Prodware — Update 11 November 2015

Prodware sells and integrates its own and third-party software for small- and medium-sized enterprises (SMEs) across Europe. Its software products are typically sold to sit on top of the Dynamics enterprise resource planning (ERP) and customer relationship management (CRM) platforms from Microsoft. The company has more than 1,400 employees in 15 countries, with over 19,000 customers across the group.

Prodware is the leading partner for Microsoft Dynamics in EMEA. It is expected to grow as a result of strong demand for CRM and ERP systems for small- and medium-sized enterprises across Europe, driven by the move to SaaS systems and the need for mobile-capable systems. Management has put in place a target for 2020 of €300m in revenues and to help achieve this goal it has announced the launch of Prodware Academy, a recruitment and training initiative to both enable and drive sales growth.

Despite the forecast increases in revenue and earnings, Prodware trades on earnings multiples that are well below those of its Europe-listed comparators. The balance sheet is improving and the restructuring of the Qurius operations is now complete. As the results show through and investment markets’ understanding of, and belief in, the investment story develops, the shares should see a rerating to a level more in line with the comparators.

Placing the shares on the average FY15 P/E multiples of Prodware’s closest listed comparators in margin and business-model terms (K3 and Sword) suggests share price of €22.6.

We use a basic DCF model to ‘sense check’ the valuation and this also suggests that the share price fails to reflect the cash-generation power of the business, with a share price estimate of €14.5 using a WACC of 12%

We forecast revenue and profits growth for Prodware; CAGR FY14-17e revenues of 5.9% and EPS of 24.5%. Although the broader enterprise software market may not be delivering significant growth, Prodware is well placed with exposure to key growth areas. Furthermore it should see the benefits of the improvement in product mix as the former Qurius operations drive up the proportion of sales obtained from software, rather than integration work and its investment in people with the Prodware Academy programme translate into increased revenues.

With a lacklustre economic backdrop and in a competitive industry that is in a constant state of flux, delivering on market expectations is not guaranteed. Prodware’s exposure to Microsoft as a partner is a risk, but with what we believe to be greater commitment to Dynamics from senior management at Microsoft, this is a receding concern. Prodware Academy and the establishment of the Business Consulting division are clear statements of intent to drive revenues and margins but are not without risk.

Paris-based Prodware sells and integrates its own and third-party software for SMEs across Europe. It has software products that sit on top of the Dynamics ERP and CRM platforms from Microsoft, effectively filling the gaps in the Microsoft offerings to produce market-appropriate solutions. The company has over 1,425 employees in 15 countries, with approximately 19,000 customers. Almost all Prodware’s products and services are mission critical for customers, and as a result, Prodware sees a very high level of recurring and repeat revenue – with management stating that such repeat income is around 80%.

Strategic focus on building software: Prodware’s strategy is to target markets and applications where it believes unit sales can run into the high hundreds or even thousands, seeking to avoid creating bespoke solutions for clients or undertaking simple integration work. By working in this way, Prodware maximises the reuse of programming code and earns significantly higher operating margins than those seen by pure-play systems integrators.

Pan-European platform for growth: the acquisition during 2011-12 of the operations of Qurius nearly doubled revenues and made Prodware the leading partner for Microsoft Dynamics in EMEA. Although similar to Prodware in some ways, Qurius was more focused on reselling and implementing, rather than on creating a set of software products that could be reapplied. Having restructured, integrated and rebranded these businesses, Prodware should now gain from the application of the Prodware model of acting as a combined integrator and software business across Europe, taking its current overall operating margins from the high single figures back up to the mid-teens levels seen before the acquisition.

Commitment to grow: management has set the objective of building revenues to €300m in 2020 and to help achieve this is has put in place the Prodware Academy recruitment and training programme, established the Business Consulting division and stated a willingness to make acquisitions. The target is equivalent to a CAGR of 12% over the period, starting with our FY16 revenue estimate. Furthermore, with its balance sheet rebalanced, we forecast net debt will decline from €41.2m as at December 2014 to €29.2m as at December 2017, Prodware has the potential to drive growth more aggressively through bolt-on acquisitions.

