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SS&C Technologies (SSNC): Strong Recurring Revenue and a CEO With Skin in the Game

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SS&C Technologies (SSNC)

  • Price:  $60.66
  • Fair Value:  $95
  • Sector:  Technology
  • Industry:  Software

Disclaimer:  This article should not be considered investment advice.  Do your own research before investing and verify any claims or numbers stated herein.

Investment thesis

“Software is eating the world.”  That’s what Marc Andreessen, founder of venture capital firm Andreessen Horowitz wrote in 2011.  Ten years later it still rings true.  Every part of our lives is driven by software.  Companies and various other organizations have their systems driven by software.

The thing that’s changed over the past decade however, is that now, instead of companies having the actual software installed on their systems, they are simply buying the rights to use software on the cloud.  Firms rarely buy software these days; instead they buy the service the software delivers instead of the actual code.  This is what’s called software as a service (SAAS).

SS&C Technologies provides software services to financial and healthcare organizations.  It’s one of the largest providers of software in the financial industry.  Specifically, it’s the world’s largest hedge fund and private equity administrator as well as the largest mutual fund transfer agent.  (Mutual fund transfer agents maintain records of shareholder accounts; calculate and disburse dividends; and prepare and mail shareholder account statements, federal income tax information and other shareholder notices.)

We believe that SS&C is a company that will benefit from various secular tailwinds over the coming years, making it a great investment to hold for the long-term.  Specifically, these factors include:

  1.  The continuing trend of financial and healthcare companies migrating to the cloud to run software that powers their organizations.
  2.  Further adoption of remote work environment policies by these companies.
  3.  Increasing complexity of financial and healthcare regulations will require software that can help navigate compliance.
  4.  Increased demand for transparency, efficiency, and risk management in financial services, especially after learning the lessons of the 2008-2009 financial crisis.
  5.  An aging population will require more sophisticated healthcare solutions; this will require software that can provide data and analytics to healthcare organizations; in turn, healthcare providers will be able to improve their customer’s experience through better access to data and an enhanced user interface.
  6.  Increasing need outside the US for complex financial software to manage investments as other countries get wealthier, especially in the Asia-Pacific region.

SS&C is in a strong position to capture a large part of the total addressable market for financial and healthcare software solutions going forward.  This is a market that’s only increasing and growing in value.  Their client base is still only a fraction of the total number of financial services providers globally.  They have plenty of room to grow, both through acquisitions (55 businesses acquired since 1995) and organically.  

One of SS&C’s competitive advantages is their history of being a trusted provider to financial and healthcare companies since 1986.  Their software services are a “sticky” product, meaning once customers have been using it for a while across their organization, it makes it harder to transition to a competitor’s products.  This is usually because there are high switching costs when changing software providers.

Part of this is because a company would have to take the time to re-train their employees to use new software.  This works in SS&C’s favor as can be seen by their 96% revenue retention rate in the last 12 months and over 90% for each of the last 5 years.

Another factor that gives SS&C a competitive advantage is their proprietary software.  Since they own all their software and control the source code, they can quickly identify and deploy product improvements and respond to client feedback.  They have a highly diversified client list and no client represents more than 5% of their revenues.  This helps make them a resilient company.

We think that SS&C Technologies stock will be a long-term compounder as they continue to benefit from all the above factors and grow their revenues.  In addition, the stock is attractively priced as we’ll attempt to demonstrate below.

Company & Industry Overview

SS&C Technologies provides software as a service (SAAS) to financial and healthcare companies.  The buyer gains the benefit of the use of the software without having to acquire data centers to house and run software.  This lowers a company’s fixed costs and allows them to spend less time on owning and integrating assets, and more time on providing value to their customers.  This makes a company much more efficient.

SS&C was founded in 1986 by William Stone.  He’s still the CEO and also the largest shareholder, owning 13% of all shares.  This should give you confidence as an investor.  It shows that the founder and CEO’s interests are aligned with yours. Mr. Stone has some skin in the game and that should be comforting to us as investors.

