Description

Thesis / Idea

Kinaxis (KXS), is a provider of mission critical supply chain software, that enjoys best-in-class retention rates (~97%), high switching costs and a strong competitive position. Recent financial performance remains solid but has been obfuscated by a slowdown in new business owing to macro conditions and shift to longer-term contract lives with big escalations (depresses near-term ARR growth but grows effective ACV), optically depressed margins from a lumpy revenue stream, and duplicative costs from a move to the public cloud that will normalize in the coming years.  In addition, KXS remains highly under the radar of many investors – it has been a 11x bagger since its 2014 IPO but has never been written up on VIC and is rarely discussed, and trades at a wide discount vs US peers. The stock has been flat for the last 4 years and is down 31% from its all-time high in November 2021. Mgt and the BoD seems to agree, as they launched a 5% buyback program in November 2023, which is a first. We suspect we can earn a high-teens to low 20% IRR here.

Business Overview

Kinaxis provides software for supply chain operations. The business is based in Canada, and was founded in 1984 as Cadence Computer Corporation, but in 1996 shifted focus from hardware to software and released the first supply chain planning platform. In 2005, the company changed its name to Kinaxis, and became one of the first vendors to move to a subscription model. It went public on June 10, 2014 at $13 per share (C$307M market cap). Over the last decade since the IPO, its revenues have grown from $61M to $427M (22% CAGR). Today, the market cap is C$4.9B (12x bagger / 28% IRR from IPO).

On average, a Kinaxis contract is over 3 years, but 5 year contracts are not uncommon, the company has contracts as long as 7 years, and the average contract length has been increasing over time. Gross retention is not disclosed annually but management speaks to it broadly, and recently disclosed it has been consistently in the 95% to 100% range.  This is mission critical software that is very sticky. The downside is that sales cycles tend to be quite lengthy (historically 12-18 months), as do implementation times (6-12 months). The primary reason for churn is when a customer goes bankrupt or is acquired. Implementation for a solution like this can take up to a year, and it also takes time for employees to be trained and adopt the tool, so moving solutions is a very hard lift and not taken lightly.

Kinaxis initial focus was on customers in the high tech & electronics. At IPO in 2014, KXS had 5 vertical markets: high tech & electronics, A&D, Industrial, Life Science & Pharma and Automotive (which was very nascent). In 2016, high tech was ~40% of revenue and life sciences was ~30%. By 2019, both high tech and life sciences were 30% each, and KXS added the Consumer vertical in 2017 and the Retail vertical in ~2020. Today, there are 7 verticals, but they have also had recent success in the Oil & Gas industry, a new area within the Industrial vertical, landing BP as a sizeable new customer in Q4 ’21, and Shell and ExxonMobil in Q2 ’23.

Earlier in its lifecycle, KXS had significantly more customer concentration. In 2014, the top 10 customers accounted for 47% of revenue, and one customer was >10% of revenue. Today, the top 10 customers are 20% of revenue ($84M or $8.4M per customer) and no customer is above the 10% level. The customer base is a who is who of some of the biggest, most demanding customers such as Honeywell, Unilever, Qualcomm, and Merck. Geographically, 57% of revenue comes from Americas, 27% from EMEA, and 16% from APAC.

In Q2 ‘23, KXS crossed the 300 customer mark (disclosed as 300+ customers today), and the customer base has 2x’ed in the last 3 years, with 2023 being the biggest contributor to new customers yet. This translates to ~$1.2M in average revenue per customer (and $0.9M average ARR / customer), although the biggest customers can spend >$5M. In 2023, ~50% of new customer wins were large enterprises and ~50% of wins were small and medium enterprises.

Customers generally seem very happy with the solution and view it is a big improvement vs prior solutions / status quo – which tends to be either a module of SAP (Integrated Business Planning = IBP), a custom-built tool, or no dedicated program (not uncommon for non F500 businesses). A lot of customers who don’t have a solution rely on emailing a bunch of spreadsheets back and forth to try to attempt to create a version of the tools that KXS has.

The ROI from Kinaxis is viewed as excellent. While it is not cheap, it typically pays for itself within a few months to a year, because a small reduction in inventory on hand or ensuring in-stock rather than out of stock on a base of large numbers = huge dollars.

In terms of competition, SAP has been the primary competitor, with ~70% of current Kinaxis customers coming from SAP. SAP’s solution is widely viewed as inferior by industry experts and the product gap appears to be widening. Other players include Blue Yonder (fka known as JDA Software, founded in 1985 and acquired by Panasonic in 2021), and then far less frequently OMP (privately held, founded in 1985, based in Belgium), Anaplan (founded in 2006, acquired by Thoma Bravo in 2022, but more focused on financials), 09 Solutions (founded in 2009, based in Dallas, backed by GA and KKR).

Kinaxis is the leader in Gartner Magic Quadrant for Supply Chain Planning, and its position has strengthened over the last decade. In Q4 2023, management said their win rate remains strong, at >60% of deals vs their top 3 competitors in 2023.

