Description

Upland is one of my favorite portfolio companies in the last several years. I feel that we know this company very well. I’ve met the CEO and CFO founders several times. I speak with the CTO on a quarterly basis. I’ve interviewed many customers and former employees of the companies that Upland has acquired over the years. The running joke in our office is that founder/CEO Jack McDonald is my adoptive father (a riff off of the episode of Always Sunny in Philadelphia where Mac tries to befriend Chase Utley https://www.youtube.com/watch?v=_6cEOk7x4HA). This write-up is admittedly not as thorough as I would like. If there is a topic you would like further explored then please let me know. I would be happy to provide more analysis. Doing so would be helpful to my thesis.

What’s the opportunity?

Upland is a relatively early stage, cloud-based version of Constellation Software. Why should this comparison get everyone’s attention? Because the Canadian software roll-up has annualized at 44% over the past ten years, a 3700% return. As outlandish as this might sound, I think Upland is a better business and it has the potential to match, heck maybe even exceed, this unheard of decade-long return. It’s a similar business model (acquire sticky, profitable software and run the business like a capital allocator), but it is better because Upland’s portfolio consists of modern, cloud-based subscription companies. I will describe the elements of this advantage later, but I believe the benefits of cloud and services-based architecture are material and they become more valuable as Upland scales.

What’s the valuation and return framework?

Upland is currently valued at 16x run rate EBITDA and a ~4% normalized FCF yield. I think that EBITDA and FCF per share can grow at +30% per year in a rather conservative scenario for a long time (model at the end). Constellation is currently valued at 23x EBITDA and is growing mid-to-high teens. I think Upland should trade at a premium. As it scales and the company enters the next phase of its growth (organic growth and solutions selling) I am reasonably confident that Upland will eventually trade at a premium to Constellation. Management has repeatedly expressed excitement because business is “getting easier.” They are getting better deal flow, banks are lining up to lend them more at better rates and customers are increasingly including Upland in enterprise-wide discussions. Buying businesses that are becoming higher quality usually works out well.

I underwrite a $65 current fair value at 22x current EBITDA. I think that fair value can compound at +30% per year for the foreseeable future, with further upside potential if Upland can meaningfully increase the velocity of acquisitions or further augment their organic growth rate as a result of efficient sales and marketing and solutions selling (I know I’ve used this term twice without explaining WTF I am talking about, I will later). 

The obvious objection – Upland is a rollup and I don’t do rollups

I hear you. It’s usually a good rule to have. But the founder/CEO who owns 8% of the company reads The Outsiders a lot, so we’re good (I’m kidding) (https://www.forbes.com/sites/forbesbusinessdevelopmentcouncil/2019/08/13/the-outsiders-revisited-business-lessons-for-consolidation-companies/#7ccd572e4fbc) 

Most rollups fail because 1) the business model lacks economic rationale (see my short write-up from forever ago on Swisher Hygiene, a low-quality business that had negative economies of scale) and 2) because roll-up management teams are prone to take big swings that usually result in epic whiffs (see MicroFocus’ acquisition of HPE). Jack McDonald, who again has most of his net worth invested alongside shareholders, has repeatedly told me that if he ever buys a company with substantially more than $25MM in revenue (meaning he is taking a big swing) then I should sell the stock immediately. Who says that? A guy that knows he’s playing the long game. 

So why should we invest in a software company run by a guy who reads The Outsiders and tells us to sell the stock if he does anything too aggressive? Because execution has been near flawless, the business model is really attractive and the runway for a decade of high growth potential is virtually guaranteed by the hundreds of billions of VC/PE dollars that have been/are being/will be invested in software businesses. 

Summarizing the strategy

Upland is a capital allocator and efficient operator in a large and growing market where pursuit of growth at all costs supersedes economic discipline. As illustrated in the graph below, VCs have dumped ungodly amounts of money into cloud-based software. This “up and to the right” trend is going to continue. Regardless of whether we are in a bubble, the world will continue to digitize. 

As an acquirer of modestly successful, but undersized and unprofitable businesses, Upland offers investors a way to ride the wave of SaaS, while at the same time taking advantage of some of the tulip mania. “Hot ice, that’s right, hot ice. I heat up the ice cubes. It’s the best of both worlds!” https://www.youtube.com/watch?v=gF8rlghyxJU

Upland’s business model is to 1) acquire subscale, but high-quality, SaaS-based software companies, 2) move them to AWS and 3) rationalize spend by prioritizing customer retention over organic growth. In doing this they improve the EBITDA margins from roughly break-even to 50% contribution margins. This margin profile is not hypothetical. Upland’s run-rate consolidated EBITDA margin is 37%, a 600 bps improvement from 2017 and 2,000 bps improvement from 2016.

Upland uses cash flow, debt and, about every two years, equity to fund their growth. They acquire businesses at 5-8X EBITDA. Levering the company at 2.5X to 4X EBITDA means that they can grow meaningfully without needing much cash or equity issuance. Following their recent equity offering, Upland is levered at 2.5X debt to EBITDA. I believe they can grow 30% for several years without issuing equity or meaningfully exceeding 3.5X debt to EBITDA. With the stock trading at 16XEBITDA (which I think is discounted), prudent equity issuance should be viewed positively.

