Growth outlook maintained

Esker is a document process automation (DPA) software developer, specialising in moving business processes from paper-based to digital. Its software is used to automate the purchase-to-pay and order-to-cash cycles. The company principally operates a SaaS delivery model and the majority of revenues are generated from customers using its on-demand solutions. Esker’s revenues are well spread geographically, with 52% from Europe, 42% from North America and the remainder from Australia and Asia.

Esker reported revenue growth of 14% for H117 (9% organic constant currency growth). Operating profit grew 4% y-o-y to generate an operating margin of 15.6%. Share count increased over the period from a combination of option exercises and shares issued in part payment for e-integration. This resulted in reported basic EPS increasing 2.6% y-o-y. The combination of a stronger than expected contribution from the recent e-integration acquisition and the recent weakening of the dollar versus the euro drives a small increase to normalised and reported EPS.

On an EV/sales basis, Esker is trading at a discount to DPA companies and at a premium to French small-cap software companies. Esker’s forecast revenue growth is better than both groups, as are its forecast operating margins. On a P/E basis, Esker trades at a premium to the DPA companies and broadly in line with French small-cap software companies for FY17 and FY18. In our view, the transition to SaaS is likely to suppress operating margins across the software sector (even after transition costs are taken into account). Esker is ahead of many peers in making this transition and is already generating strong growth and margins. The company has recurring revenues of c 80%, which gives a high level of revenue and cash flow predictability. Management continues to assess acquisition targets, preferring businesses that are international, profitable, have an existing customer base and have already made the move to a SaaS business model. The company has a strong net cash position and is forecast to build this over the next two years.

Our forecasts and the Esker share price will be sensitive to the following factors. Currency: Esker is exposed to the US$/€ exchange rate. Competition: Esker competes with well-established, well-funded software companies and will need to maintain its technology to compete. Pace of adoption of SaaS solutions: As more customers move to on-demand software, Esker will see a decline in on-premise licence sales in favour of subscription-based revenues. Rate of decline of legacy business: The legacy businesses are very profitable maintenance revenue generators. The rate at which these businesses decline will have an impact on profitability. Reliance on datacentre providers: Esker leases datacentre capacity for its on-demand products. Changes in the availability and pricing of capacity will have an impact on Esker’s profitability.

Esker is a document process automation software developer, specialising in moving business processes from paper-based to digital. The company made the transition to the SaaS delivery model earlier than many peers, and now the majority of revenues are generated from customers using its on-demand solutions.

Esker was founded in 1985 by Jean-Michel Bérard, the current CEO. Management was originally focused on software consulting, and developed its first host access product in 1989. The company listed on the Nouveau Marché in 1997. From 1998-2000 the company made a series of acquisitions in the US host access and fax server markets. Esker launched the DeliveryWare platform in 2000, Mail on Demand in 2003, Esker on Demand (an automated on-demand mail and fax service) in 2004 and FlyDoc in 2006. The current SaaS products for accounts payable and accounts receivable were launched in 2009. The company’s listing was transferred from Euronext C to Euronext Alternext in 2010. The company has recently made some bolt-on acquisitions: TermSync and CalvaEDI in 2015 and e-integration in 2017. Esker’s revenues are well spread geographically, with 52% from Europe, 42% from North America, and the remainder from Australia and Asia.

The majority of Esker’s revenues are generated from the Document Process Automation (DPA) software business (93% in FY16). The remainder of the business is grouped into Legacy Products, consisting of the Fax Server business (which automates fax sending and receipt) and the Host Access business (which enables customers to access mainframes from PCs). The company is focused on growing the DPA business – its software is positioned to support order-to-cash and purchase-to-pay business processes. Esker is working to broaden the functionality of its product suite and to ultimately join up the processes to create a business collaboration network. It is also exploring the opportunities that such a network could open up in the supply chain finance market. As well as increasing headcount in consulting and R&D to support organic growth, management is keen to acquire complementary businesses, with a particular focus on EDI1 and/or UK companies.

As described above, the company’s CEO, Jean-Michel Bérard, founded the company in 1985. Emmanuel Olivier joined the company in 1999, was originally the CFO and became COO in 2003. He previously worked at Ernst & Young in France and the US for seven years. The CEO’s brother, Jean-Jacques Bérard, is the EVP of R&D, having joined Esker in 1995. Other members of the management board include Eric Bussy (director of marketing and product management), Steve Smith (COO, Americas), Eric Thomas (VP business development) and Anne Grand-Clément (global director of professional services and technical support).

