Thursday, July 12, 2012

CEGID Group S.A. - Business Software


CEGID Group (Cegid) is a 29 year old business that has grown to become one of Europe's leading business software firms. The core of the business is its dominance in management software solutions for certified public accounting firms, a dominance made possible by its long-term strategic partnership with the CPA profession in France. (Indeed, the software suite was developed in partnership with CPAs).

Cegid took advantage of its mastery of this niche to expand into adjacent markets: taxation, treasury functions, and financial reporting, mostly for middle-market companies. It now has 36% market share in those adjacent markets.

Using these services as an introduction to its wares, it has expanded further, into branded, modular enterprise management software suites that encompass human resource management, merchandise management, procurement, logistics, loyalty program tracking, and so forth. 

Today, Cegid has an installed base of more than 95,000 customers, spread among eight business lines and comprising companies of every size. The original certified public accountant market accounts for just 26% of Cegid’s revenue, while custom in the retail, restaurant, hotel/resort, manufacturing, and public sectors account for the remainder. 

Half of Cegid's sales consist of recurrent revenue, and the transition to SaaS among its installed customer base is growing fast. A non-random sampling of Cegid’s clients includes L’Occitane, Longchamp, Quiksilver, Devanlay Lacoste, Billabong, Calvin Klein Jeans, Club Med, Darjeeling, Guess, L’Oreal, and Habitat.

This is a summary of Cegid’s operating performance over the last 7 years:




Revenue growth has been in the region of 7.6% per year, compounded; operating profit has grown a slightly faster at 8.5% per year; and the marginal return on invested capital –  growth in operating profit per euro growth in operating assets – is 25.7%.

Whereas the competitive position of James Halstead is almost entirely premised on neo-Ricardian principles, Cegid's competitive position relies on that combination of specialization, customization and installation known collectively as "switching costs".  The uncertainty is in the original sale; after that, the customer is, more or less, locked in. Switching from one product or provider to another has costs – in re-training, disrupted systems, installation fees, and so on – that, unless Cegid makes a catastrophic mistake or is resolutely unresponsive, won’t be borne quickly or easily by its customer base. Such a defensive line -- more Passchendaele than Maginot -- is not easily breached by competitors.

How much, then, is this business worth?

Although Cegid has grown at a reasonably brisk pace over the past ten years, there is, I think, no particular reason to believe that it must grow – despite management’s wish that it continue to do so. Indeed, because of the effectiveness of switching costs as a barrier to entry in the enterprise software space, most of Cegid's growth has been acquired rather than organic. I am therefore reluctant to place a value on growth.

There is, however, strong justification for believing that the franchise -- that is, the stream of profits that will flow from servicing the already installed base of customers -- is reasonably secure.  The nature of the barriers to entry, as well as Cegid’s history of retaining clients, argues for that.  

I venture, then, that it’s reasonable to assign a 7% discount rate to Cegid’s normalized profit – an unlevered operating P/E ratio of 14.5x. (Some readers may have more faith in EV/EBITDA than I do; for them, the corresponding EV/EBITDA multiple is 5.13x).

Applying that multiple to Cegid's normal after-tax operating profit values the enterprise at  €335 million, and the equity €253 million. The 8.81 million shares therefore worth in the neighborhood of €29 each, 100% above where they're trading at the time of writing. 




Disclosure: I have a position in Cegid.

4 comments:

  1. Curious how you came up with a few of your metrics / calculations...

    How are calculating owner earnings, return on operating assets, & cash return on gross cash invested? Also, are you using 'net' working capital to come up with operating assets?

    Finally, how did you come up with a normalized after-tax profit?

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  2. Thanks for the questions:

    After-tax operating profit = (EBIT + amortization of acquired intangibles + the interest expense embedded in any operating leases) less taxes applied to this amount.

    “Owner earnings” = after-tax operating profit minus net interest, lease interest and other, non-operating expenses, after tax minus minority interest.

    Return on operating assets = after-tax operating profit divided by operating assets

    Where:

    Operating assets: (operating) working capital + net property, plant and equipment + operating leases, capitalized at 7x + any intangible assets that have to be replaced in the future (like software).

    and

    Operating working capital = trade receivables + inventory + prepaid expenses minus trade payables minus accrued expenses

    --

    Gross cash invested = undepreciated property, plant and equipment + capitalized operating leases + operating working capital

    Cash flow = cash from operations + debt and lease interest expense, after tax.

    --

    I will do a write-up at some point, explaining and justifying this methodology, but, for now I’ll say that:

    I find it useful to separate out the business itself from the way in which the business is financed. Having done that, ROIC (operating profit/operating assets) tells you how good the business is: is it earning its cost of capital? is it better than other businesses in the same industry? Is it improving or deteriorating over time? Etc

    The Cash Return rate will give clues about whether depreciation s being understated, whether goodwill write-downs are distorting the true picture of the business’ health, how much actual cash is being generated in return for the cumulative cash invested in the business, and so forth.

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    Replies
    1. Started taking notes from your site, love the information, but had a quick question. I am starting your site from the beginning as well so if you answer my questions in later posts disregard this comment.

      Under your explanation of how to calculate Operating Assets you put to capitalize operating leases at 7X, why 7X? Is that a number that will generally lead to a pretty safe estimate? Are there instances where I should use a higher or lower number?

      Thanks in advance for any of my questions that you might answer.

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    2. Thanks for the question.

      What one is trying to do is to reconstruct the value of the asset that is being employed. The formula is:

      Asset Value = Rent / (r + (1/Asset Life))

      where r is the company's cost of debt.

      r at 4% and an asset life of 10 years will give you an asset value of 7 x rent (with 30% of rent as imputed interest and 70% as imputed depreciation).

      It's worth constructing a mini spreadsheet with the above formula so that you can plug in your own r, asset life and rent values.

      Whatever capitalization rate you use shouldn't affect net income / owner earnings / FCF. Make sure that you have appropriately accounted for the tax shields on the imputed interest expense embedded in rent.

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