Description

Investment Overview / Why the Opportunity Exists

Sylogist is a public sector software-as-a-service (SaaS) business whose stock has been orphaned due to its history of poor corporate governance along with a recently implemented strategy shift and dividend cut that caught investors off guard. The strategy shift, which the market hasn’t yet approved, was the result of the retirement of the former CEO concurrent with a board-initiated strategic review and was executed with the sole focus of driving shareholder value for the first time in the company’s recent history. Company specific issues, along with the massive selloff in small companies and software related businesses during 2022 has caused the stock to be left for dead, despite possessing some characteristics that point to an intrinsic value much higher than where the shares trade today. There is ample evidence that the company’s new direction is proving effective, but investors have been slow to recognize the shift, despite the company arriving at what I believe to be an important inflection point as of Q1 2023.

Since their hiring, the current management team has made tremendous progress, turning this previously low-growth cash cow that had no business being public into a high value prop software platform by launching and acquiring in-demand products, repairing customer relationships, and returning the business to organic revenue growth. CEO Bill Wood has run this playbook before, having spearheaded two successful private software company exits / sales, and is highly incentivized to drive significant value with Sylogist.

Sylogist has not been written up on any investment forums, there are only two sell side analysts, and their IR presence leaves much to be desired. Shares trade on the TSX, over the counter in the US, and three funds as the largest shareholders own over 30% of the business. Daily average volume is less than CAD $200k/day. In line with my comments above about a checkered past, Sylogist’s previous issues remain in the rearview mirror, but from the market’s perspective, they still sting. These dynamics mean that despite the strong fundamentals, shares trade at 9.0x 2023E EBITDA compared to peers in the 18-25x range.

Public market peers such as Tyler Technologies, Blackbaud and The Sage Group, among others, have outlined the formula for success in this industry as well as the formula for significant long-term returns which consists of organic growth complemented with accretive M&A. Sylogist is now executing this playbook and has the opportunity to grow revenues organically at a low-double digit to mid-teens rate from here with EBITDA not far behind. As the company’s recently initiated internal investments continue to bear fruit, there is an opportunity for both margin expansion and multiple expansion. In a macro environment where two of the biggest worries are inflation and a recession, the combination of nondiscretionary recurring revenue and pricing power makes for an attractive setup. Over time, and with proper execution, I believe shares offer greater than 100% upside.

Background / Strategy Shift

Before moving on to the business, it’s important to set the stage for where we are today and provide some historical context regarding all the positive changes that have taken place recently.

Sylogist was founded in the late 1990s as an undifferentiated reseller of software products called Fintech Services Limited, where it remained, three CEOs later and into the early 2000s. In 2002, Fintech Services restructured their operations, enacted a name change to Sylogist and started focusing on selling SAP ERP products as well as municipal solutions. Jim Wilson (the former CEO), a large shareholder who had served as Chairman since 2001 was pointed CEO at the time following a series of strange transactions where Sylogist acquired two unrelated businesses owned and operated by Jim. Jim operated as CEO until Bill Wood’s hiring in 2020.

Shortly after Jim Wilson’s hiring, compensation, for which there was no formal program, started to get out of control, and in 2014, a new incentive structure was put in place that compensated management based on a percentage of free cash flow that the business was generating. That started the former management team down a path of reinvesting nearly zero margin, managing the business for cash flow, paying a hefty dividend and milking the company for compensation. Unsurprisingly, the result of this was a lack of investment in things like customer support, account management and the continuous neglect of customer relationships. Sylogist remained in this state, with their Net Promoter Score dropping each year, until 2020.