Over the last few quarters Upland’s organic growth rates have improved from negative mid-single digits to positive single digits. I think they can sustainably approach double digits over the next two years. Until last year, Upland would more or less let go all of the sales people from the companies that they acquired. As the business has scaled, and margins have achieved a level necessary to prove out the model and stabilize the business, Upland has started to retain sales people and is beginning to explore various cross-sell and solutions selling strategies. In much the same way that 3D printing is meaningfully more efficient than traditional manufacturing because they utilize inductive processes versus deductive processes, Upland’s investment in sales people are likely to be far more efficient than the normal SaaS-based company. They will only keep productive people, and because they know exactly how effective those people were within the company that was acquired, there is relatively little risk that the sales person will be a dud.

Once acquired, Upland runs software businesses like they are for-profit organizations instead of not-for-profit lottery ticket machines. VCs and founders are great at bringing ideas to life. But unless the business is scaling to the moon, they very quickly become the wrong men and women for the job. Most start-ups fail. A few are wildly successful. But what happens to the ones that don’t IPO or get sufficient scale (+$25MM in revenue) to get acquired by the likes of Vista or Thoma Bravo? Increasingly, they get acquired by Upland. 

Upland has emerged as one of the “go to” acquirers for these assets. As Jack is fond of saying, over the last 20 years he has signed 45 LOIs, closed 41 acquisitions and never been sued. CFO Mike Hill will tell you that none of the 22 Upland acquisitions have meaningfully underperformed expectations. Based on the cumulative financials, I believe him. They announce revenue for every deal that they do. Current run rate revenue is $220MM, against $200MM of acquired revenue. A few years ago, net dollar retention was around 90%. It’s currently 98%. As mentioned previously, organic growth rates only recently turned positive. So all of the “growth” has come in the last few quarters. The business is getting better as they scale. The company has 20 straight quarters of meeting/beating guidance. All in, since 2012, cumulative M&A deployed is around $483MM. The current $81MM in runrate EBITDA implies a <6x multiple. 

I get the strategy and I see that they are good at it, but what exactly do they buy?

Upland buys businesses that deliver work management solutions to their customers. If that sounds awful broad that’s because it is. If you haven’t heard, software is eating the world. It’s not uncommon for a reasonably sized company to have a thousand software vendors. The tail of niche enterprise software companies is very long, offering Upland a functionally unlimited list of potential acquisition targets.

As best I can tell Upland will acquire just about any software business that helps companies automate processes and serve customers better. They’ve acquired 23 businesses since 2012. There is significant breadth, and even a bit of overlap, in the businesses that Upland has acquired. The shared criteria is that the acquired companies have 1) $5-$25MM in revenue, 2) +90% net dollar retention, 3) are growing 10-15%, and 4) deliver enterprise-grade SaaS products to large customers with +$25K in ARR per account. 

Here is a picture depicting the acquisitions to-date. While none of these are going to offer knock your socks off growth, they are each reasonably high quality. As we move forward, the individual features of these acquired businesses will get broken down into constituent parts (microservices) and reassembled into product enhancements and even entirely new offerings (solutions selling).

Solutions selling, microservices and cloud insights

Solutions selling means focusing on the customer’s problems as opposed to just trying to push the company’s existing products. While this is mostly a BS platitude espoused by other technology companies that profess customer love, Upland is uniquely capable of delivering products that customers want in an economically efficient manner.

For those of you who haven’t spent much time researching software, the move from monolithic software architecture to services-based architectures is one of the major trends in the modernization of software applications. Here is a decent summary of the differences between monoliths and microservices - https://dev.to/alex_barashkov/microservices-vs-monolith-architecture-4l1m. This illustration synthesizes the difference well. 

The “so what” for Upland is that their software is a services-based architecture. This gives Upland the ability to mix and match functionalities across their acquired companies to either materially improve an existing customer’s experience (driving improved retention and pricing power) or create entirely new software products. My two favorite analogies are using Lego pieces to “free build” new structures and a references back to childhood soda machine suicides.

Furthering the above illustration, Upland has built a unified user interface called WorkCenter that serves as the platform for serving up capabilities from their portfolio of acquired companies. Here is a screenshot.

Upland released their first custom-built solution suite in April(https://www.businesswire.com/news/home/20190403005454/en/Upland-Announces-Ground-Breaking-Professional-Services-Automation-Solution). Upland PSA (Professional Services Automation) combines functionalities from four separate acquisitions to deliver and platform that covers the full lifecycle of a professional services engagement. Although I don’t have details on the costs associated with assembling Upland PSA, or its revenue contribution, management is very excited. The CFO has told me that they can churn these products out at virtually zero cost. In my last call with the normally subdued CTO he exclaimed that solutions selling will be a “game-changer” and that it has pulled Upland into CIO-level conversations at large enterprises which would previously have been unfathomable.

The final point I’ll make here is to highlight the insight and iteration opportunities that come from selling cloud-based subscription software. Customers don’t use 70% of the features that come with the software they buy. Running software for your customers on the cloud gives you visibility into which features are getting used and which are not. By knowing exactly how your customers use the software you sell them, you are dramatically better off when it comes to pricing your products and, in the case of Upland, providing new features/functionalities/entirely new platforms. 

Financial model

Here is a model for the next several years. I think the biggest takeaway is that Upland doesn’t have to materially accelerate their M&A cadence (they have acquired $72MM in revenue over the last twelve months) and the assumptions around margins contemplate only modest leverage.

Catalyst

Compounding