While Kinaxis is primarily a subscription solution, its total revenue is somewhat lumpy as there are a few different components:

1) Pure SaaS (60% - 70% of revenue) – this is the bread and butter SaaS revenue that comes at a ~80% gross margin.

2) Subscription Term Licenses (STL / from 2% to 14% of revenue depending on the year) – this is subscription revenue, but some customers (eg A&D) still prefer a term license over SaaS, which makes the reported revenue streams quite lumpy. It also significantly swings profit margins as STL are ~95% gross margin.

3) Professional Services (20% to 30% of revenue). Given the time and complexity of installations, PS is a substantial % of the business but has been recently elevated at ~30% of revenue given many recent customer wins. We expect this will return back to more normalize levels in the coming years. PS gross margins are much lower – 22% in 2023.

4) Maintenance and support (4% to 7% of revenue). This is the annuity stream attached to STL and is also very profitable with ~90% gross margins.  

Recent Results / State of Play

The current market cap is C$4.9B ($3.6B US). The company has a net cash balance sheet (8% of market cap), so the TEV is $3.3B US. KXS trades at 6.4x ‘24E revenue and 34x ’24 EBITDA and 55x P/E. Given the business is running at far below long-term margins, I think the more relevant metric is revenue.

For historical context, KXS’s NTM revenue multiple steadily expanded from 5x at IPO to 10x in 2018 before spiking to a peak of 17.3x in Oct 2020. Valuation still remained very high (16x) until the end of 2021, when the multiple steadily deflated to ~6x today.

KXS stock is down -30% from its all-time high in November ’21, has been flat over the last four years, and is down -10% over the last year.

In November 2023, the company initiated a share repurchase program where they can acquire up to 5% of shares. They have never repurchased shares before. They acquired $37M of stock in Q4 ’23 (1.1% of shares) and $21M in Q1 ‘24.

Revenue
So what has happened from a KPI / financial point of view during this time period? Generally, the business has performed well despite a challenging environment, but with a backdrop of 28% ARR growth, management put out an aggressive mid-term SaaS revenue target of 30% or higher, which they are unlikely to hit.

Organic xFX ARR grew 21% in 2019, 15% in 2020 (bookings hurt by Covid), 21% in 2021, 23% in 2022, 17.5% in 2023. Performance did slow during 2023, as mgt noted that while the pipeline was growing nicely, similar to other software businesses, the time to get contracts signed was extending, and deals were getting pushed out. ARR growth by quarter was as follows: Q1: +20%, Q2: +19%, Q3: +17.4%, Q4: +17.5%, Q1 ’24: +15.6%. SaaS revenue growth by quarter was as follows: Q1: +28%, Q2: +25.4%, Q3: +25.7%, Q4: +18.8%, Q1 ’24: +16.2%. In addition, SaaS revenue was guided to grow 17% to 19% in 2024, which was well below consensus at the time (24%). We also suspect that absent another macro deterioration, this outlook may prove conservative. If we compare current RPO vs guidance for next year SaaS revenue, we get a ratio of 86%, which compares to 84% in 2022 and 83% in 2021, so it seems like management has applied additional conservatism to the pipeline/outlook.

Profitability
Owing to the sizeable swings in STL mix (discussed above), EBITDA margins have been volatile historically. They reached 30.1% in 2019 (when STL was 14% of revenue), fell to 16% in 2021 (STL was 2.4% of revenue), rebounded to 22% in 2022 (STL was 11% of revenue), fell to 17.6% in 2023 (STL was 4.6% of revenue), and are guided to 18% to 20% for 2024 (STL expected to be 2.0% of revenue).

So on a Rule of 40 basis, KXS has optically gone from 49% in 2020 (25% SaaS revenue growth + 24% EBITDA margin), to 42% in 2023 (24% SaaS revenue growth + 17.6% margins), and 2024 guided to 37% (18% SaaS revenue growth + 19% margins), which seems like a sizeable degradation. 35% Rule of 40 is still decent, but is actually significantly understated owing to several factors. 1) STL mix is at the trough at 2% of revenue vs an average of ~6% (~200 – 300 bps of margins). 2) KXS is in the process of moving customers from on-prem hosting to fully deployed on the cloud (Azure and GC). This began in Q2 ’22 and is expected to wrap by 2025. Currently the business is paying for both, which is depressing margins by ~600 bps. If we adjust for this and some other non-recurring costs, then the 2024 guidance would be for 27% margins, which combined with 18% SaaS revenue guidance would be = 45% on Rule of 40. The company has a mid-term target of 25% EBITDA margins. 

Returns

Our perspective is that KXS should be able to grow SaaS revenue in the high teens % per year over the next 3-5 years and ultimately achieve very attractive EBITDA margins, given best-in-class gross retention. Assuming that KXS trades at 25x ’27E FCF, this equates to a high-teens IRR.

Catalyst

-Ongoing customer wins and stabilization / acceleration in ARR

-Improvement of margins – removal of duplicative cloud costs and inherent operating leverage

-ongoing repurchase activity