In September of 2020, the Board announced the undertaking of a strategic review, concurrent with Jim Wilson’s retirement at the end of the year, with the goals of the strategic review to evaluate alternatives to drive shareholder value (for the first time in a decade) while finding and hiring a new CEO who would be given a growth mandate. Boutique M&A advisor Shea & Company was hired to facilitate the strategic review (aka get the business sold). Channel checks indicated a significant amount of interest at the time, but there was a lot of low hanging fruit to clear (i.e. repairing customer relationships), so no deal was consummated. In October 2020, the strategic review was concluded with the Board determining that the best course of action would be to attack the many near-term market opportunities for growth as opposed to selling the business. Bill Wood was hired a month later. At the time of his hiring, Sylogist had nearly 60% EBITDA margins and a 5% dividend yield.

A few events that followed Bill’s appointment included:

• The hiring of key executives, including a CTO, CRO and new CFO as of Q1 2023
• An uplisting to the TSX from the TSX Venture exchange
• An NCIB put in place to acquire 10% of shares outstanding
• The upsizing of the credit facility from $40mm to $75mm
• The execution of three major acquisitions (Municipal Accounting Systems, MissionCRM and Pavliks, discussed below) that added products, revenues and EBITDA

On top of these changes, two other significant announcements took place. First, in mid-2021, Sylogist announced the continuation of increased investments in sales, marketing and product development to drive organic growth, which would have the result of lowering EBITDA margins from previously high levels, down to 30%, while still maintaining the Rule of 40 posture. Unfortunately, at the time of the press release, no specific investment levels were discussed, no clear use of cash was outlined, and no margin targets were given.

Second, at the end of 2022, in conjunction with their Q4 results, Sylogist announced a new capital allocation plan whereby they would be continuing to heavily invest in sales, marketing and product development and would also be cutting the dividend (a 9% yield at the time) to do so, freeing up $11mm in annual cash flow. The stock dropped 20% on the news but recovered a few days later to around current levels. In addition, a renewed NCIB was put in place, and the credit facility was again upsized to $125mm from $75mm, providing additional acquisition firepower.

Here's a snapshot of quarterly financials going back to Q1 2018, leading up to the implementation of the strategy shift in Q2 2021. You can see the change in top line growth, EBITDA margins, and the dividend payout ratio.

The strategy shift, lower margin outlook and dividend cut weren’t well telegraphed or previously guided (causing the stock to drop 20%), but the quick recovery in the following days at least indicated the market understands that management is serious about driving shareholder value moving forward. But a lot of moving parts, some unexpected capital allocation moves, and the expectation that growth investments will have to deliver an ROI, means a discounted stock. In addition, like most small companies and software related businesses, 2022 was not kind to Sylogist shares, which were down nearly 60% despite the tremendous progress made during the year. The shares still haven’t recovered despite a clear inflection point in operational execution.   

Today, Sylogist is executing an organic growth strategy centered on its three core verticals. The strategy shift will be bolstered by significant tailwinds including the large addressable market among their customer base, low digital penetration among the same customer base, the acceleration of software tools post-COVID, and a fragmented market for products and services that Sylogist can tap into for M&A. I think it’s a positive signal that the management team is willing to endure short-term discomfort in exchange for potential long-term value creation. Discussed below, their recent internal investments have been paying off nicely.

Business Overview

Sylogist is a public sector SaaS business that provides mission-critical software solutions to nearly 2,000 customers worldwide in three public sector verticals consisting of non-profits through their SylogistMission segment (36% of revenues), Government organizations through their SylogistGov segment (16% of revenues), and K-12 schools through their SylogistEd segment (33% of revenues). Within these verticals, software solutions consist of ERP, CRM, fundraising, education administration, and payments products, among others. I don’t believe detailed explanations for each segment are required, but one use-case example would be a growing non-profit that requires more advanced fund accounting and donor management software that integrates with the rest of the organization’s applications. This organization could implement Sylogist ERP to address their needs. Sylogist typically works with smaller and mid-market organizations in specific end markets such as school districts, faith-based organizations, museums and local non-profits. According to end users, Sylogist’s products carry high value propositions and sticky customer relationships as they serve a critical need for most customers by integrating into their technology stack and daily workflows. Sylogist and its peers are great businesses given their asset light nature, lack of cyclicality, durable recurring revenue streams and significant cash flow profiles. Even during a long period of significant underinvestment and customer neglect under the prior management team, Sylogist still maintained its nearly 60% EBITDA margins, and based on a historical examination of organic growth, was still able to grow recurring maintenance revenues between 2-3% per year for nearly the past decade.  