Favourable point in technology evolution: although the broader economic environment in Europe remains lacklustre at best, Prodware is set to benefit from the renewal cycle for ERP systems, many of which were put in place prior to the millennium, and the growing demand for mobile solutions and SaaS within both the ERP and CRM arenas. Furthermore, the increasing provision of SaaS and hosting services binds Prodware more tightly with its clients, providing opportunities for additional value added through the newly created Business Consulting division.

History and strategic development: Prodware was formed in 1989 and in its early years it developed SME software products for a number of commercial endmarkets, and grew a healthy business in providing networks and related security. As the enterprise software market developed, it focused on reselling and integrating the software of others, most notably Sage and subsequently Microsoft. By the middle of the last decade, Prodware had established itself as an integrator and host of products and services on a national scale, with activities in francophone markets across Europe and Africa. In February 2011, Prodware took the first step towards what became the acquisition of Qurius, a Netherlands-based integrator of Microsoft ERP and CRM, which had operations in the Netherlands (where it was Microsoft’s top local partner), Germany (where it ranked number two with Microsoft), the UK, Spain and Belgium. This created a European leader providing SME software working on the Microsoft Dynamics ERP and CRM platforms. With the Qurius operations fully digested, in 2015 Prodware’s management has placed the focus on growth with the launch of its 2016-2020 development plan, the Prodware Academy Programme and the Business Consulting division.

Prodware discloses its operating performance across two categories: Infrastructure & SaaS, and Software licences & integration services. While this reflects the way the product is provided, it provides limited insight into the level of the value added within the product or service. However, Prodware also provides a breakdown of revenues, but not profits, into Licences & Materials, Services, Maintenance & Support and Hosting (SaaS), giving a slightly better view of the direction the business is taking.

We believe, the provision of software in its various forms is the most important driver of value for Prodware. Revenues in this area are growing, and are recurring in nature because their ongoing payment of the subscription is required for delivery of the service.

Prodware typically earns overall operating margins of 20%+ on sales of its software, a much greater margin than it earns from its other activities. The strategic and operational imperative for the group is to drive the software side of the business.

Prodware provides its software on both a traditional (licence fee plus ongoing maintenance and support) and a SaaS (hosted)-based manner. In common with much of the rest of the software industry, Prodware has been focused on shifting its business more towards the hosted SaaS provision of the software. This shift has a number of benefits for both Prodware and its customers. It provides customers with lower up-front costs of software and a significantly reduced requirement for investment in, and ongoing support of, hardware. For Prodware it changes a business model with typically lumpy cash flows to one with steady and predictable income streams, all be it at the cost of reductions in cash flows and recognised revenues at the start of the provision of the service.

Management believe that over the medium term, typically three to four years, the revenue stream and profits from SaaS-delivered software will be greater than comparable software provided on a traditional basis. Although the increase in SaaS revenues accounts for the majority of the growth in Prodware’s overall software revenues, the move actually distorts the underlying picture of growth at Prodware because every €1m of SaaS income is broadly equivalent to €3-€4m of traditional income.

Prodware has five main areas of sector focus: manufacturing, professional services & communication, distribution services, financial services and what is described as ‘commercial unmanaged & public sector’. Across these industries, there are 23 sector-specific products. In addition to these verticals offerings, Prodware can provide key application-specific products of its own, for example e-business, BI (business intelligence) and product sustainability, or from software partners. In recent years Prodware’s efforts to create its own best-of-breed SME focused solutions in these application areas has been the focus of both its IP purchasing and product development. It should be noted that these application solutions are not Microsoft-specific products and can work on a number of other platforms including ones from SAP and IBM. Prodware has interface or middleware software to allow all these elements to work together.

The largest part of Prodware’s software offering covers software for applications on top of a Microsoft ERP or CRM platform, which fills the gaps to take the standard Microsoft platform and create a fully-fledged industry specific product. The fact that work needs to be done to produce a complete solution for a specific industry application is not due to any shortcomings in the Microsoft products. They are built that way to allow resellers/software partners an opportunity to address a broad spread of markets and to add and extract value themselves.