Esker develops and sells DPA software operating in five areas: procurement, accounts payable, accounts receivable, sales order processing, and document delivery. These can be combined to fulfil two basic cash cycles as per Exhibit 2: order-to-cash (O2C) – to fulfil customer orders and collect payment; and purchase-to-pay (P2P) – to order and pay for goods and services.

DPA software for the other four processes operates in the following way. For receipt of documents (eg sales orders, supplier invoices), the software converts paper documentation into digital format, and populates standard templates with the data from the digital document. The software can also extract data from other sources such as emails, email attachments and faxes. The software is self-learning – if there is any doubt over the accuracy of the data, the user compares the original document to the digitised version and corrects it as necessary. The standardised data can then be fed into the customer’s ERP system and processed and viewed by the relevant people throughout the organisation before being archived automatically. For sending documents, the software generates orders or invoices in the format required, and if paper documents or fax services are required, Esker’s document delivery service can be used.

Document delivery services enable customers to send business documents via cloud fax or mail centres directly from their desktop or enterprise applications. Esker services on-demand document delivery through its fax servers located in France, the US and Australia and mail production centres located in France, Belgium, the UK, the US, Australia, Spain and Singapore.

The software improves productivity by accelerating the cash conversion cycle, reducing errors, enabling faster processing, improving process visibility and improving customer service. It has the added benefit of reducing paper and paper-related costs and is environmentally friendly.

The software also meets government legislation around e-invoicing. In Europe, the EU has mandated that paper and digital invoices should be treated equally and lays out ways that documents can be authenticated. EU member states are obliged to implement the 2014/55/EU directive by November 2018: this specifies that businesses selling to government entities must use e-invoicing that is based on specified interoperability standards. This should increase demand for e-invoicing solutions. In Latin America, e-invoicing is government-mandated in order to ensure tax compliance and collection.

Esker on Demand is Esker’s main product. This multi-tenant, SaaS solution was originally developed by Esker in 2004, ahead of many other software companies’ entry into the SaaS market. It started to gain traction from 2009 as customers were attracted by the lack of upfront investment and the usage-based payment mechanism. Esker’s longest-standing product is DeliveryWare, an on-premise solution. Typically, new business is for Esker on Demand, although some customers prefer to use the on-premise solution for security reasons. The company has more than 5,000 SaaS customers and 320,000 SaaS users.

Esker upgrades the Esker on Demand software on a quarterly basis. Every three years, Esker takes the previous SaaS upgrades and incorporates them into one large upgrade of the DeliveryWare software.

Esker acquired TermSync and CalvaEDI in 2015 and e-integrations in early 2017. TermSync is a US cloud-based invoice processing platform provider. Its solution improves the efficiency of the accounts receivable function, and includes the ability to track invoices, schedule reminders, and analyse performance. Esker is using the TermSync solution to enhance its existing accounts receivable offering in the US, and launched the solution in France earlier this year. CalvaEDI is an EDI network service provider, providing gateways between its customers’ different computer systems. CalvaEDI has more than 300 customers in transport and logistics, predominantly based in France. EDI has typically been implemented by large customers but Esker wants to extend the technology to smaller customers. CalvaEDI continues to trade under its own name and is working with Esker to develop new services, in particular, to offer Esker customers with automated order-to-cash cycles the benefit of EDI integration. e-integration is a German-based EDI business, further strengthening Esker’s EDI offering. Its online exchange network has c 7,000 members and c 600 active clients, mainly German industrial companies, some with international exposure.

Esker has a direct sales presence in Europe (France, Germany, Italy, Spain and the UK), the US and Asia-Pacific (Australia, Malaysia and Singapore). The company has sales representatives in Miami (to target South America, in particular Argentina, Brazil, and Colombia), Brussels (to target European-headquartered US companies) and Montreal. Both South America and Canada are serviced out of the US and Belgium out of France, although it is likely that staff will be hired in the relevant countries once the business grows. Esker also sells its software on a white-label basis to several companies.

The salesforce tends to target those responsible for business processes – in most cases this will be the finance department, although sometimes it is customer services. The company will also work with the customer’s IT department, but this is mainly to work on integrating the software rather than to sell to. As the implementation process takes time and can be disruptive, most customers tend to select Esker for one process initially. Esker may then benefit from growth within that process, eg more departments, more geographies. Some customers then go on to use Esker for additional processes.

As hiring appropriately qualified staff for implementation work in the relevant countries can be challenging, the company is seeking smaller system integrators to do this work on behalf of Esker, aiming to convert some of them into resellers over the next few years.