Although Sylogist is not the cheapest solution (and is not attempting to be), I’d view their customers as both budget conscious and ad-hoc, which plays into the continued demand for cloud-based software to manage costs effectively and the need for them to utilize software vendors with subject matter expertise. For customers, Sylogist’s solutions typically represent between 15-20% of their budgets, and are critical to their workflow, so cloud based services reduces the cost burden especially when considering the move from large upfront license-based fees to monthly recurring payments. This is typically not an expense that is tinkered with much, especially given the benefits provided and willingness to remain with a provider even in the face of price increases. Channel checks also confirm that it’s very difficult to find cost savings in this area so typically they are found elsewhere in the budget (meaning software is the last thing to be cut). Lastly, conversations with customers indicate that Sylogist has significant room to raise prices over time, as that was the last factor mentioned in a purchasing or churn decision.

The end markets in which Sylogist operates both insulate them from competition and provide a favorable demand backdrop leading to a strong growth runway. The majority of Sylogist’s customers don’t typically have the resources to internally develop what they need and aren’t being catered to by larger organizations such as Tyler Technologies, Salesforce or SAP, for example. Although there are a number of competitors in the public sector space such as Tyler Technologies, Blackbaud, The Sage Group and Powerschool, the market overall is much less competitive than the private sector and none of the companies mentioned here focus on Sylogist’s customer base, have a specific solution tailored to that customer base, or have made the necessary investments to compete. This is evident in Sylogist’s historical customer retention numbers, which were in the high 90s even in the face of prior mismanagement and customer neglect. In terms of Sylogist competing against larger organizations, the typical dynamics between small and large organizations apply; public sector customers are not as attractive as private sector customers and the TAM is much smaller, providing less incentive for larger businesses to enter.  Furthermore, legacy software and especially ERP vendors are priced out of Sylogist’s market and can’t capture all the specific use cases required to compete. Manufacturing and servicing industries (where legacy vendors have market share) have been among the first to shift to cloud-based software, and those end markets represent a small portion of Sylogist’s business mix. 

Channel checks indicate that often Sylogist products are displacing things like Quickbooks, manual Excel templates or even green screen (COBOL) systems. Setting aside the customers who remain on legacy software systems that either must be upgraded or replaced (some of which have been discontinued altogether), and you have both a long runway for growth with continued demand and a natural replacement with the Sylogist platform. I say natural replacement because several of Sylogist’s products are built using the Microsoft Dynamics platform, where Sylogist can not only customize products for specific verticals but can also benefit from the reputation and track record of Microsoft during customer acquisition and when cross-selling adjacent products and services. This is evident from the former Microsoft employees who have called Sylogist their ‘public sector partner’ making for a simple transition among new customers.

Sylogist has three separate revenue segments within each of their verticals, made up of Cloud Subscriptions (40% of revenues), Maintenance and Support (25%) and Professional Services (29%). The remaining percentage of revenues consist of Licenses and Hardware sales, located in Other Revenues and immaterial to the top line. Approximately 70% of Sylogist revenues are recurring between Cloud Subscriptions and Maintenance and Support, providing both visibility and resiliency into the business. Sylogist is currently transitioning legacy on-premise customers to the cloud as well as attacking white space for new customer growth, which the current management team has been largely successful in doing based on increased bookings, backlog and revenue growth. Moving forward, management’s strategy is to grow both organically and via M&A, while focusing on the organic growth of software subscription revenues. A continued shift to more SaaS revenues will come with higher margins and increased cash flows as well as magnify the overall attractiveness of the business.