Prodware provides enterprises with the necessary software and skills to set up and maintain their business systems. In doing so, Prodware applies its own people, skills and software and the software of others, mainly Microsoft but also other software vendors whose products link with those of Prodware or Microsoft.

Prodware is the leading integrator of Microsoft Dynamics (the Microsoft offering principally targeted at SMEs but also finding wider application in major global enterprises) in Europe, and has, we believe, several thousand customers on Microsoft platforms. Within the Dynamics line of products, Prodware focuses on the Microsoft Dynamics NAV and AX ERP platforms, including AX for retail and Microsoft Dynamics CRM.

Prodware typically earns high single-digit operating margins from these operations. When made by the original Prodware operations and increasingly the former Qurius businesses these sales are linked to, and drive, sales of Prodware’s own software. A key focus in the restructuring and realignment of the former Qurius operations was in developing the link between integration sales and own software sales and the benefits of this is expected to show through in coming years, with the software revenues growing particularly strongly in non-Francophone geographies.

Exhibit 5 below sets out the competitive landscape for Prodware. It finds itself between the megavendors, like SAP, Oracle and IBM, the niche specialists, like Cegid or Generix, and the lower-price micro and smaller enterprise-focused providers, like Sugar CRM or ebp. Prodware is far from alone in its drive towards SaaS and all the companies that it competes against have SaaS-based offerings or are attempting to provide them to customers.

Clients in Prodware’s target markets cannot afford the price of full systems from the likes of SAP or IBM, where starting prices run into hundreds of thousands if not millions of euros. Furthermore, they are also unwilling to work on the long delivery timetables to which these vendors work.

Working on established Microsoft platforms gives Prodware instant credibility with customers that the niche providers generally struggle to match. Furthermore, there is a clear appeal for these customers from the apparently seamless linking of solutions based on Microsoft platforms into the desktop applications with which they are already comfortable, ie Word, Excel, Outlook and PowerPoint.

Although it is focused upon the SME market, Prodware still has significant sales into blue chip customers that validate the quality of the company and its products. Prodware makes significant sales into local operations of major companies, like Michelin, Toyota, Findus, Airbus and Le Creuset, and has local market leaders including Optic 2000 (French opticians), Supermercados Covirán (Spanish supermarkets), Real Madrid (Spanish football team) and Gigaset (German digital phones) among its customers.

Microsoft-related sales account for over three-quarters of revenues at Prodware. The company is very much at the centre of the Microsoft Dynamics CRM and ERP ecosystem in Europe, a fact recognised in its Gold Partner status and its membership of the Microsoft Dynamics Inner Circle.

For some years Dynamics had something of an undefined position within Microsoft, but in recent months this has changed with the clarification of the Microsoft group strategy under its new CEO, Satya Nadella. It is noteworthy that for much of the last decade Mr Nadella was responsible for the Microsoft Business Systems division of Microsoft of which Dynamics had been part. In June 2015, Dynamics was moved from being a separate entity outside the major Microsoft divisions to being part of the Cloud and Enterprise division. This change, alongside the other recent statements from Microsoft suggest that this growing business is being placed firmly as part of the platform approach – something that is wholly consistent with Prodware’s strategy of creating software that runs on top of other software platforms.

The business solutions and middleware elements are developed entirely in house. Development work is undertaken in six centres in Bordeaux, Grenoble, Romania, Tunisia, Israel and the Czech Republic. The current locations are mostly relatively high cost, but these cost disadvantages are diminished by the high level of state support that Prodware receives. Currently, Prodware gains 30c back in tax credits for every euro it spends on development. These tax credits are then set against tax due or paid to the company when no tax is due.

Prodware sells the vast majority of its products directly to customers as opposed to resellers. Because of its role in reselling, hosting, integration and development, Prodware has always acted as the interface with customers. As the Prodware software market has evolved and with the industry majors struggling to service the local activities of major corporations, Prodware has set up strategic partnerships with global systems integrators, including IBM and PwC, allowing Prodware to access larger customers, and IBM and PwC to access smaller ones, to their mutual benefit. While we do not anticipate significant revenues from these channels in the short run, we regard it as an interesting and promising development. Additionally the App Store for Microsoft Dynamics CRM gives Prodware the opportunity to sell its Dynamics-based products in geographies beyond its home markets, including North America.