SS&C’s financial software helps companies with securities accounting, front-to-back office operations, performance and risk analytics, regulatory reporting, and portfolio management.  Their clients include alternative investment funds, investment management firms, institutional and retail asset managers, insurance companies, registered investment advisors, wealth managers, banks, and brokerage firms.  They provide an attractive alternative to clients that don’t wish to install, manage, and maintain complicated financial software.

The company is the largest fund administrator for alternative investment managers including hedge funds, private equity, real assets, and fund of funds. They help to provide transparency of a fund’s assets and the valuation of those assets.  Their clients include some of the largest and well-recognized firms in the financial industry.

An interesting thing to note is that SS&C is highly optimistic about growing their revenues in the Asia-Pacific part of the world.  They’ve made recent acquisitions that have expanded their footprint into Asia, and over the last three years, revenue from that region has increased 84% to $207 million.  They view this as a compelling growth opportunity in the years to come.

SS&C’s healthcare software includes solutions for pharmacy and healthcare administration companies and helps them with information processing and payment integrity needs.  These solutions include claims adjudication (medical claims adjudication refers to the determination of the payer’s responsibility with respect to the member’s benefits and provider payment arrangement), benefit management, care management, and business intelligence services.  Their healthcare clients include individual and government sponsored health plans and healthcare providers.

SS&C has 22,000+ employees across 150 offices in 35 countries worldwide. They have 18,000+ clients that span the financial service and health industries, making their revenues highly diversified.  75% of their revenues come from North America and 25% outside North America.  No single client represents more than 5% of revenue.

SS&C’s software services are provided under contracts with initial terms of one to five years and require monthly or quarterly payments and are subject to automatic renewal at the end of the period.  This results in a high contractually recurring cash flow base.  Their revenue retention rate in each of the last five years has been over 90% on their software-enabled services.  This goes to show that SS&C’s customers are highly satisfied with the value they’re receiving.

As you can see from the below pie chart, SS&C controls a relatively small portion of the pie for financial services software, but has been aggressive about growing that share.  This is demonstrated by the high volume of acquisitions they’ve made over the years. (55 companies acquired since 1995.)  Talking about acquisitions in the most recent earnings conference call, William Stone stated: “Well, we constantly go after acquisition candidates, and we’re methodical about it, and then we’re also disciplined about what we’re going to pay.”

The company mentions that it intends to continue to employ a disciplined and focused acquisition strategy to broaden their product offerings and add new clients.  This has allowed them to grow revenue at a 34% compound annual growth rate (CAGR) over the past 9 years.

Additionally, as you can see below, the global financial services application software market is growing at a blistering pace.  It has a CAGR of about 8% and is expected to reach a market value of $143.8 billion by 2025.  SS&C is in a prime position to garner a good share of this market.

Source:  https://univdatos.com/news/Global-Financial-Services-Application-Software-Market-2019-2025-to-attain-market-value-of-USd-143.8-billion-by-2025

Software spending is only increasing as the financial services and healthcare landscapes get ever more complex.

There’s also a trend in the financial services industry toward AI, robo-investing, automated investing strategies, and a push for investment managers to lower fees and be more efficient.   This is a trend that helps SS&C sell their software.  This is because it helps managers streamline the investment management process by constructing, analyzing, and managing a client’s portfolio with greater efficiency.

In the healthcare industry, an aging population will result in the need for more sophisticated healthcare solutions.  With an average of 10,000 people turning 65 years of age per day in the US, there will be an explosion of healthcare data that will be generated over the years.  This data needs to be utilized and analytics provided so that healthcare companies can provide the best care while running their organizations efficiently.

Now that we’ve discussed qualitative factors about SS&C’s business, let’s look at some quantitative metrics and ratios.

Financial Metrics

Now we’ll look at some metrics for SS&C’s stock and calculate factors such as what rates of return it earns on its capital and how cheaply or richly the stock is priced as a multiple of earnings and cash flows.