Recent Business Results and Outlook

In line with my comments in the strategy shift / background section, since 2021, Sylogist has been reinvesting around $10mm/year in the form of product development and sales and marketing. The sales and marketing department now consists of sixteen employees as opposed to just three when management took the helm, and product development is responsible for building the current version of Sylogist’s software platform. Customer account management has improved the company’s NPS score to around 50 today, while also engaging in cross-sell opportunities that have also been bearing fruit.

Organic growth in software subscription revenues was negative during 2021, but as of Q4 2022 turned positive for the first time since that period. Sylogist also reported mid-teens to low 20’s consolidated organic growth rates during Q4 2022 and Q1 2023 in addition to both ARR and bookings growth.

Moving forward, the growth strategy will be focused on both new customer wins, cross-selling, and wallet share expansion among existing customers. Investments in customer account management have allowed Sylogist to effectively cross sell their customers and introduce them to new products and services which has translated nicely to the top line growth referenced above. There will also be an emphasis on rolling out products in new verticals (a new SylogistGov product has yet to impact the top line as initial customers are being onboarded now) and utilizing channel partners to drive additional customer wins. From their time as a software reseller and through management’s experience, the company maintains relationships with valuable channel partners in the Government and Education spaces which should bode well for future growth. I believe the use of channel partners could add a few hundred bps to gross margins if utilized successfully. Although management hasn’t quantified it at this stage, their recent comments on the use of channel partners confirms their excitement regarding the opportunity.

…As I’ve shared previously, there, for us to achieve the scale that I see for Sylogist being going forward, there is going to need to be a healthy blend between our direct sales force as well as a partner channel. He (the new Chief Revenue Officer) has deep partner experience, partner channel experience and building partner channel and executing and developing not just partners that are tangents, but really walk and talk as if they were Sylogist.

…The partner channel right now is – has affected the performance minimally both Microsoft as well as our own partner channel, outreach and community that we are building on a 12-month to 24-month basis, material. And why do I say that is because most of the performance that we have seen in terms of our growth really isn’t reflecting the opportunity in the SylogistGov as well as the SylogistEd, that’s ahead of us…

...So, as we turn up the partner community, which is our primary strategy for SylogistGov in North America, the impact that I anticipate that we will have will be material in terms of our ability to grow revenue and to primarily do it with passive revenue growth, which is IP related versus having to add more and more people to be able to deliver the services.

…We expect the majority of Ed and Gov to be – the service side of it to be delivered through our partner channel and partner community over time. So, it’s a great question. It’s really one of the exciting parts for our story going forward is the headroom for where we see growth and scale coming is just, we are only scratching the surface of it at this time in the markets we serve through that partnership strategy.

While organic growth in cloud subscription revenues have inflected positively for the first time in 18 months, consolidated top line results reveals that Professional Services has made up the majority of consolidated organic revenue growth. This is expected given the upfront implementations required for new SaaS customers, the shorter sales cycles with services, and the fact that it’s easier to sell one-time projects. Professional services growth won’t garner the multiple that I believe is deserved, but the importance of this segment shouldn’t be discounted as professional services help drive positive customer service, word of mouth referrals, and cross-selling opportunities (things that was completely lacking with the prior management team). Most importantly, professional services implementations have historically been a leading indicator for future cloud subscription revenues. Outsourcing this segment wouldn’t make sense for those reasons, and mostly because Sylogist wants to capture the entire customer relationship. Furthermore, professional services are incorrectly viewed as single projects. Sylogist recently disclosed a 60% ‘attachment rate’ (of recurring revenue) to professional services, indicating that not all projects are one time in nature.

An illustration of the recent inflection point in cloud subscription revenues is below, referencing the following organic growth numbers:

*Of note, the Bellamy Discount refers to a historical customer recently onboarded at a three-year, discounted price. The company did this to provide a runway to transition them to the current platform.

