Description

At current levels, we believe SS&C Technologies Holdings (NASDAQ:SSNC) represents a highly attractive investment. SSNC is a high-quality business led by stellar management and shares are attractively valued for reasons we understand.

Founder and CEO Bill Stone has a long history of creating shareholder value and holds a huge stake in SSNC. Bill founded the Company in 1986 with $20,000 in savings, IPO’d SSNC in 1996 at $12.67 (split adjusted), took it private with the Carlyle Group in 2005 for $37.25, and re-IPO’d the Company in 2010 at $7.50 (split adjusted). Since its 2010 IPO, EPS has grown from $.45 to $3.95 (2019) and shares are up ≈8x. Bill’s 13% stake is currently valued at >$2bn.

SSNC is a high margin, recurring revenue business with low capital requirements: pre-tax unlevered cash margins are 37%; the Company has >95% revenue retention; LTM EBITDA is $1,850mm vs. LTM CapEx of $150mm. Overwhelmingly, the software and services SSNC provides its clients are non-discretionary, utility-like, and a pain to replace with something different.

SSNC trades at approximately 25x 2020 estimated earnings, and >21x 2021 estimated earnings. Not only does SSNC trade at a more attractive multiple, it is also less economically sensitive: S&P earnings will be down 25% in 2020 vs. 2019 while SSNC’s 2020 earnings will be up. More significantly, SSNC trades at a huge discount to comparable businesses – relative to most, SSNC has superior margins but lower growth (note, the number below are based on average 2020-2022 consensus):

We think SSNC is mispriced due to concerns around a) leverage levels; b) equity market exposure; c) slow organic growth.

We think the leverage concern is without basis. Many investors are cautious about businesses with debt, especially during times of heightened economic uncertainty. SSNC produces a lot of cash, especially relative to its debt levels.

Although SSNC is not experiencing revenue retention pressure due to COVID, new sales have slowed. SSNC’s low case 2020 guidance assumes normal business activity – i.e. in person meetings and stabilization of client work patterns – doesn’t return until 2H21. Based on low-end guidance, SSNC ended 2Q20 at 3.7x leverage (net-debt / 2020 EBITDA). Based on guidance, SSNC will generate $500mm of free-cash-flow in 2H20; the resulting reduction in net debt would take leverage to 3.5x at year end 2020.

Further, the Company has no significant debt maturities until 2025.

Given SSNC’s cash flow profile, we think the Company’s capital structure is wholly appropriate and view the long-duration and low-cost debt positively – equity holder returns will benefit from it.

We think the equity market exposure concern is without basis. While there is a perception in the market that SSNC’s revenue is heavily exposed to equity market returns, in our assessment <5% of SSNC’s revenue is directly correlated to equity markets.

Many market participants are familiar with SSNC through its hedge fund administration business, where revenue is typically based on a percentage of assets under administration (“AUA”). If a fund client performs poorly because the markets are down, the Company’s AUA and revenue generally decline. In our view, this has caused a misperception that SSNC’s revenue is highly correlated to equity markets, when in fact it is not.

Most of SSNC’s revenue has no correlation to market direction. Even in the fund administration business, the portion of assets with directional market exposure is quite low. And there are segments of the overall business, such as trading solutions, that tend to benefit from increased market volatility.

SSNC’s revised 2020 guidance underscores our view. SSNC issued revised 2020 guidance on April 30^th (and then in July slightly modified revised guidance). The biggest driver of the revised guidance was a slowdown in new sales and implementations stemming from widespread work-from-home disruptions. Management downplayed any concerns around either revenue retention or equity market exposure risk.

We think low organic growth is an issue. For the last 4 quarters before 2Q20 (when organic growth went negative due to referenced sales/implementation delays), SSNC’s organic growth averaged 3.6%. The Company’s medium-term target is 5%. Financial services IT spend is mature, and SSNC’s growth is in line with the overall industry. While the organic growth is not inspiring, we think the following are important points:

-        SSNC’s operating and financial leverage means mid-single-digit revenue growth translates to high-single-digit earnings growth.

-        Over many years and many deals, SSNC has created substantial value through oftentimes bold M&A, and we don’t expect that to change. Organic or inorganic, 9x growth in EPS since 2010 is remarkable. Bill Stone doesn’t shy away from his reputation as a rapacious cost cutter of inefficiently managed businesses. Across SSNC’s 7 largest acquisitions since 2005, the Company has improved margins by almost 1,800 bps on average over the 2-year period following purchase.

We think the combination of business quality and resilience, management quality, and a low valuation provide ample downside support to the current share price. We think some combination of earnings growth, multiple expansion, deleveraging accretion to equity, large scale M&A, or other positives that result from strong business execution, will result in material upside.  

Catalyst

See above