NetDimensions (Holdings) — Update 18 April 2016

Since it was founded in 1999, NetDimensions, which is registered in the Cayman Islands, has grown quickly, with c 185 employees based at offices in Hong Kong (head office), the US, UK, the Philippines, Germany, Denmark and Australia. NetDimensions offers its software both as traditional on-premise licences (with 20% support), an on-premise “annual licence” rental model and as a hosted rental service (ie single-instance software as a service, or SaaS), which is marketed as Secure SaaS. The product is sold both directly and through a reseller network, with the emphasis now increasingly on selling direct and to larger enterprises operating in ‘high-consequence’ industries where there are more stringent requirements for regulatory compliance and hence training. The group also provides its customers with professional services, including training, implementation, consulting and content.

Revenues have grown in each year since FY04 (compound growth of 27% pa) and the group was profitable in all years at the adjusted operating level until FY12. In FY13, the company raised $6.1m in a placing and introduced a new business plan focused on stepping up the pace of investment, while a further $10.5m was raised in FY15. The headcount has risen by 42% since end-FY12 and the group continues to invest heavily in software development. We forecast revenue to grow 11% in FY16 to $28.2m and 13% in FY17 to $32.0m. The group was loss-making between FY13 and FY15 due to the increased investment, and we expect a reduced loss in FY16 before the group returns to profitability (at the normalised level) in FY17.

IT budgets are typically cut in economic downturns, although many of the group’s customers are required by regulation to offer training which may provide some resilience. The LMS offers a highly efficient and cost-effective delivery mechanism and in some instances, it can be seen as mission critical. However, an LMS is a discretionary spend for many organisations and a key challenge for the group is to embed its solution into its customer businesses by offering wider functionality, improving productivity and potentially generating revenues for customers. The group’s small scale may put it at a disadvantage to its larger US multi-tenant SaaS competitors.

The stock trades on c 1.1x our FY16e EV/revenues, falling to c 0.9x in FY17 and c 0.8x in FY18. We expect the group to return to profitability in FY17 and trade on c 41x our earnings in that year, falling to c 22x in FY18. Our DCF model (which assumes a WACC of 12%, a long-term margin target of 22% and terminal growth rate of 2%) values the shares at 96p, or 68% above the current share price. In our view, this valuation is supported by the group’s profitable track record, strong customer base, efficient cost base and scalable business model. We believe the group’s strategy to grow both geographically and by broadening its solutions offers significant upside to the valuation.

NetDimensions has established a strong foundation in supplying learning management system (LMS) software and services over more than 15 years. In 2012, it sought to broaden its profile as a Talent Management System (TMS) provider, and a new Talent Suite was launched. A Performance module was introduced shortly afterwards, followed by an Analytics module in early 2013. The company’s current strategy is to target customers that operate in high-consequence industries (see page 4). These are industries where accidents or failures can be catastrophic, whether that is disrupting society (eg financial services, government), damaging the environment (energy), risking consumer safety (food processing, healthcare, manufacturing, pharmaceuticals), or potentially maiming or causing loss of life (transportation). Furthermore, NetDimensions has been increasing its focus on larger customers with 5,000+ users, and in July 2014 it reorganised and expanded its services offering, to make the product offering more attractive to larger customers, which typically have more complex services requirements. The group’s software is based on single tenant architecture, but multi-instance solutions are also offered using shared, or virtualised, servers. It uses the java programming language.

The group’s flagship product, NetDimensions Learning, manages the entire learning and development process from enrolment and delivery to testing, tracking and reporting. It provides a highly personalised learning environment with individual development plans, competencies, licences and certifications. Further, it has robust security as all internet requests are individually controllable and auditable, with transactions passing through a security module before being processed by back-end components. A single installation with a relatively modest hardware footprint can handle more than 500k users, while the group’s cloud-based offering can cope with even larger user numbers. The software is sold as a standalone solution, and the customer configures the software and adds the content. The LMS is not used for developing content. However, NetDimensions has a growing professional services team that can help customers configure the software and help with content development. The software includes add-ons, such as links to WebEx, to enable online conferences.

An LMS is a software application that delivers online courses, assessments or training programmes and incorporates administration, documentation, tracking and reporting features. LMSs are used by enterprises to manage formal training (exams), informal training (generic employee training) and extended enterprise training (training for other parties such as customers, suppliers and partners, which can often be revenue generating).

NetDimensions’ goal is to become a leading provider of talent management systems and related compliance solutions to high-consequence industries. The aim is to drive recurring revenue growth to achieve long-term sustainable profitability and hence the focus on driving SaaS rental revenues. It is looking at expanding into new markets and is seeking to drive growth both organically and via acquisition. NETD has been focusing on selling directly, and resellers are favoured in specific verticals such as airlines or geographies such as China and the Netherlands. The sales focus is on the group’s Secure SaaS offering, which is a fully hosted solution, supported by the ISO 27001 security standard. The expansion into services is driven by customer demand, particularly as the group is winning more large multinational customers, in deals that typically have significantly more complex services requirements.

