Description

Trading in line with trophy software assets, MANH is poised to see EPS growth fall off as cyclical tailwinds unwind and cloud growth takes longer to materialize. The valuation of 60x 2024 P/E will need to adjust to the companies go forward single digit EPS growth.

Business Description

• MANH is a leading provider of supply chain management software products which help retail, CPG, and logistics companies optimize their inventory management, omni-channel commerce initiatives, and physical warehouse / distribution center operations. Customers use MANH software to manage complex supply chains by providing better demand forecasting, procurement and supplier management, inventory tracking, scheduling production, order fulfillment & return handling, logistics & transportation, as well as to get real time reporting and analytics overlaid on this whole process. Traditionally, these processes are managed by homegrown point solutions (often manual / excel-based workflows) which have siloed data and no top down visibility. MANH software helps to digitize and unify these workflows and allows for improved coordination between various stakeholders (manufacturers, suppliers, distributors, logistics providers, customers, etc.).
• Over the last decade, the growth of e-commerce has driven traditional brick-and-mortar retailers to focus on providing seamless omni-channel experiences to their customers by delivering products as quickly and efficiently as possible across the desired channel (in-store, mobile, desktop). This trend has increased the demands on order management and inventory tracking systems as merchants need to figure out what the most effective place (distribution center, local store, directly from the wholesaler, etc.) to ship the product from is. Online shopping has also increased the volume of certain transactions like processing returns, which can be very expensive if handled inefficiently. Having more information to flexibly react to customer preferences in the most efficient way possible has become more relevant, pushing retailers to modernize their processes with digital workflows like MANH.
• Historically, the company has primary sold its software in an on-premise delivery format with very limited subscription offerings. MANH sold perpetual licenses with attached maintenance contracts for ongoing support/updates. In 2016, the company began offering cloud-based subscriptions. The Cloud model allows for customer to outsource the management of the software to the vendor (MANH) who is then able to pass on constant R&D innovation to the platform that customers get over time. This is notably different than the on-premise world in two ways: (1) its a financial model change from upfront 1-time software purchases to a subscription model and (2) its a technical change where the post-production responsibility of the operations passes from the customer to MANH and this comes with a host of challenges that require MANH to build and run modern multi-tenant micro-services based infrastructure on top of GCP.
• As you can imagine, the implementation process for these supply chain software systems can be very time intensive and complex. There is a high degree of customization as customers need to encode company-specific requirements and business logic which can vary by geography and industry. This system needs to be integrated into other complex enterprise software systems like CRM, ERP, MRP, Contact Center, customer support, etc. Employees need to be trained to properly use the new system and change management consulting is also a component of deployment. Post-deployment there can be ongoing support required to ensure the system is up-to-date with evolving needs of the business. 
• The need for customization results in an incredibly high professional services revenue mix that is effectively unrivaled in software at ~50% of total revenue. Additionally, the company also resells computer hardware and physical RFID/barcode scanners to help customers facilitate warehouse operations. Hardware revenue represents 3-4% of total revenue. When accounting for the non-recurring nature of perpetual software licenses, the company's recurring revenue as a percent of total was only 42% in FY22.
• There are a number of competitors including SAP, Oracle, Blue Yonder (formerly JDA), Infor, IBM Sterling, HighJump, E2Open, and Epicor. There are also some other companies involved with supply chain that offer overlapping features in some areas but are not as focused on warehouse and transportation management systems (e.g. SPS Commerce, Descartes, OpenText). Manhattan is certainly one of the more established players in this market, but its competitive landscape is a lot more crowded than other vertical software markets which tend to be winner take most (like VEEV, CWAN, ADSK, GWRE, etc.).
• Financial Profile
  • MANH is expected to do ~$915M of revenue in 2023 (19% growth)
    • $480M of professional services (23% growth)
    • $250M of cloud revenue  (42% growth)
    • $140M of maintenance revenue (-2% growth)
    • $15M of perp licenses (-40% growth)
    • $25M of hardware (-17% growth)
  • MANH should do $272M of Adj. EBITDA and $220M of FCF
    • Gross margins are 56%
    • R&D is 14%, S&M is 9%, G&A is 8% (this is already a pretty lean structure, not a ton of margin headroom with GMs in the 50s)
    • Adj. EBITDA margins are 29% and FCF margins are 24%
  • Manhattan was founded in 1990, went public in 1998, and today has ~1,800 customers supported by ~4,500 employees 