Should this trend continue, which I believe it will, it will have the effect of improving the financial profile of the business including higher revenue growth, increased gross and EBITDA margins as well as higher cash flow conversion. Consolidated organic growth rates have reached record highs as of the last two quarters, and there remains a significant runway for new customer growth, M&A and cross selling. While not broken out, software gross margins are in the 75-80% range with minimal incremental opex / capex needed to sustain growth in cloud subscription revenues. If investors can wrap their heads around the idea that in between the goal of intentionally decreasing margins (only to see them potentially increase again), that a lot of value is being created, then I think investors can grasp that Sylogist is building a stronger business, which stands in stark contrast to the prior management team’s efforts.

In addition to the organic opportunities, there are a number of secular trends driving increased adoption of software and digitization within the public sector which stands in contrast to the private sector. First, COVID accelerated the digitalization of most things in the non-profit and government worlds. Remote employees, citizen engagement, payment capabilities, ERP modernization and budget deficits have led to an increased adoption of software. Second, there is significant customer demand for software integrations, reflected by the number of customers I spoke to who mentioned the necessity of being able to connect their CRM / budgeting / people management / accounting system to one platform where these applications can speak to one another. This not only makes life easier and helps play into the trend of catering to more tech savvy younger employees, but for smaller non-profits, budget deficits and lean expense profiles mean that transitioning to lower cost, cloud-based solutions makes sense for all parties. Third, the industry is made up of highly fragmented legacy systems, providing a large opportunity for vendors to provide more modern solutions. Lastly, the fragmentation of the industry and desire for larger players to consolidate systems, products and offer the latest features means that there are plenty of acquisition candidates to roll up that would both increase the value prop and be revenue/earnings accretive.

Strengthening via M&A

Both Tyler Technologies and Blackbaud are proven consolidators in the government / public market software spaces, and Sylogist is well on its way as an acquirer. During the past three years, Sylogist has successfully acquired three businesses in key verticals made up of Municipal Accounting Systems (MAS) a highly regarded provider of student information management and accounting software to K-12 schools, Mission CRM, a developer of fundraising and donor engagement software, and Pavliks, a provider of SaaS applications to public sector member associations. The competitive landscape is very fragmented, and acquisitions typically come with synergies and predictable integrations. Although management hasn’t provided specifics regarding potential revenue or cost synergies, channel checks indicate there should be some duplicate back office / personnel costs, and with recent investments dedicated to building out a valuable and scalable software platform along with a dedicated account management team, cross-sell opportunities should be available over time.

Capital allocation via M&A has been strong, considering the following:

Mission CRM was acquired for $2.9mm. Mission was doing a little over $1.0mm in revenue at the time of the deal, and growing rapidly, with earnout targets for 2024 that management fully expects them to reach. Mission CRM is the developer of the Mission CRM fundraising and donor engagement SaaS platform, built on a Microsoft Dynamics 365 and Azure foundation, fully embracing the Microsoft Data Model for large and mid-market nonprofit and non-government organizations.

Pavliks Group was acquired for $11.4mm. At the time of the acquisition, Pavliks was doing $9.4mm in revenue and $1.6mm in EBITDA, growing 20% per year. Pavliks is a provider of proprietary SaaS applications and professional services primarily to public sector organizations and member associations.

MAS was acquired for $37.5mm. At the time of the acquisition, MAS was doing $7.7mm in revenue and $4.4mm in EBITDA, which will grow as they expand to additional states. Based in Shawnee, Oklahoma, MAS is a highly regarded provider of student information management and accounting solutions to K-12 public school districts. MAS was founded in 1985 and has grown to serve nearly 85% of the Oklahoma K-12 public education market with its integrated Wen-GAGE platform. MAS is highly complementary to the Company’s existing SaaS K12 solutions and will allow the Company to provide more feature-rich, scalable and flexible offerings to customers and new school districts throughout the country.

