‘We used to say we had long-term customer relationships – now we say we have lifetime customer relationships’
For most companies, corny lines like that are the product of a hyper-caffeinated marketing team. But Gentrack’s chief executive Ian Black was dead serious when he said it at yesterday’s investor briefing. He went on to explain why:
‘Once a utility decides on a billing and [customer information] system – and embeds it deeply in its operations and business model – it’s very difficult if not impossible for them to change. As a supplier, you would really have to drop the ball for that to happen.’
Junifer focused on start-up utilities
Margins should expand as growth continues
Purchase price fair; deal adds value
Gentrack’s customer captivity was a major drawcard when we first upgraded the stock to Buy in late 2015. So, at first, it was surprising to hear that the company had bought a UK-based competitor – Junifer Systems – that managed to grow from a standing start to 25 utility customers in just five years. Had we underestimated how easy it was for customers to switch providers?
As with most things, the devil is in the detail. Junifer isn’t poaching customers from competitors – it’s catching them while they’re still tiny start-ups.
The little fish
Deregulation of the UK energy market over the past decade has allowed businesses and individuals to switch energy providers, instead of being tethered to their local municipal utility. Energy retailers now compete for customers the old fashioned way – different pricing and packages, value adding services, promotions and marketing – all of which has seen a flood of start-ups trying to fill different niches.
Larger competitor Hansen Technologies and enterprise software heavyweights such as SAP cover the big end of town – including the UK’s six major energy utilities, which together have an 85% market share. Here, customers are particularly ‘sticky’ and almost never change billing providers unless there’s a merger.
But Hansen and SAP’s systems are generally custom made and can cost millions to develop. The new energy start-ups needed to find a billing software provider with a relatively cheap and simple offering. Gentrack and Junifer were the clear choices.
With the purchase of Junifer, Gentrack is now the number one billing provider to all but the ‘big 6’ large incumbent energy retailers, with 32 of the UK’s 44 small-scale utilities now using Gentrack or Junifer software. Management said that every single start-up in recent years had signed up to either Junifer or Gentrack – and no UK customer has ever left.
Being the dominant provider for small-scale energy retailers is a great position to be in. Independent energy retailers currently make up around 15% of the market, but the UK’s energy regulator expects that share to expand to 30% by 2020.
If Junifer and Gentrack can maintain their high share of new entrants, and the energy retailers themselves continue to take customers from the ‘big 6’, as the regulator expects, Gentrack’s UK business has some significant growth ahead. Junifer will also make a good platform for Gentrack to expand into other countries where deregulation is also creating lots of utility start-ups.
Growth has already been impressive. Junifer had revenue of a bit over £3m in the 2015 calendar year. That doubled to £6m in 2016, and it's expected to increase a further 70% to £10.8m in 2017 – with a bit over half of that being recurring subscription revenue.
Earnings before interest, tax, depreciation and amortisation (EBITDA) is expected to be £4.2m in 2017, giving Junifer an impressive EBITDA margin of 38% compared to Gentrack’s 29%. Management attributed the difference to the extra operating leverage associated with Junifer’s out-of-the-box ‘software as a service’, compared to Gentrack’s more tailored system. Pre-packaged software has a higher proportion of up-front fixed costs, so additional revenue falls quickly to the bottom line.
Despite Junifer’s higher margins, management still believes this to be a ‘synergistic acquisition’ and expects to remove duplicate costs over time, which should improve margins further.
The purchase price also seems reasonable – £42.0m (NZ$74.6m), or around 10 times expected EBITDA for 2017. Gentrack itself trades on a forward EBITDA multiple of 12.
Junifer is riskier and less established – it’s almost a start-up itself, being only five years old – but given the company’s fast growth and high margins, the price looks good. If the market doubles over the next few years, as the regulator expects, and Junifer can maintain its competitive position, the purchase price may be a steal.
Really, we’re stretching to find anything about the deal we don’t like. The only slightly disappointing element is how the purchase will be funded.
To start, Gentrack is taking on £17m of additional debt. No-one would accuse us of being fans of debt, but in this case Gentrack has a pristine balance sheet and the debt is in British pounds, which is very low cost with an interest rate below 2.4%. All things considered, we won’t lose any sleep.
The next element of funding is a share placement to private equity firm HgCapital and to Junifer’s management team, worth £20m and £3m respectively. In total, around 11m shares are being issued, which will dilute existing shareholders by around 15%.
We would have preferred the company to offer shares to all shareholders – rather than favour one large one – but there are benefits to the current setup: the placement to Junifer’s management – which also carries a two-year restriction on trading – aligns its interests with Gentrack shareholders to ensure a smooth transaction and management’s ongoing commitment to grow Junifer.
The placement with HgCapital is also strategic: HgCaptial is a £9bn funds management business focused on application software with ‘deep investing experience in the renewable energy, smart energy management and utility billing software sectors’. HgCaptial’s senior partner is to get a seat on Gentrack’s board of directors and his experience and relationships won’t go astray.
Diluting shareholders is always a bitter pill. However, Gentrack’s executives own roughly a quarter of the company’s stock; if they’re willing to be diluted, they clearly see value in the deal.
Management estimates that Junifer would add around 10% to earnings per share for the year to September 2017 if it had been owned for the entire year. Management also reiterated its long-term goal for 10% growth in revenue and EBITDA before the inclusion of acquisitions.
The stock has doubled since we recommended buying Gentrack 19 months ago, putting it on an underlying price-earnings ratio of 26. We’re increasing the price guide slightly and continue to recommend you HOLD.
Note: With several substantial shareholders, Gentrack’s stock is highly illiquid with a large spread between the bid and offer prices. To ensure you aren’t caught overpaying, it’s important your purchase orders have a limit price and are not made ‘At Market’.
Disclosure: The author owns shares in Gentrack and Hansen Technologies.