One of the newest investments in the Forager Australian Shares Fund doesn’t look like much of a value stock. Losses over the last five years total $22m. It doesn’t look like much of a growth stock either. Revenue has only grown 5% per year over the same period. And it’s not exactly bombed out: the share price is up by a third in 2019.
So why have we bought shares of RPM Global (RUL)?
The company is one of the few listed global enterprise software providers in Australia. It operates in a space well known to Australians: mining. Of all the world’s mining software, 60% has been developed in Australia. RPM’s software helps clients work out when to mine sections of a deposit, when dump trucks need a service, and how to best budget for future mine profitability.
The business started its listed life as Runge more than a decade ago. Then, mostly a people- oriented mining consulting business, it struggled through the GFC and the subsequent few years. RPM still owns that mining consulting business and a coal testing laboratory. In late 2012 the company installed a new managing director and began a major transformation.
Skills and skin in the game
Richard Matthews, a veteran of the Australian enterprise software space, made major changes. He cut staff numbers by 40%, installed new senior executives and upgraded the company’s stale software suite. New products and a few acquisitions followed.
Since Matthews focussed the company on the software business, recurring maintenance revenue from installed software has grown by 13% per year. Because the product is difficult to replace, less than 5% of this revenue stream is lost every year.
But why hasn’t this increasing revenue translated into profits for RPM?
Building that software hasn’t been cheap. Software development spend more than doubled over the last five years to $14m per year. With work on a few new products now completed the development spend declined last year and will continue to fall.
Spreading the revenue out
The company has also changed the way it sells its software. A few years ago a client would have purchased a perpetual license upfront and paid a maintenance fee every year. Now, the majority of RPM’s software is being sold on a subscription model, equal annual fees instead of a big upfront payment and a much smaller maintenance fee.
But that means a hole in revenue and profits in the first year of a sale. Over three years the total amount received under both models remains the same. And over ten years the subscription model results in RPM receiving 80% more revenue.
Performance better than it looks
Adjusting for lower expected software development spend and the move from perpetual licenses to subscriptions makes for a big change to profits. Earnings last year would have been double the reported level.
Matthews also has form turning around and selling software businesses: first Mincom and then eServeGlobal (which remains listed but sold a big division). With a high corporate overhead, any sale will allow the acquirer to reduce costs dramatically. Owning 3.5% of the company, all acquired on-market, Matthews has a big incentive to maximise value if any bidder comes knocking.
In the meantime the business will continue to grow a valuable stream of cashflows. About 5% of the current market cap (after adjusting for cash holdings) will be generated in free cash flow this year. After three years of growth and strong cash generation, that 5% would grow to 19%. RPM looks to be a rare find: a growing recurring revenue business at a valuation a value investor can live with.
This is an excerpt from the upcoming December Quarterly Report – if you would like to receive this report (and all future reports) in your inbox, you can register to do so here.
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