Prodware’s most significant development in recent years has been its acquisition of the operations of Qurius, taking Prodware from being a leader in its markets in France, to a leader across Europe. The transactions have given Prodware access to customer bases in new geographic areas, new products and considerable cross-selling opportunities. Furthermore, there is the opportunity to improve margins from driving Qurius along the same value-added path already established at Prodware, as well as scale efficiencies and leveraging the R&D base.

Prodware’s €24m acquisition of Qurius’s operations was in stages. Prodware first acquired a 10% stake as part of a partnership agreement in early 2011, and then on 31 July 2011 Prodware and Qurius announced their intention for Prodware to buy Qurius’s operating companies in stages. At the time of the announcement of the wider acquisition, Qurius was suffering losses at an EBIT margin level in the mid-single figures on its approximately €100m of revenues. The task of repairing Qurius has not been entirely simple and in several areas it has been significantly more challenging than was initially hoped. That said, there appear to have been no black holes and following the conclusion of the restructuring of the German operations in early 2015 the structural work appears complete. Over FY12-14 Prodware recorded €15m in restructuring charges. We have a forecast a further charge of €3m for FY15e relating to the final issues, principally in Germany. Taking these figures into account gives a full cost of acquisition of €42m – an EV/revenue figure of approx. 0.4x.

The completion of the turnaround of Qurius, together with the rebalancing of the balance sheet, has allowed the management to focus once again on driving the growth of the business. Alongside the H115 revenue announcement, Prodware’s management announced the planned launch of Prodware Academy, a programme to hire approximately 125 people over the coming year and more over the following three, as part of the company’s 2016-20 plan of growing revenues to €300m by 2020. The intention is to seek high quality talent from both universities and larger competitors and to offer them a more dynamic work environment with greater levels of responsibility than is typically available elsewhere. By the time of reporting the H1 figures in October, Prodware had already hired 126 people, mostly outside the Francophone territories.

While these new recruits will in due course find roles across most areas of Prodware’s business, the bias is to be towards the higher value-added areas, including the Business Consulting division that management created in FY H115. With only a few tens of staff this is not on the scale of Prodware Academy at present and is, in our view, unlikely to grow to more than a single figures percent of overall revenues in the medium term. However, we believe that its greatest impact on the group could be via improved client retention and increased level of sales in other areas rather than simply through its direct contribution.

The impact of the new staff will be seen first in the costs line, with revenues showing through several months later. Management anticipates that it will be H216 before a positive effect on operating profits is seen.

Management has also stated that the intention is to grow the revenues not only organically, but also through acquisition and, with the balance sheet in better shape, bolt-on acquisitions in major European economies are a realistic proposition.

There are a number of key areas of sensitivity to Prodware’s operating, financial and share price performance that must be considered.

We have examined the valuation of Prodware on both multiples and DCF bases.

Prodware has a number of local (Paris-listed) and European comparators (see Exhibit 5 below). Although none provide exact read-across for Prodware, they strongly suggest that the shares are undervalued on a relative basis.

K3 is a more focused software business that works mainly on the Microsoft Dynamics platforms, but with a primary focus on retail, manufacturing and distribution industries, but it is the closest comparator to Prodware with regard to the combination of own software and the Microsoft Dynamics platform. The other comparators set out below are mostly either purer-play software companies or lower value-added integrators/resellers. In general, the growth prospects of the integrators are less attractive than those of Prodware, while those of the software companies are specific to their products and the markets they serve.

Prodware’s shares trade at a discount to almost all these comparators on EV/EBITDA and P/E bases. We do not regard these discounts as wholly justified given the revenue and profits growth we forecast for Prodware.

Placing the shares on the average FY15 P/E multiples of Prodware’s closest listed comparators in margin and business model terms (K3 and Sword) suggests share price of €22.6.