In May 2013, the company raised $6.1m in a placing of 10.75m shares at 38p and introduced a new business plan, which involved stepping up the pace of investment. The goal was to attain $50m revenues along with growing, sustainable profits in five years, through both organic growth and acquisitions. In November 2015, NetDimensions raised a further $10.5m in a placement of 12m shares at 60p. The new funds are being used to expand the group’s support functions in Germany, along with its hosting and R&D in Hong Kong and Manila. It has also bolstered the balance sheet, which makes the group’s products an easier sell to its increasingly blue-chip customer base and provides funds for acquisitions.

The primary focus is on seven verticals, listed below. Over time, the company may become more specialist, as each sector requires its own tailored development programme.

NetDimensions is seeking to acquire businesses in the TMS space with a focus on software vendors, content/courseware providers or potentially specialist consultancies in healthcare or life sciences. Acquisitions could be used to broaden the Talent Suite into new modules, such as recruitment, on-boarding, compensation or succession planning. Target companies are likely to operate in North America and/or Europe, with customer bases focused on high-consequence industries and they are likely to have revenues in the range of $10m to $20m. Verticals of particular interest include US healthcare and life sciences. Financing could include existing cash resources, equity and/or debt, including via an existing debt facility with Silicon Valley Bank.

In September 2015, NetDimensions announced that CERN, the European Organisation for Nuclear Research, had selected NetDimensions' LMS to oversee the training requirements of up to 15,000 users to enable them to meet the highest certification management standards.

CERN required an efficient LMS to manage all of the training, which includes safety, management skills, and language training, along with certifications across the organisation. In addition to the strict qualifications for different job roles, CERN requires members of personnel to complete additional certifications to make sure they are held to the highest standards for safety. CERN has c 15,000 personnel on site each day and they have a wide range of training needs. These members of personnel need certifications to gain access to the experiments at the Large Hadron Collider.

CERN had some very specific and strict requirements related to data security and system flexibility and NetDimensions won this contract in a competitive tender against top LMSs from both North America and Europe. NetDimensions Learning integrates with CERN’s existing infrastructure, including solutions for access control, financial administration and course registration, as well as the main HR system, using NetDimensions’ comprehensive set of APIs. Training and certification data is exported to the access control system, which is then used to authorise people's access on site. When a person enters the building and uses their access card, the system then authorises access based on the certifications needed to enter the area and their validity.

Norton Healthcare ($1.5bn+ annual revenue) is one of the largest integrated healthcare systems in Kentucky, US, with more than 12,500 employees at five hospitals, 13 Norton Immediate Care Centers and 90 physician practice locations. Following an extensive search, Norton Healthcare selected NetDimensions Learning to support 14,500 users at more than 140 locations.

As a regulated healthcare provider, compliance and reporting on staff training to multiple groups including the Joint Commission and the American Nurses Credentialing Center had become a burden. Norton Healthcare’s LMS required complex workarounds to produce necessary reports, which consumed staff time and resources and was a distraction to the company’s core mission of providing quality healthcare. In addition, Norton Healthcare staff found the existing LMS difficult to use, but also incapable of meeting their need for mobility in an on-the-go and on-demand learning environment. Hence, Norton Healthcare embarked on an initiative to identify a replacement solution capable of delivering the robust learning and training the company’s teams desired as well as the comprehensive reporting and audit trails required by regulators and credentialing agencies.

Following the aggressive rollout of NetDimensions Learning, Norton Healthcare immediately saw a decrease in both the number of learner complaints and help desk requests. More importantly, it saw an increase in user adoption of the learning system and a rise in the number of end-users completing courses. Administrators and end users have reported increased satisfaction in the system and Norton Healthcare has been able to deliver more learning using fewer staff resources. Administrators are now able to quickly collect training data and produce reports for the Joint Commission and other regulatory agencies and with considerably less effort required. Managers can access learning analytics that provide granular reporting and observe end-users’ learning and training behaviours. NetDimensions argues that the flexibility and capabilities of its solutions deliver a more individualized and personalized training experience which helps Norton Healthcare better fulfil its commitment to the care of its patients and the community.

The group has established a healthy track record of revenue growth, with revenues jumping from $1.8m in FY04 to $25.4m in FY15. In our view, there are several industry-specific drivers and management initiatives that are set to sustain the growth trajectory:

Competitive environment: A major sector for SaaS players

NetDimensions competes with a number of predominantly US-based talent management companies. It also competes with Oracle and SAP, which offer LMS functionality in various ways, including as part of their integrated suite offerings. The peers it most often comes up against in competitive tenders are Cornerstone OnDemand and Saba Software, which both have multi-tenant SaaS offerings (multi-tenant means a single instance of the software is used by multiple customers). We note that NetDimensions’ single-instance SaaS architecture appeals to a range of security-conscious companies. Indeed, some customers require on-premise solutions while others are required to have their data hosted inside their country of operation, which supports on-premise or single-tenant hosted solutions. Further, Saba has recently been acquired by a private equity company, suggesting it could face a period of change. We believe NetDimensions stands to benefit from its Hong Kong base and strong knowledge of Asia.