As of 9-22-20

  • Price:  $60.66
  • Shares Outstanding:  265m
  • Market Cap:  $16,075m
  • Enterprise Value (EV):  $22,644m

(EV = market cap + long-term debt – cash)

  • P/FCF:  12

(P/FCF = price per share divided by free cash flow per share for trailing 12 months)

  • EV/EBITDA:  13

(EV/EBITDA = enterprise value divided by earnings before interest, taxes, depreciation, and amortization for the trailing 12 months.)

  • ROE:  10%

(ROE = net income for trailing 12 months divided by shareholder’s equity at the beginning of the period.)

  • ROC:  11%

(ROC = net income for trailing 12 months divided by beginning capital, whereas capital is shareholder’s equity plus long-term debt minus goodwill minus intangibles.  In this case, SS&C has a lot of goodwill and intangibles which makes capital negative in the denominator, so for this ROC we only subtract goodwill from capital to get a positive number.)

  • ROC2:  49%

(ROC2 = net income for trailing 12 months divided by beginning capital.  “Capital” in this case is calculated as current assets minus current liabilities plus net property, plant, & equipment.  This is an alternative calculation for return on capital.)

  • FCF/REV:  29%

(FCF/REV = free cash flow for trailing 12 months divided by revenue for trailing 12 months.)

  • P/E = 32

(P/E = price per share divided by earnings per share for the trailing 12 months.)

  • P/S = 3.5

(P/S = price per share divided by sales per share for the trailing 12 months.)

  • D/E = 129%

(D/E = long-term debt divided by shareholder’s equity.)

  • D/Market cap = 43%

(D/Market cap = long-term debt divided by market capitalization.)

  • Operating Margin:  20%

(Operating Margin or EBIT Margin is earnings before interest and taxes divided by revenues for the trailing 12 months.)

  • EBIT/TEV = 4.2%

(EBIT/TEV = earnings before interest and taxes for the trailing 12 months divided by enterprise value.)

  • GP/TTA 5-yr avg. = 155%

(GP/TTA 5-yr avg. = gross profit divided by total tangible assets, an average of the last 5 fiscal years.)

(See “Definition of Terms” section below for a further explanation of what all these metrics mean.)

Interpretation of Above Metrics

Looking at the above metrics, we’d say that SS&C looks cheap based on a P/FCF ratio of 12 and an EV/EBITDA ratio of 13.  These are very low for a high margin software company.  However, a thing to note is that they have a large amount of debt on their balance sheet.  Their interest expense took up 36% of their operating income (EBIT) in the past 12 months.  This is why these ratios look cheap.

Their D/E ratio is 129% which is high, but their D/Market cap ratio is 43%, which looks reasonable.  A positive thing to note is that most of SS&C’s long-term debt principal payments aren’t coming due until after the year 2024, so that gives them plenty of time to pay the debt down.

The ROE and ROC ratios don’t look too impressive at 10% and 11% at first glance.  However, these numbers should improve as SS&C pays down debt and more of their cash flow gets turned into net income.

On a P/E basis, SS&C looks expensive at 32 times earnings for the trailing 12 months.  This is because earnings are depressed due to high interest expenses. SS&C took on a good amount of debt to make all their acquisitions.  The positive thing to note is that they’re committed to paying down their debt quickly.  Over the past 2 years, they’ve paid down 16% of their long-term debt and look to be reducing it quarterly.

SS&C’s operating margin is great at 20%.  Their EBIT/TEV or enterprise yield of 4.2% doesn’t make the stock look cheap, but it’s reasonable.  Their GP/TTA 5-yr average is amazing at 155%.  (Gross profit to total tangible assets)  Since they have a lot of goodwill and intangible assets on their balance sheet, this makes their tangible assets very low, in turn making GP/TTA ratio high.

This is typical of many software and tech companies.  They don’t carry many tangible assets like factories or machinery or equipment.  Most of their assets are intangible in the form of software trademarks or patents.

The FCF/REV ratio of 29% is great.  This means that 29% of SS&C’s revenue is being turned into free cash flow from which they can pay dividends, buy back stock, and pay down debt.  Free cash flow is defined as cash from operations minus capital expenditures.