Thesis

• Over the last ~2 years I believe that MANH saw elevated growth from the cyclical spike in e-commerce and the supply chain disruptions which both drove  increased demand for MANH's supply chain software. This growth rate should moderate as customer demand mean reverts to more normalized levels. 
  • During 2020 & 2021, the growth in e-commerce drove renewed interest in supply chain software modernization. While there was initial disruption to deal cycles in 2Q/3Q 2020, the pipeline of companies looking to handle the spike in online demand by driving more digital transformation of their back-end systems increased dramatically. 
    • US E-commerce sales growth stepped up from ~15% in 2019 to ~35% in 2020, growth has since moderated to high-single digits
    • "Q1 of 2020 was a record. And then we had a couple of pretty bumpy quarters in Q2 and Q3 of 2020. But by Q4 of 2020, we're starting to see things stabilize and come back. And then, as I said, a record again in 2021. So just kind of an important bit of a blip there in 2020. I think, and as we've seen from almost every angle, digital transformation has accelerated during the COVID period, and that's been helpful to fuel that growth." - CEO, March 2022
  • The supply chain shortages and uncertainties which followed the pandemic only continued this trend, putting more pressure on retailers and logistics providers to quickly get visibility into their supply chains
    • "I think that the general geo supply chain disruptions are going to continue... But demand is certainly high for capacity on the digital transformation side as e-commerce continues to grow... there's a real immediacy and an urgency to get product distributed out to end consumers, and the optimization of the deployment of inventory around the country becomes particularly important." - CEO, February 2022
    • I think we're seeing the cyclical nature of this dynamic reverse for some other supply chain software vendors like E2Open:
      • E2Open's revenue began shrinking Q/Q in May given macro pressures on their customers, FY24 revenue estimates have fallen 13% since the start of 2023
      • As I understand it, E2's revenues are more closely tied to volumes so MANH's software revenue won't be as volatile, but the general spending environment among their end customers appears to be more muted and that's going to have an impact on software bookings and MANH's non-recurring components like services/hardware
  • MANH's long sales cycles & implementation times meant this pipeline of activity carried over into solid bookings and revenue performance throughout 2022 and 2023, but I believe there's risk to these growth rates in 2024 and beyond
    • Over the last 18 months, while most software companies were decelerating rapidly, we saw the above factors accelerate MANH's growth rate
    • Services growth went from single digits pre-pandemic to negative 16% in 2020, then has rebounded to +10% in 2021, +18% in 2022, and +23% in 2023
      • I would imagine there were lots of change management consulting projects kicked off in 2022/2023 to help companies "re-think" supply chains to deal with shortages / geopolitical risk
    • Hardware growth should also mean revert after revenues more than doubled between 2019 and 2022 to support fulfillment center build outs
• Cloud growth story can become prolonged and be a head-fake over time while pressuring EPS growth
  • I definitely get the on paper benefits of transition to cloud, but I generally think these transitions can often get pushed out and happen a lot slower than people think:
    • The growth narrative over the last 5 years has been the cloud story, but usually when an industry's SaaS penetration is this low two decades into the 21st century there is a good reason for it
    • They've been at this for half a decade are only at ~10% of their customers on Cloud. There's different ways of looking at that fact b/c on the one hand there's a 10x potential to sell into the existing base, on the other hand its taken them 7 years and they've only got a few hundred customers on Cloud so it doesn't seem like it immediately appeals to everyone / there's no driving motivation thats going to open the floodgates to where total revenue growth can grow 20s sustainable from here.
    • MANH's cloud software still has to be heavily customized, so while it is cloud-delivered it's not clear to me that this is a drastically better innovation model over time with more operating leverage and R&D benefits being passed on to customers. Often when you've got this heavy customization going on each accounts tends to get bogged down in non-standardized spaghetti code that breaks down upon updates.
      • "In terms of customization and so forth, there is still going to be customization required regardless of whether it's on-prem or in the cloud." - CEO, October 2020
      • "The thing that we've done that is -- that is a little unusual is we also allow customization, right? Because that world is driven by the need for customization. So most of the -- sort of what you would consider to be the pure play and the early adopter cloud companies, which are fabulous, but the ADPs and the HCM and the -- even the CRM guys that don't allow customization, we have to like customers -- so we -- those first 3 tenants that I described on top of allowing our customers to customize their solution, that's the definition of native cloud for us." - CEO, June 2023
    • These are really important systems and large tier 1/2 customers are hesitant to hand over the responsibility of running this system to MANH and there's just not a ton of impetus or motivation to take the risk of ripping out a critical system that's more or less working fine
      • "And at this point, it's been clear feedback to us that they're looking for packaged application software with sophisticated functionality that could help them optimize their supply chains and at least to this point, aren't looking for that in a multi-tenant Software-as-a-Service environment, where they might give up some ability to package that solution to best meet their needs" - CEO, 2010 (old quote I know, but I think its still largely true for the Tier 1/2s customers)
      • "I think that there is the opportunity for some folks that will accelerate those upgrade discussions because they can get their hands on brand-new innovation that delivers real ROI faster, and we're going to certainly help them with those business cases. We're going to see -- clearly, we're going to see some customers, as we always do with technology transitions, have a pretty long tail on the migration. And -- but the great news is they can do it at their own pace. They can migrate at their own pace. There's no particular acceleration required, they get to do it at their own pace and frankly, we'll be there for them when they're ready." - CEO, July 2020
