated that the company would take “bolder steps” this year internationally, “particularly with railways and in big cities.”  My understanding is that management is primarily referring to non-German-speaking Europe (e.g. France, Portugal, and Scandinavia).

• As discussed above, M&A could be a critical step toward achieving greater traction in new geographies.

• Net, I am not underwriting success in international expansion, but it certainly represents optionality.

Why this opportunity exists

• Stock is off-the-run, illiquid, not well-known by investors, and covered by only a single sell-side analyst.

• Management is highly conservative and does not provide investors with much quantification, disclosure, or financial targets related to bus electrification, cloud transition, or other long-term value drivers.  The one target management does provide is an EBIT/GP ratio of 12.5% which the company has exceeded for years.  The company doesn’t even hold earnings calls.

Appendix

Exhibit 1: IVU.suite capabilities for bus and rail

Exhibit 2: rail customer growth

Exhibit 3: global footprint

Exhibit 4: financial history

Exhibit 5: revenue detail

Exhibit 6: estimated core gross and EBIT margin analysis

Exhibit 7: history of revenue growth guidance achievement

Catalyst

Catalysts/how it plays out

• I believe the company will comfortably exceed its revenue and EBIT targets for this year for the following reasons:

• On March 24, this historically conservative management team guided to 2021E revenue growth of at least 8.7%, the fastest growth rate to which it has guided in the last six years (Exhibit 7).  

• When the company reported 1Q21 results, it stated that it had 90% of its guidance already booked in orders-on-hand.  

• Subsequent to that, the company announced that it won a pan-European tender for DB Regio Bus AG, the largest bus operator in Germany, a contract value IR has indicated is in the LDD million range over ten years.

• The company has repeatedly indicated it is seeking acquisitions of companies to expand its product portfolio and customer relationships outside of Germany.  The company has ~53M EUR of cash, including the notice deposit, at its disposal which gives it buying power to make a meaningful acquisition with little to no dilution.

• Important thesis signposts include continued rail tender wins in Europe and any sign of improved traction globally, as well as any indication that bus electrification is yielding increased tender activity and cross-sell opportunity.  Regarding electric buses, the company indicated in its 2020 annual report that it is “anticipating further orders in the months ahead, including with [its] partner Daimler Buses,” so news on that front should be imminent.  There is a large (EUR 31M) active rail tender in Italy currently that has recently been awarded to an as-yet unnamed vendor that could potentially be IVU; it is also encouraging to see the company’s recent rail win in Australia.  

• Over time, better disclosure on the incremental opportunity created by bus electrification and longer-term financial targets should improve visibility toward my base case.

• While not fundamental, the equity could benefit from ESG fund flows over time.  IR has indicated that most calls over the last six months have been with US-based investors, which is unusual.