Description

This investment is ideal for PA due to it's size and for investors looking overseas. 

All figures are in Swedish Krona or SEK. 1 USD is equal to 9.05 SEK. It is easier to get a relative idea of value since most their costs/acquisitions are done in that currency.

Overview

Vitec is a software company that offers industry specific business applications known as Vertical Market Software (VMS) in the Nordic market employing 467 people. VMS differs from horizontal market software (HMS) in that HMS could serve many different businesses (i.e. Microsoft Office Excel) whereas a VMS serves only one specific business or industry (like Blackboard is for education). Vitec offers its services in a variety of industries including real estate and property management, energy management, auto dealerships, finance, media and health, through its subsidiaries. VMS has many benefits such as:

• ·         High switching costs, their services are mission critical
• ·         High recurring revenue 77% for Vitec
• ·         Low maintenance capital expenditure
• ·         Long lead development times
• ·         High margin and ROC business: 21% EBITDA margin, 20% return on capital and 43% return on equity with minimal debt

Vitec is based in Sweden and plans to consolidate mature VMS in the Nordic area with a potential market of 100 acquisitions and total turnover of 4 billion SEK, 7x Vitec’s current revenue.

Business Segments:

The two biggest revenue generators for Vitec are the Estate Agent and Real Estate subsidiaries comprising 65% of the revenue. Here is a rough breakdown of revenues by subsidiary:

• 1.      BU estate agent provides software for real estate agents and companies building new apartment houses. The software is used by 90% and 70% of the Swedish and the Norwegian real estate brokers respectively. The software is a Microsoft gold partner[1].
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• 2.      BU Real Estate provides a software platform for building owners, construction and management companies, property managers and real estate developers. Services include rental administration, development and maintenance.
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• 3.      BU Media provides software to newspaper and other media companies.
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• 4.      BU Energy provides forecasting software system of electricity and heat demand, wind power, and software supporting the technical management and maintenance of the energy distribution networks. It is used for short term forecasting (1-10 days) by utilities and other companies. Aeolys Windpower is used for 8% of Sweden’s total wind power forecast
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• 5.      BU Health provides data management and electronic medical records used for health care in Finland and is a new VMS market they entered in 2015.
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• 6.      BU Auto provides software for the Norwegian and Danish automotive sector with support for sales, purchasing inventory control, billing accounting and salary. The auto industry is a new VMS they entered in 2014 by acquiring Autodata of Denmark for 33 million SEK:
• a.       38 million in sales,
• b.      100% recurring revenue and
• c.       EBITDA of 6.4 million.

Then in 2015 acquiring Data Mann and Info Easy for less than 1x sales with 70% and 50% recurring revenues respectively. Through Data Mann they entered new VMS in the legal profession and IT systems for the dry goods industry.

• 7.      BU Finance and Insurance covers a range of financial industries including wealth management, banking, insurance, etc. focused mainly in Denmark.

Thesis

Vitec’s thesis is based on their ability to grow and operate efficiently.

There are 3 ways Vitec can grow:

• 1.      Organically by winning new contracts or leveraging untapped pricing power.
• 2.      Inorganically by acquiring businesses in VMS markets they currently operate
• 3.      Inorganically by acquiring businesses in new VMS markets.

Their acquisition targets possess the following qualitites:

• 1.      Niche VMS
• 2.      Dominating market position (#1 or #2) 
• 3.      High recurring revenues
• 4.      10-100 million in SEK turnover
• 5.      5-7 times EV/EBITDA purchase price

Their target market has 100 businesses with 4 billion SEK in sales, but they are currently in negotiations with a few of them totaling 350 million in turnover. To put this in perspective, their 2016 revenues came at 675 million.

In 3 years they will be able to:

·         Buy a few businesses with cumulative turnover of 350 million

·         Have signed a revolving credit facility of 250 million with bank Nordea on a four-year term.

For FY2016 Vitec made 142 million in sustainable free cash flow calculated as below:

Trading at 13x sustainable free cash flow, Vitec has been able to grow at a 13% annualized clip over the past five years, whilst producing an average return on invested capital of roughly 20%. 2016 was a year of low acquisitions but we don’t believe the situation to be permanent, as management has demonstrated an opportunistic acquisition mindset. 

Why does this acquisition strategy work?

Vitec is careful regarding the price they pay for companies with great economics. Most of these software companies are mature businesses where the founder/operator was the software engineer in the late 20^th century. Most of the CEOs sell for cheap because they are not as business savvy and most of the time they want to retire or cash out. Vitec was founded in 1985 in a similar fashion, the current CEO and VP decided to write a software for energy management. It wasn’t until 2003 that they polished their business plan of acquiring and consolidating similar software companies.

Post-acquisition, Vitec produces operating efficiencies, consolidate them and offer a more comprehensive suite of services to it’s customers. Despite the business's untapped pricing power, Vitec prefers to raise switch costs via customer enlightenment - we do not doubt management will tap into pricing power over a longer-term horizon. 

Vitec provides for efficient movement of capital within its conglomerate, moving capital to its highest return investment. Once you build a track record, you gain a reputation on the industry for being the preferred seller; this is the subtle flywheel effect.

Customers

Vitec’s customers are very fragmented with a couple of hundred up to several thousand customers per market. Usually the software provided by Vitec is low cost relative to their revenue usually 1% of revenue. On the other hand, since the customers are usually small in size, that takes away the risk of developing the software in-house.

Risks

1.      Competition

a.       The biggest risk is a copycat, companies with financial power and business acumen trying to replicate their business model. That will increase target valuations and will decrease the number of potential acquisitions. So far, we haven’t found any company trying to emulate their business model.

2.      Size

a.       Once they reach a certain size, they will need to make bigger acquisitions in order to grow significantly. The risk in this case is the availability of targets, but so far they could at least increase revenues by 7x. The reason this inefficiency exists in such a market is because big software companies like SAP or Oracle don’t bother entering due to their large size.

3.      Alternative software

a.       As explained above, the likelihood of customers finding a similar software is hard. Developing it in-house or hiring consultants to provide a new one is costly and has high lead time. Nonetheless, Swedbank Fastighetbyra AB, a Swedish chain of real estate agents, did develop their software in house and fired Vitec. These situations have been rare and lack the magnitude to affect Vitec’s business model.

Catalyst

• Vitec recently got uplisted as a Swedish mid-cap company
• Further acquisitions