The ASX might be desperately short of successful tech companies but Technology One (ASX: TNE) is a big exception. For long-time Technology One shareholders the returns have been incredible. Over the past 5 years total shareholder returns have been a whopping 37% per year for a total five-year gain of over 380%. So what is the story behind this shareholder hero, and are the shares still a bargain today?
The Technology One model
Technology One provides deeply integrated enterprise software for a wide range of customers, and with a particular focus on government clients. The beauty of enterprise software is its high switching costs. If a company wants to change its enterprise software platform it will need to retrain thousands of workers, rework a large chunk of its internal processes, and potentially risk destabilising the entire business.
Those switching costs mean that the average customer sticks with Technology One for a very long time. In fact, the company is proud to say that it still retains many clients from when it first launched almost 30 years ago. That staying power means Technology One doesn't need to spend as much on continuously chasing new business, and has pricing power in existing client relationships; both of which add up to high returns on capital. Technology One has posted a return on shareholder's equity of over 30% for several years.
One of Technology One's critical points of differentiation among enterprise software providers is that the company provides an end-to-end solution without use of third party implementation partners or resellers. This gives Technology One full control over its software and allows it to ensure that new customers aren't disappointed by the myriad problems that typically derail new software implementations.
The power of founders
Founder-led companies have a tendency to outperform. It is hard to match the passion and ownership that comes from having started the enterprise from scratch. Technology One is a classic example, with founder CEO Adrian DiMarco still at the helm almost 30 years later. The Technology One model, with its focus on long-term customer satisfaction, is arguably only possible because of DiMarco's leadership.
Where competitors will use third party vendors in order to juice short-term growth, Technology One has instead focused on building a solid foundation for long term gains. That long-term focus shows up in multiple domains.
In product innovation, Technology One currently spends almost 20% of its revenue on reinvesting in research and development. Compare that with an industry average of around 12% and you can see why customers have been willing to stick around. As the company finishes up its current investment in a new cloud product over the next few years it expects R&D spending to fall to a, still high, 15% of sales – providing a nice boost to the bottom line.
In sales, the company begins engaging with potential clients as much as 7 years before they expect them to need new software. That marathon-length lead time enables Technology One to build a strong relationship with key stakeholders and understand precisely what the customer will need, so they are poised and ready when it comes time to switch.
Is the price right?
Technology One has generated incredible returns for long-term shareholders, but the flipside of those returns are that the shares today are a lot less attractive than they once were. My intrinsic valuation estimate suggests that Technology One is trading a little above fair value today.