Continued M&A is an additional lever to pull for value creation that is not factored into my base case valuation, and despite still elevated private market valuations, the deal pipeline remains incredibly full, with management at one point targeting $20-25mm in revenues via M&A during 2023 (that target has since been adjusted, but management claims the pipeline has doubled). In the valuation section, I discuss how accretive M&A could add significant equity value over time.

Brief Industry Overview

Public market software is a growing industry. Gartner and others predict 5-7% growth in public sector software through 2030, driven by a number of secular trends. Sylogist cites multi-billion-dollar TAMs within each of their verticals, creating a huge growth runway with the increased adoption of software. TAM estimates are to be taken with a grain of salt, but conversations with industry experts helped form the view that the public sector is at least a decade behind the private sector in terms of technology modernization. Growing demand for software, combined with rising IT budgets, citizen demands for digital government, a gradual shift to the cloud and a younger generation entering the government workforce provide for sustainable, decades-long growth drivers in this market. There is also significant demand among Sylogist’s customer base for centralized tools that can communicate and operate with each other as opposed to individual more siloed solutions. Setting aside the significant whitespace opportunities in Education and Government based on various government programs, Sylogist should continue taking share which will allow them to grow faster than the industry overall.

What’s more, public sector and government software has proven to be one of the more attractive and resilient sectors as a highly defensive category given the high retention rates, lack of cyclicality and profitability profiles of these businesses. Tyler Technologies, Blackbaud and Sylogist have been free cash flow positive for over 15 years and both Tyler and Blackbaud grew right through the GFC with little to no changes in margins (Sylogist revenues / operating income declined, but they were significantly sub-scale at that stage with less than $10mm revenues. They were still cash flow breakeven from ’07-09). This makes for the ideal financial profile for private-equity owners.

More specifically, this is an attractive industry for several reasons:

• Demand is high and will remain steady moving forward given the large number of existing organizations and the current low penetration rate of software applications, especially among smaller organizations.
• There are decent switching costs here given the critical nature of some of the applications and especially as software integrations are developed. Conversations with customers confirmed that significant price increases or incredibly horrible customer service would have to take place before they started shopping around.
• The move toward building a ‘platform’ means there are soft network effects for certain providers with larger product portfolios. If your CRM software can work with your ERP software which can work with your budgeting software, it’s difficult for competitors to unseat that experience. Blackbaud for example has historically underinvested in their software capabilities so despite a large product portfolio, none of the programs are cohesive, making them susceptible to competition.
• There are barriers to entry or soft moats in the form of reputation, relationships, and track record. You’ll often hear CEO Bill Wood talk about the collegial environment into which Sylogist sells and how referrals and word of mouth are still effective marketing techniques. This also explains the consolidation of the industry given the ease of buy vs. build for larger public sector software businesses.
• There is a lack of cyclicality among these businesses based on the above characteristics, typically driving extremely durable economics. Setting aside Sylogist’s and peer performance during the GFC (which was very strong), customer and employee conversations indicate that these types of software and IT tools are not among the first things to get eliminated when reaching for cost savings.
• The industry continues to consolidate. Fragmentation exists from both a software and geographic perspective, and scale matters from both a customer acquisition standpoint as well as a reputation standpoint (trusted vendors get more business). As a result, the landscape is ripe for adding value through M&A.

Management

Shareholders are invested alongside strong operators and a team capable of executing accretive M&A. Sylogist is led by CEO Bill Wood who is both experienced and aligned with shareholders to drive value moving forward. Bill has significant industry experience, serving as a founding member of Blackbaud along with prior roles at Access International and more recently as President and CEO of FrontStream, a PE backed provider of payment, donation, and employee giving SaaS solutions to non-profits. FrontStream had over 10,000 customers and revenues of nearly $50mm at the time of Bill’s exit, which culminated in the sale of the business to Marlin Equity Partners. During his time at FrontStream, organic growth was complemented with tuck-in M&A, and management is running the same playbook at Sylogist, where there is a lot of customer, product, and relationship overlap with SylogistMission.