Esker sold its software on a white-label basis through Neopost in France for several years and in 2015 entered into a joint venture with Neopost to expand the scope of this agreement. The JV (owned 70% Neopost/30% Esker) is focused on selling Esker’s software to SMEs in France and the US. This is a market that Esker’s direct salesforce tends not to target. In FY16, Esker reported a €123k contribution from its share in the joint venture, and the joint venture generated c 5% of group sales.

The company’s medium-term plan is to provide a business collaboration network and it is progressively adding functionality to achieve this. Currently, Esker provides a portal for each process and is encouraging the use of its portals by buyers and suppliers through the provision of functionality such as invoice status and chat. The longer-term goal is to connect these portals together to create a networking platform that would allow customers and suppliers to interact securely and could be used for direct exchange of purchase orders and invoices, payment of invoices, early payment discounting, dispute resolution and data clarification. The network should enable full visibility of invoice status (ie it should be possible for both supplier and buyer to see that an invoice has been approved for payment), at which point it should be possible to provide supply chain financing to either party.

Several invoice networks are active in this space, for example Taulia and Tungsten, offering invoice factoring, reverse factoring and/or dynamic discounting. Esker is evaluating the supply chain financing market, and we believe it is most likely to enter the space via partnerships with banks or factoring companies rather than trying to offer the financing itself. We note that in some cases, banks are already acting as referral partners for Esker. For a bank to offer supply chain finance, it needs good visibility over the customers’ invoicing processes – there are certain banks that have realised that if their customers use Esker’s software, they will be able to make more informed decisions about providing finance to those customers.

Esker competes against a different group of companies for each business process and by geography. As well as specialist DPA software companies, the company also sees competition from business process outsourcers such as Accenture and Xerox.

Esker has the advantage that its software can be used across all processes, reducing the number of software suppliers a company deals with and simplifying the implementation process. More than 11,000 companies globally use Esker software, including GE Healthcare, Hyundai, Samsung, Siemens, Vodafone and Whirlpool. Esker has more than a decade’s experience in SaaS delivery and has achieved various SaaS certifications such as SSAE16 and ISAE3402, providing a level of confidence regarding business continuity and data security.

Accounts payable is the most competitive area – when Esker wins business it tends to be for customers that have decided to move from manual to automated processing, rather than winning business from an existing supplier (although this occasionally happens). Accounts receivable has historically been the strongest area – the customer owns the process so the document format is set in-house and therefore data recognition is more straightforward. Due to European legislation around electronic signatures, demand for automated accounts receivable processing is growing, as companies move from paper to digital invoices. Esker sometimes replaces mail houses in this market. The most complex market from a technical perspective is sales order processing. This is because end-customers send orders to Esker’s customers in many different non-standard formats such as faxes, emails, or within email attachments. This market has the fewest suppliers and Esker has a very high win rate.

The table below shows the most common competitors for each process. Competition tends to be country-specific; for example, Billtrust for accounts receivable in the US, ITESOFT for accounts payable in France. Global competitors include Basware, Kofax and OpenText.

Document delivery has a different group of mail-focused competitors, including j2 Global, Docapost, and Maileva (both subsidiaries of Le Groupe La Poste), and OpenText.

Many customers use Esker’s software to enable them to join supplier networks such as Ariba or OB10. These networks usually require e-invoicing and Esker’s software enables them to produce invoices according to the requirements of the networks. In other cases such as Taulia, the networks rely on invoices that are approved for payment in order to provide supply chain financing. As Esker’s software provides dashboards to show this type of information, Esker is able to introduce customers with the necessary volume of approved invoices to the networks.

Esker’s Legacy Products division includes fax servers and host access products. While the legacy business continues to be supported, the company is not actively chasing new business or developing new products.

Our forecasts and the Esker share price will be sensitive to the following factors:

Esker reports revenues in two ways: 1) split by business line, ie DPA and Legacy Products, on a quarterly basis; and 2) split by type of revenue: traffic, maintenance fees, licence sales, hardware and services, on an annual basis. Traffic revenues are generated on a per transaction basis from Esker on Demand and FlyDoc customers. Licence and maintenance fees are generated from DeliveryWare on-premise licence sales and the Fax Server and Host Access businesses. Hardware sales are generated by the Fax Server business. Service revenues are generated from on-premise and on-demand DPA business. Older DPA subscription sales were structured on a traffic-only basis, with service revenues charged for the initial integration of the software. For the last few years, Esker has sold on a hybrid subscription model that guarantees minimum monthly revenues plus transaction-based revenues, reducing Esker’s dependence on the speed at which a customer implements the software. On-demand contracts are typically signed for a minimum of 12 months, and most commonly are for three years. See Exhibit 7 for historical and forecast divisional performance.