  • 40s cloud revenue growth today is juiced by migrations which will run out of steam as the low hanging fruit customers have already been penetrated
    • The company is guiding for cloud revs to grow ~30% in FY24 to ~$330M, in my view 30% growth for $330M of SaaS revenue is not a tremendous success story when its being aided by migrations
    • If this were a standalone business it'd probably be growing 20% at that scale and I'd say a $300M-ish SaaS business growing 20% would prob fetch $2-3B valuation today, not $13 billion
    • As the law of large numbers kicks into effect and the room to replace maintenance runs out, I don't think this line item can be the growth engine you need it to be to make the math work
    • SPLK Cloud ARR growth is a good case study, when the migrations runway dried up Cloud ARR growth went from ~75% to sub 30% in 18 months and brought total company ARR growth from mid-30s to mid-teens (... I know this is overly simplified and there was loads of other stuff going on) 
  • The decline of >90% GM perpetual license and high margin maintenance streams is tough drug to lean off of, cloud GMs are much lower even after they get to scale
    • One of the reasons SPLK cloud revenue success was more limited was that the entire sales team comp structure is predicated on the notion that perpetual software business can print boatloads of cash, those $$$ are very hard for teams to truly walk away from
    • MANH's Adj. EBIT margins are expected to be pressured by 175 bps next year from the decline of license and maintenance revenues
    • The margin decline combined with revenue growth decelerating to 10% next year is causing Adj. EPS growth to decelerate from a 26% CAGR over the last 3 years (FY20 to FY23) to just 4% growth next year
• As top-line growth moderates and margin leverage remains limited, lackluster Adj. EPS growth will drive a compression of MANH's premium valuation multiple
  • I think MANH is a medium quality software business trading like it's a top decile asset. When you look at it on EV/Revenue its up there with IOT/ZS/PLTR/MDB and when you look at it on EV/recurring revenue its effectively the most expensive asset in software. MANH trades at 13x 2024 revenue, 30x 2024 recurring revenue (Cloud + Maintenance), and 41x 2024 Cloud Revenue. The asset is simply mis-priced. 
    • There is no way that a dollar of Manhattan Associates' recurring revenue should be worth twice as much as a dollar of Snowflake's recurring revenue... and most VIC members would likely agree that the SNOW multiple itself is already too high... IDK maybe some lazy longs think physical warehouse software and cloud data warehouses are the same thing? ;)
    • I know there's a lively debate going on right now in the CDNS/SNPS posts about appropriate valuation for a great software business. MANH is in the same ballpark valuation range as those assets but is far behind in terms of business quality. I am not trying to say MANH is a bad business, but it's certainly not in line with the an EDA duopolist sitting at the forefront of the most important wave of technological innovation on the planet. 
  • I would steel man the justification for the valuation as follows: This is a profitable, defensive, and sticky vertical software business that has entrenched itself in its customers' mission critical processes allowing for good pricing power and the team has shown consistent execution over time as they've delivered solid revenue growth and mid-teens EPS growth and cloud gives the business a long run-way for that to continue
    • The above case gives me a lot of deja vu to the 2019 argument as for why Guidewire should trade at $120/share. Guidewire was doing ~$460M of ARR growing 13% and was worth $8.4B in the summer of 2019. Whenever any brave soul would ask "Hey why are we paying over 18x ARR for a low-teens grower again?" the bulls would reply "Haven't you heard?! It's an entrenched mission critical sticky vertical software provider which can be very profitable over time and its got great competitive dynamics. The cloud makes this business even better and will drive growth for at least another decade!", I at times was one of those bulls and I learned my lesson the hard way.
    • Roll forward 4 years and you've got a stock that's been dead money as the ~13% ARR CAGR couldn't keep up with the ARR multiple compressing to 11x as the trajectory of cloud adoption disappointed. We've learned that GWRE's cloud transition is going to take a lot more time than initially promised as many customers are perfectly happy to keep their on-premise software running way longer than the average software analyst would have guessed. When it comes to putting mission critical highly customized software for conservative verticals in the cloud it's just not the same pitch as Salesforce selling horizontal cloud-based CRM.
    • For some perspective, MANH's recurring revenue (Cloud + Maintenance) has CAGR'd at 16% over the last 7 years so pretty close to the GWRE ARR growth rate. If we put 11x on MANH's 2024 recurring rev you would get $80/share (60% downside). Okay, fine maybe the bulls are right and MANH is way better than GWRE, let's raise the multiple by 100% to 22x and call it... $160/share? Still 25-30% downside?
  • Descartes
    • There's a Canadian company called Descartes Systems which does cloud-based logistics & supply chain mgmt software that is ~90% recurring revenue and it has grown at an 18% CAGR over the last 4 years. Descartes has 77% gross margins, 45% Adj. EBITDA margins, 37% FCF margins and trades at $6.8B EV for $233M of FCF next year (29x FCF). MANH has lower growth, lower GM, lower EBITDA margins, lower recurring revenue mix, lower FCF margins, lower cloud penetration, yet trades at 54x FCF (almost twice the multiple).
  • I personally think this should trade for ~45x 2024 Adj. EPS which is still a very generous multiple in the grand scheme of things. At 45x $3.65 of 2024 Adj. EPS you get to around $165/share which is 25% downside from here. The company's clearly not a zero, nor is it a melting ice-cube, but I do feel like its likely in for a period of underperformance following the 82% YTD move (could also be a good funding short) especially if cloud adoption disappoints.

Catalyst

Growth deceleration, delayed cloud transition