In terms of alignment, the compensation structure received a much-needed overhaul once Bill Wood was hired. Today, management is compensated on adjusted EBITDA growth along with four strategic objectives: organic growth, operational excellence, net revenue retention and customer wellness. Bill Wood was granted a 500k options package with a $10.30 CAD strike, 250k of which vest when the stock reaches $15.00 CAD, and the remainder vesting through 2025. It goes without saying that I view this structure as much more reasonable than the one implemented by the prior management team. There was also a decent chunk of insider buying among Bill and other members of the management team during late 2022.

Of note, a new CFO is now in place which I regard as an upgrade from the prior CFO who lacked public markets acumen and had little experience outside of Sylogist. New CFO Sujeet Kini is an experienced private market executive and conversations with him along with reference checks allude to his ability to communicate this story successfully. During multiple public calls and presentations, Sujeet has outlined the desire to increase the company’s disclosures surrounding software related metrics moving forward, a very positive sign. I believe we should start seeing disclosures surrounding bookings, ARR, and retention numbers, among other things.

Valuation

At a CAD $6.00 share price, and with 23.6mm shares out, Sylogist has a market cap of $142mm. Adding in net debt of $8mm, the enterprise value is CAD $150mm. During FY22, Sylogist generated CAD $56mm in revenues and $16mm in adjusted EBITDA. If management were to hit on their 15% organic revenue growth outlook for FY23, and EBITDA margins remain at their soft guided 25%, they will generate around $17mm in adjusted EBITDA, for an EV/EBITDA of around 9.0x. given the margin reduction to 25% from 30% in FY22, I’d view FY23 EBITDA margins as trough moving forward, especially given the potential operating leverage I discussed as well as the continued revenue shift toward cloud subscription services. In a normalized scenario I see EBITDA margins creeping back up toward 30% over time.

As mentioned, Sylogist is targeting mid-teens organic growth from here, and recent results indicate that they have been under-promising and overdelivering. Just a few quarters ago, management’s outlook called for low double-digit organic growth, which they easily surpassed during the past two quarters.

Q4 2022

The investments we made to jump start growth and the effective execution of our strategy over the last 18 months were even more evident in our financial results this quarter. I am pleased to announce that organic growth for our most recent quarter was a record 22%. This is 17% on an FX-adjusted basis, a full 26 percentage points higher than in Q1 2022. Subscription revenue is up 3% from last quarter, or 12% on an annualized basis.

Q1 2023

Momentum has continued in Q1 with Sylogist achieving record quarterly revenue of $15.9 million. That’s an organic growth rate of 21% or 17% on constant currency basis. This growth was broad-based across the business. Recurring revenue was strong in Q1 at $9.8 million, a 12% year-over-year growth rate. This was led by our cloud revenue which grew 14% year-over-year. We see this growth as a validating measure of how successfully we are executing our profitable growth strategy.

That said, my base case valuation assumes revenues can continue to grow at low double digits from here, as I don’t believe 18-21% organic growth rates are sustainable but welcome the chance to be proven wrong. However, at 9.0x EBITDA, before buybacks and M&A, I don’t believe the company has to grow 15-20% for this to work out well.

In terms of where margins ultimately end up, it’s difficult to be precise, but examinations of similar software businesses and conversations with management and industry experts indicate that there should be some leverage on both the gross margin and opex lines. In fact, there are opportunities that exist across nearly every line item on the income statement. As software subscription revenue continues to grow, and represents a larger portion of the business mix, and if Sylogist is successful in implementing channel partners, margins should see a material uplift, especially given the lack of cyclicality, largely fixed SG&A, and variable costs in sales and marketing should taper off with scale.