Another thing to note is that SS&C’s board of directors recently renewed their common stock repurchase program, and increased the program to $750.0M.

Remember, investors and the marketplace are always looking forward toward the future.  The above numbers represent the past and while they may give us a glimpse of how profitable or cheap the company is, what we really need to do is make some logical estimate of what earnings and cash flows will look for SS&C in the future.  This is what we’ll do in the next section as we construct a discounted cash flow (DCF) model in an attempt to estimate the value of SS&C’s stock.

Discounted Cash Flow Valuation

We’ll use a free cash flow model to estimate the intrinsic value of SS&C’s stock.  We’ll have to make reasonable forecasts for revenue growth for the next ten years as well as how much of that revenue is translated into free cash flow available to shareholders.  We use free cash flow after buybacks since the money that SS&C uses to buy back stock isn’t really available to us; it just reduces the share count.

Looking over the past several years however, we see that SS&C has not repurchased a meaningful portion of their shares, so we’ll assume their share count will stay fixed into the future.

In our model we assume that free cash flow after buybacks is 25% of revenue on average, similar to what it’s been over the prior 8 fiscal years.

We then make an estimate of what multiple of revenue we’ll be able to sell the stock for in year 10.  That’s called our “terminal value.”  The P/S ratio has averaged about 3.5 for SS&C over the past several years so we assume we can sell the stock for 3.5 times revenue in year 10.

We discount each year’s cash flow by a discount rate to get present value for today.  Finally we sum the discounted cash flows to get a value for the firm.  To get equity value we take this number and subtract debt and divide by shares outstanding to get an estimate of value per share for SS&C.

We come up with an intrinsic value of $94.97 for SS&C, representing 56% upside from the current price of $60.66.  Now, of course there’s many assumptions built into this valuation.  We assumed the revenue growth rate as shown above and assumed revenue will grow at an annual rate of 12.32% over the next 10 years.

This is lower than what SS&C has grown their revenue at for the previous 9 years of 34.17%.  In this way we are being somewhat conservative.

We also assume that free cash flow after buybacks averages 25% over the next 10 years, that we’re able to sell the stock in year ten for 3.5 times 2029’s revenue (our terminal value is 2029’s revenue of $14,810 times 3.5 = $51,836), and that the share count stays the same for the next ten years.

Here’s a link to the Google Docs spreadsheet so you can play with the numbers and assumptions yourself to see how they affect intrinsic value.

https://docs.google.com/spreadsheets/d/1e_9awarixbWGO1-eOg9CEGRFzG8DqGbiaIsxyhlxDFU/edit?usp=sharing

Relative Valuation

Now let’s compare and contrast some numbers to see how SS&C’s stock is priced relative to its competitors.  (See “Definition of Terms” section below for an explanation of what these ratios mean.)  I chose the two most direct competitors for SS&C, both of which are leading providers of financial services software, Envestnet and Fiserv.

It looks as though SS&C compares very favorably to its two most direct competitors.  It’s ROC is much better than Envestnet and on par with Fiserv’s. SS&C is also superior on the EBIT/TEV, EV/EBITDA, and P/E measures.  Its P/S ratio is slightly cheaper than the other two companies, and its operating margin is better.  SS&C’s debt to market cap ratio is higher than both its competitors.

Risks

Of course, investing isn’t without its risks and SS&C has several risks we should be aware of as investors.  Some include the following:

  1.  Their clients include companies in the financial services industry and any downturn in the general market, a recession, or other economic stability could cause their clients to suffer financially and therefore reduce the demand for SS&C’s software services.
  2.  SS&C has a relatively large amount of debt and any disruption to their business can potentially cause them problems in paying interest expenses and principal payments on that debt.
  3.  They may not realize the benefits from their acquisitions in the future and may fail to successfully integrate their acquired companies.
  4.  Any reduced participation in the financial markets due to increased volatility or other factors could reduce SS&C’s revenues since their fees are tied to market activity and assets under management of their clients.
  5.  SS&C faces significant competition in the financial services software sector from companies such as Fiserv, Envestnet, State Street, BNY Mellon, and other companies.  Some of their competitors are larger and have more resources.  If SS&C can’t outperform the competition with superior products and services, their revenues will suffer.

