It's not often that a company which has seen its share price double in the last 12 months qualifies as our Top Stock, but this is a special company with a long runway ahead of it.
Communication and payments are two cornerstones of everyday life that keep rapidly evolving. Integrated Research (ASX: IRI) is brilliantly positioned to profit handsomely from both the migration to Unified Communications (based on Internet Protocol Telephony networks — IPT or VoIP as it is commonly called) — and the massive long-term growth in real-time payment processing.
To give you a sense of the market size – and the company's aspirations – technology research firm Gartner has forecast the likely growth of the Unified Communications market:
Source: Company report
If that wasn't impressive enough, these numbers from Boston Consulting Group shows the potential of Integrated Research's payments business:
Source: Company report
We're sure you'll agree they are certainly attractive markets to be participating in.
Clipping the ticket on communications and payments
Integrated Research provides the solutions businesses require for rapidly increasing technological complexity and real-time transactions.
It is a global provider of performance monitoring and diagnostics software for business-critical computing and unified communications networks. Its flagship product, PROGNOSIS, is an integrated suite of applications that monitors and manages distributed IT infrastructure, payments systems, communications, and internet applications.
Integrated Research has had a seat at the IP telephony table since the technology's infancy in 2000. It began by monitoring Cisco's IP systems but now supports other key unified communications (UC) providers such as Avaya and Nortel.
The transformational deal for Integrated Research came in 2009 when communications giant Avaya selected PROGNOSIS to replace its in-house developed VoIP monitoring tool. A slimmed-down version of PROGNOSIS is now shipped with every Avaya PBX sold worldwide. This gives Integrated Research an excellent foot in the door and exposes a large customer base to its software.
The Avaya relationship is important to Integrated Research, but the company does not depend on it. Integrated Research continues to sell its products through other major vendors such as Alcatel, Cisco and Microsoft, as well as via resellers and direct sales. The latter is shaping up as a game changer for unified communications – and for Integrated Research.
Gartner forecasts strong growth in IP telephony in the coming years. Although this is a driver of Integrated Research's business, the company is already looking ahead to the future. It's increasing its focus on payment systems and the consumerisation of information technology (IT).
Wait … unified what? Consumerisation who? Let's take a look at these concepts.
Unified communications means what the term implies. Imagine your fixed line, mobile, IP phone and video all being unified, with calls routed through a chosen device. Add in your text messaging, email and contact management system, and you're starting to get the picture.
The consumerisation of IT is best described as Bring Your Own (BYO) to work. Whether it's a BYO device, such as a smartphone or tablet, or a BYO application such as Twitter or Dropbox, it means one thing — increasing complexity for IT departments.
Integrated Research has the experience and is well positioned to support businesses as they grapple with this increased complexity and the need for real-time monitoring of IT systems and connected devices.
Integrated Research is primed to reap even more rewards from its historically steady growth. The company has more than 600 customers in its installed base who are already providing steady streams of recurring revenue. Combining a strong reputation and loyal customers, several of whom are among the world's largest, with forward-thinking new solutions, is a proven model for increasing profits and margins.
Management has sensibly diversified the company's revenue streams with the addition of Consulting Services and Payment Processing. Along with Unified Communications, and Infrastructure, the company now has four revenue streams.
The 31% growth in Consulting Services in fiscal 2012 was impressive and the company delivered similar growth in Unified Communications and a slightly higher 36% growth in payment processing. For payments, Integrated Research has partnered with ACI Worldwide, a company that dominates the payment-processing market.
Despite the sluggish US economy, the Americas was Integrated Research's fastest growing region. Americas revenue jumped 25% last year. The company is focussed on getting all of its regions firing at once, and a reasonably sluggish (at least relatively speaking) 6% growth in Europe and a slight decline in Asia Pacific are areas of focus for management (with some new staff now also on board) in the 2013 financial year.
Pay it again, Sam
Integrated Research, like many software vendors, enjoys a high level of recurring revenue. The company's revenue model is two-fold: customers pay upfront licence fees to use the software, plus they pay annual maintenance fees, typically 20% of the licence fee, for the lifetime of the customer relationship. With a remarkable 90+% retention rate, recurring revenue represents 34% of total revenue today.
We love recurring revenue models for several reasons. During difficult economic times, recurring revenue provides a safety cushion of cash flow that can get a company through the turmoil. Businesses may delay a new purchase, but they are less likely to cut maintenance expenditures.
This in turn makes leadership more effective because it can adjust strategy with the benefit of time. More exciting is that recurring revenue compounds with the addition of layer after layer of new customers, especially with a 90+% retention rate.
The software business is brutally competitive, but the silver lining is in the high margins and maintenance. Once you've written all the code, the software itself is practically free to manufacture and distribute. Integrated Research currently operates on a net margin of 18.5%.
Management are focused on controlling expenses, capping growth at a low 6% in 2012. As increasing sales and recurring maintenance revenue hit the top line, management's focus on cost control will result in more dollars falling to the bottom line.
With a market capitalisation of around $150 million, Integrated Research is debt-free and flush with cash — $12.0 million as of 30 June 2012. It continues to sensibly invest around 20% of revenue in research and development — the pipeline of future growth.
Management increased the final dividend to 3 cents, bringing the total 2012 dividend to five cents. With a stock price of around $0.90 cents, that's a very healthy dividend yield of 5.5%. While a P/E of 16.8 times doesn't appear screamingly cheap, we think the growth potential makes it an attractive price.
Risks
Although most competitors are relatively small, competition is always a major risk. Software is built layer upon layer, and while this ensures superior product capabilities in established players, such as Integrated Research, it can hinder their ability to capitalise on the latest software trends.
With most of Integrated Research's revenue coming from the U.S. and, to a lesser extent, Europe, currency movements are another risk. To mitigate this risk, Integrated Research hedges a portion of its expected revenue six to nine months out. Nonetheless, a large, rapid change in exchange rates could adversely affect reported income.
The greatest risk is from the speed of the global economic recovery combined with Integrated Research's exposure to banking. Banks are Integrated Research's largest customers, and if the global economy falters, these financial institutions may postpone spending on new software.
Foolish Bottom Line
Integrated Research's reasonable price and attractive dividend yield present an attractive value proposition. When combined with the growth catalysts of unified communications, payment processing and consulting services, this company epitomises growth at a reasonable price.
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Last updated: 25th September 2012
This report has been updated by Scott Phillips. Employees and contractors of The Motley Fool, including Bruce Jackson and Scott Phillips may have an interest in any shares mentioned in this free report. These interests can change at any time. The Motley Fool has a clear and concise disclosure policy.