The importance of the eventual business mix and the use of channel partners can’t be overstated. Although certainly not apples to apples, a look at ServiceNow historical operating results show that they went from spending 42% of revenues on marketing in 2014 to 34% today, professional services revenues declined from 17% of revenues in 2014 to 5% today, and nearly 50% of their new ACV was influenced by channel partners during 2014, where that number stands at 75% today. You can imagine the effect this had on both gross and operating margins, which have expanded significantly during that time period. With Sylogist software gross margins in the 75-80% range, and with professional services making up 35% of TTM revenues, the setup is at least similar in terms of potential.

My base case valuation assumes low double digit revenue growth, a smaller amount of margin expansion, and no inorganic growth. In this scenario, Sylogist would generate somewhere around CAD $20-23mm in EBITDA by 2025 equating to 7.5x EBITDA on the low end, and 10x free cash flow. I think Sylogist can trade around 14-16x EBITDA based on improved perception and the characteristics discussed above, resulting in a share price that offers greater than 100% upside. This is before continued buybacks and M&A, and with only slight operating leverage and margin expansion. I believe these estimates are conservative. The business could grow faster than expected, they are currently repurchasing stock, and it’s very likely they will execute on additional deals. If Sylogist were to reinvest a chunk of free cash flow during the next 2-3 years, earnings power could increase considerably. I estimate that with $50mm invested in M&A, the economics of previous transactions suggest that EBITDA could increase by nearly 50%, which, on top of organic opportunities, would cause EBITDA to nearly double within the next few years. At Sylogist’s current multiple, $50mm in deployed capital could translate into an additional $65mm in incremental equity value.

The bear case offers 15-20% downside while considering scenarios I’d view as unlikely including zero M&A, mid-single digit revenue growth, no leverage on sales and marketing, channel partners, or new products, and places a 10.0x multiple on a disappointing 2025 EBITDA number. I think the more likely scenario in the event that internal growth investments disappoint, is that the business becomes a platform for M&A, management can buy back a lot of stock and the business would still be receptive to a takeout offer at a multiple higher than today’s valuation. Even if the bear case deserves consideration, the stock remains massively sold off despite today’s business being much better, with a re-vamped organization, better products, stickier revenues and real organic growth. Also important to note, absent multiple expansion, there is an attractive current IRR in place given the free cash flow yield + growth.

Without relying on relative valuations, sanity checks reveal that Sylogist trades at the low end of peer valuations, and below every relevant M&A transaction I could find among public sector software, small cap software, platform businesses and vertical specific companies. If you want to argue that Sylogist shouldn’t trade in line with true compounders such as Tyler, The Sage Group or Blackbaud (recently upgraded by Raymond and given a valuation of 19x FY24 FCF), I won’t push back too hard, but a multiple 6-7 turns lower than the median peer valuation, despite having similar or better fundamentals seems unwarranted.

Given the history of outside interest, business improvements, cash flow and unlevered balance sheet, Sylogist could also find themselves on the receiving end of an acquisition offer, as the government/non-profit software space is incredibly acquisitive due to the fragmented nature of these businesses, value to both strategic and financial acquirers, and durability of the business models. Although the standalone return profile is attractive, management’s track record indicates that a sale of the business could be a likely scenario. Even share-losing Blackbaud, who has consistently underinvested in the business to the point of declining revenues and margins, finds itself in the midst of a take-private offer from a private equity firm.

Risks

• Competition
  • Larger organizations enter into Sylogist’s end markets and try to undercut on price to gain share
• Recession
  • Non-profit funding, donations, grants get cut, IT budgets decline significantly
• Margins never lift
  • The company isn’t successful with operating leverage
• M&A risk
  • Integration
  • Valuations
  • Returns on capital
• Scaling costs more than they expect
  • Internal investments never taper off, or worse, keep increasing to stay competitive
• No pricing power?
  • The company isn’t successful in raising prices over time
• Walled garden approach won’t work?
  • What if customers just ask them to integrate with current providers (competitors?)
  • Can’t open up the ecosystem because then you lose pricing / customers etc.

Catalyst

Growth / execution

New IR firm 

Management communication

Increased disclosures

Buybacks

M&A