As a sense check, we have also used a basic DCF model to value Prodware’s shares – assuming that beyond our explicit forecast period, out to FY17e, the company sees revenue growth of 3% with operating margins of 12.4% to 2024e, a full 33% tax rate and with terminal growth of 1.5%. Applying discount rates of 10% and 12% yields valuations per share of €19.3 and €14.5 respectively, which suggests the earnings and cash generation abilities of the business are not fully reflected in Prodware’s share price.

We have revised our forecasts for FY15e and FY16e (last adjusted 112 Dec 2014) and publish our FY17e estimates for the first time. The main change to FY15 forecasts is slightly lower margins, principally due to the ramp-up costs of Prodware Academy, with the lower cash figures primarily a result of the restructuring costs for Qurius in the Netherlands and Germany over late 2014 and early 2015. The impact of Prodware Academy is seen in the faster growth in revenues in FY16e (6.5% y-o-y vs prior 3.5%) and the 9% growth rate for FY17e. The slightly compressive effect of Prodware Academy on margins continues into FY16e and FY17e.

While the global enterprise software market might justifiably be described as mature and offering limited growth overall, particularly in Europe, there remain evident pockets of growth, most notably in the market for SMEs, business intelligence/big data, the shift towards mobile enabled systems and the provision of SaaS.

We forecast revenue growth for Prodware of 2.4% in FY15e and 6.5% and 9.0% in FY16e and FY17e respectively. The main driver to growth is SaaS revenues and, as discussed above, this has the impact in the short term of masking the underlying overall growth of software provision. Prodware is far from alone as a software company in suffering from this transitional impact on revenues, but with all the changes at Qurius, Prodware Academy and the ongoing shift from integrator to software vendor this element of the Prodware story has perhaps been overlooked.

Our forecasts for the coming few years include growth driven by the increase in developer numbers from the Prodware Academy programme, the benefits of the replacement cycle for legacy ERP systems from the turn of the century and the uplift in demand for new mobile centric enterprise software.

Management targets medium-term operating margins in the mid-teens post the integration or ‘Prodwareisation’ of Qurius and these are, we believe, consistent with the mixed software integrator model that management sets out. Prodware has achieved these margins in the recent past, eg in 2011, and with the benefits of operating leverage, these margins or higher should be attainable. Our forecasts include overall operating margins of 8.3% for FY15e rising to 9.5% in FY17e.

We forecast that Prodware will not pay tax for some time, although the income statement includes an accounting tax charge of 11%. Prodware has access to a considerable reserve of tax losses in France, and through Qurius in the Netherlands. Prodware had total gross accumulated tax losses approaching €77.5m with €10.6m of deferred tax assets recognised in the balance sheet as at 31 December 2014.

Prodware is a significant beneficiary of the French government’s support of technology investment, most notably through research tax credits. Prodware is given a 30% tax credit on every euro spent on technology development. These are booked as operating subsidies in the year recorded and are deducted from the tax due in the following year, or paid to Prodware if no tax is due.

As a software and services-based business, Prodware has relatively little demand for capital equipment, but it does require ongoing investment in software product, which should not be ignored. In recent years Prodware has capitalised approximately 10% of its revenues in developing software, with the related amortisation charge being broadly half of the level capitalised in the year. We forecast that development spend capitalised will increase in absolute terms over our forecast period but fall as a percentage of sales, with the associated amortisation charge growing both in absolute terms and as a percentage of revenues. We forecast cash generation for Prodware over the period FY15-17e, with our forecasts showing more than €12m of net cash generation across that period as a whole.

Prodware has historically drawn extensively on its ability to borrow directly from banks and through the issue of convertibles to finance its acquisitions. In recent years management has worked to bring down the potential dilution (21% December 2012, 0% at present) and to reduce the interest burden, redeeming convertibles and negotiating lower-cost borrowing facilities. Reported net debt at 31 December 2014 was €41.2m and we forecast that, after the impact of restructuring charges and the initiation of the drive for growth, 2015 year-end net debt will be €45.5m but that over subsequent periods the debt will decline, in the absence of acquisitions. However, management is anxious to make efficient use of sources of capital and in the first half of 2015 Prodware raised a fresh €20m five-year loan from Banque Internationale á Luxembourg with, we believe, significantly lower interest charges than those to which it had been exposed in recent years.