Ratings

  • Value:  3/5
  • Growth potential:  5/5
  • Balance Sheet:  3/5
  • Management:  5/5
  • Moat:  4/5
  • Overall Rating:  4/5

Disclaimer:  This article should not be considered investment advice.  Do your own research before investing and verify any claims or numbers stated herein.

Definition of Terms

Market cap:  This is the market capitalization or the value of the equity in the company.  It’s simply price per share multiplied by shares outstanding.

Enterprise Value:  This is the total takeover value of the firm.  It’s the value of equity plus the value of debt minus cash.

P/FCF:  This ratio is the price per share divided by free cash flow per share for the trailing twelve months.  The lower this ratio, the “cheaper” the stock.

EV/EBITDA:  This ratio is enterprise value divided by earnings before interest, taxes, depreciation and amortization for the trailing twelve months.  The lower this ratio, the “cheaper” the stock.

ROE:  Return on equity.  This is calculated as net income for the trailing twelve months divided by beginning shareholder’s equity.  The higher this percentage, the better.

ROC:  Return on capital.  This is calculated as net income for the trailing twelve months divided by beginning capital employed.  Capital is calculated as shareholder’s equity plus long-term debt minus goodwill and intangibles.  The higher this percentage, the better.

ROC2:  Return on capital 2.  This is another way to calculate return on capital, mostly applicable to industrial companies.  It’s the same as ROC above however “capital” is calculated as current assets minus current liabilities plus net property, plant, and equipment.  The higher this percentage, the better.

FCF/REV:  This ratio is free cash flow for the trailing twelve months divided by revenue for the trailing twelve months.  This represents how much of revenue is being translated into free cash flow that can be used for dividends or buybacks for shareholders.  The higher this ratio, the better.

P/E:  This ratio is price per share divided by earnings per share for the previous twelve months.  The lower this ratio, the “cheaper” the stock and vice versa.

P/S:  This ratio is price per share divided by sales per share for the previous twelve months.  The lower this ratio, the “cheaper” the stock and vice versa.  It’s usually used when companies have negative earnings per share, which makes the above P/E ratio meaningless.

D/E:  This ratio is total long-term debt divided by shareholder’s equity.  It represents how much debt a firm is using relative to its equity.  The lower this ratio, the “safer” a firm’s balance sheet is considered.

D/Market Cap:  This ratio is total long-term debt divided by market capitalization.  It represents how large a firm’s debt size is relative to its market cap.  The lower this ratio, the “safer” the firm’s balance sheet is considered.  This ratio is used when a firm’s equity is negative on its balance sheet.

Operating Margin (EBIT/REV):  This ratio is operating income divided by revenue for the past twelve months.  Operating income is also referred to as earnings before interest and taxes (EBIT).  The higher this ratio, the more profitable a firm is.

EBIT/TEV:  This is known as the enterprise yield.  It’s calculated as earnings before interest and taxes divided by total enterprise value.  The higher this percentage, the better.  If you flip this ratio around and take the inverse, it’s known as the enterprise multiple, and the lower that ratio the better.  They both represent the same thing however in that it tells you the “cheapness” of a stock.

GP/TTA 5-yr. Avg:  This ratio is gross profit for the previous twelve months divided by beginning total tangible assets.  Tangible assets are simply total assets minus goodwill minus intangibles.  The higher this ratio as a percentage the better.


Robert Nowak is the founder of RTN Investments, LLC.  RTN is a registered investment advisory managing separate accounts for clients and is modeled after Warren Buffett’s original partnerships.  RTN’s goals are the preservation of client’s capital and to outperform the S&P 500 on a rolling 5 year basis by investing in undervalued stocks of high quality companies.