In H117, recurring revenues2 made up 80% of the total, up from 79% in FY15 and FY16. Esker has a strong record of retaining customers – management estimates that churn is less than 1% per annum. As each new customer comes on board, this adds another layer of recurring revenues. In H117, the company won orders worth €5.7m (+52% y-o-y) – this is the amount of revenue the company is contracted to earn over the (usually) three-year life of the contract, and does not include variable traffic fees, which can make up the same amount again over the three years.

Esker reported revenue growth of 14% for H117, of which organic constant currency growth was 9%. It noted that e-integration contributed revenues of €1.8m (+25% y-o-y pro-forma) – this was higher than our €1.5m forecast. Reported operating profit grew 4% y-o-y to generate an operating margin of 15.6%. The higher level of legacy product licences (recognised upfront and at a close to 100% gross margin) signed in H116 contributed to the higher margin of 17.1% in H116. However, the H216 operating margin declined to 12.3% and FY16 operating margin was 14.8%. Despite a net cash position of €6.3m at period end, the company generated a net financial charge, mainly due to the weaker pound versus the euro. The tax rate of 29% was lower than the FY16 rate of 32% and lower than our full year forecast of 33%. Share count increased over the period from a combination of option exercises and shares issued in part payment for e-integration. This resulted in reported basic EPS increasing 2.6% y-o-y.

Management has maintained its outlook for double-digit organic growth in FY17, despite slightly lower growth in H117 (9%). As H116 saw the benefit of licences for legacy products €1m higher than in H117, this made a tough comparison for the period. The company saw a much lower level of legacy licence sales in H216, which should make the comparison much easier. Management also highlighted that the operating margin was likely to be in the region of 15% (H117 was 15.6% on a reported basis). We have made the following changes to our forecasts:

With 42% of revenues in the US but a lower proportion of the cost base in US dollars, the company is exposed to changes in the $/€ exchange rate. The rate was 1.106 in Q117 and 1.06 in Q217, but a recent strengthening of the euro has seen the spot rate increase to 1.199. In our cost calculations, we use a rate of 1.13 for FY17 and 1.19 for FY18. Any further weakening of the dollar could have a material negative impact on our FY18 forecasts (as $-based revenues outweigh costs).

The company ended the period with a net cash position of €6.3m. It paid out €4m for acquisitions in H117 (we estimate the majority for e-integration and the remainder the earn-out for TermSync). During H1, the company took out a loan of €10m and invested €1.6m in bonds, which are recorded as fixed assets. Gross cash was €22.3m at period end, providing ample funds for acquisitions. We forecast that net cash will increase to €14.7m by the end of FY17 and €19.4m by the end of FY18.

The company invests in tangible fixed assets for its mail centres and offices (€2.1m in FY16) and capitalises development costs (€4.8m in FY16). In H117 it capitalised €2.6m of development costs and amortised €1.7m. We expect a gradual increase in both capitalisation and amortisation in FY17 and FY18.

The stock gained 29% over the last year. We have compared Esker’s valuation to a group of listed global DPA software companies and to French-listed software companies with a market cap of €80-800m. On an EV/sales basis, Esker is trading at a discount to DPA companies and at a premium to French small-cap software companies. Esker’s forecast revenue growth is better than both groups, as are its forecast operating margins. On a P/E basis, Esker trades at a premium to the DPA companies (once loss-making Basware is excluded) and more in line with French small-cap software companies for both years.

In our view, the transition to SaaS is likely to suppress operating margins across the software sector (even after transition costs are taken into account). Esker is ahead of many peers in making this transition and is already generating strong growth and margins. The company generates recurring revenues of c 80%, which gives a high level of revenue and cash flow predictability. Management continues to assess acquisition targets, preferring businesses that are international and profitable, have an existing customer base and have already made the move to a SaaS business model. The company has a strong net cash position and we forecast this to build over the next two years.

We have performed a reverse 10-year DCF to calculate what we believe the market is factoring into the current share price. Using a WACC of 8.5%, long-term growth of 3%, working capital/sales of 0.3% and capex/sales of 7.5% (including ongoing capitalisation of development costs), a revenue CAGR of 10% for 2018-26 and EBITDA margins trending up to a terminal level of 27.1% are required to reach the current share price. This implies the company can maintain its double-digit revenue growth trajectory while growing margins over the next 10 years – in our view this is possible, but leaves little margin for error.