NetDimensions operates a traditional on-premise software licensing business model with associated support and maintenance, along with a broad professional services offering. Pricing of the software is based on the number of users and the group sells directly and via resellers, which extends its geographic coverage to more than 40 countries and rising.

In addition to the standard perpetual licence there is an annual licence option, which is popular with smaller customers wanting greater flexibility. The group also has a hosted single-instance SaaS option for customers that prefer to pay from the opex budget rather than capex. In FY15, the average customer spend, across all segments, was c $210k via the direct channel and c $10-20k via resellers (which purchase the software at wholesale prices and offer their own professional services).

FY15 revenue grew by 12% to a record $25.4m (we forecast $25.0m). Invoiced sales rose by 8% to $25.7m with direct sales representing 87% (FY14: 85%) of the total. The gross margin was higher than we expected at 83.5% (we forecasted 79.8%), mainly due to a large annual licence sale late in the period. This was reflected in the H2 gross margin which was 388bp above H214 at 85.3%. A total of 34 new clients were added in FY15, including 16 in H2. While this was down from 66 in FY14, the average deal size for direct new clients in the period nearly doubled to $210k (FY14: $106k). Invoiced sales to clients in high-consequence industries rose by 16% to $21.6m, representing 84% of total invoiced sales (FY14: 78%). Working capital increased by $1.8m, which follows three years of strong inflows. Net cash jumped by $7.1m over the period to $12.0m, largely due to the $10.5m funding raising in November. This figure was slightly below our forecast of $12.5m, due to working capital movements. Recurring revenues, represented by annual licences, hosting and support were c 68% of the total in FY15 (FY14: 57%).

Hosting services (ie the group’s Secure SaaS product) rose 26% to $10.5m and Professional services (including content from the interactive division) increased by 17% to $7.5m. These are the key areas of focus and are clearly trending sharply higher in Exhibit 2. North America revenues jumped 25% to $11.6m, to represent 46% of the total (FY14: 41%) on the back of a number of new client wins in high-consequence industries, particularly government agencies. This indicates that the business is competing well against the majors US players such as Cornerstone OnDemand and Healthstream (in the healthcare vertical). Software licensing, which includes rental (annual licences) and perpetual licences, rose 9% to $5.9m, which reflected a 17% rise in annual licences as the de-emphasised perpetual licence revenues slipped to $0.6m. Support and maintenance, which relates to perpetual licences, fell by 40% to $1.6m. The adjusted operating costs eased by 1% to $21.9m (we forecasted $22.4m), which partly reflects a reduction in quota carrying salespeople. The adjusted operating loss shrank by 80% to $0.7m (we had forecast a loss of $2.5m).

Headcount stood at 185, up from 176 a year earlier and 130 at the end of December 2012, ie before the new business plan was implemented. The main growth was in software engineers, which was reflected in the R&D bill which jumped 35% to $3.5m (c 14% of sales). The number of quota-carrying salespeople has fallen back to 20. Going forward, the plan is to operate a more structured team approach to selling in specified regions, with a quota carrying a sales executive, a relationship manager and a business development executive. The primary area of recruitment is in software engineering, in particular in Manila, where it has spare office space.

Outlook: management remains confident on its strategy of focusing on high-consequence industries and its ability to gain market share in the global talent management systems space. Contract sizes are increasing significantly, but this can also mean longer sales cycles and potentially lumpy growth rates. Profitability is ahead of target, while achieving the $50m revenue target (announced in the May 2013 business plan) by 2018 remains dependent on identifying suitable acquisitions.

We have maintained our revenue forecasts, while edging up our gross margin forecasts and increasing our share based payment assumptions. We continue to assume healthy growth in software hosting (secure SaaS), software licensing (ie on-premise rental) and professional services, with modest growth from support and maintenance. In all, we forecast group revenues will rise 11% in FY16 to $28.2m, 13% in FY17 to $32.0m and 9% in FY18 to $35.1m. We have maintained our opex forecasts, which imply 7.5% growth in FY16, as the company continues to recruit, particularly in software engineering. Our FY16 forecast pre-tax normalised loss falls by $0.4m to $0.6m, while our FY17 profit forecast rises by $0.5m to $1.4m.

LMS businesses benefit from regulatory-induced demand combined with the ability to reduce costs. However, an LMS is seen as discretionary spend for many organisations. A key challenge for the group is to embed its solution into the businesses of its customers to mitigate the risk of customer loss during economic downturns or due to a competitor’s solution. This would involve widening the functionality as much as possible across the talent management space and, when possible, including revenue-generating attributes for the customer. We highlight the following sensitivities:

Having established its position as a serious player in the global LMS market, NetDimensions has in recent years been broadening its offerings to include talent management to create fresh growth opportunities. The group was profitable at the operating level in every year from FY04 until the new business plan was implemented in FY13. The accelerated investment resulted in losses from FY13 to FY15, albeit with a 57% jump in revenue. Further, the group has a healthy financial position with an end-December 2015 $12.0m net cash position equating to c 16.4p per share at current exchange rates. The shares have fallen with the sector over the last year to trade at a discount to the 2007 IPO price of 62p. Our cash flow and peer analysis below suggests the shares are an attractive investment. We highlight the following points: