Esker — Combining growth with profitability

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 55% from Europe, 39% from North America and the remainder from Australia and Asia. In recent years, the company has made small bolt-on acquisitions and we believe it would consider further acquisitions if they added technology expertise or geographic presence at a reasonable price. The company generates organic growth from a combination of winning new customers globally and deepening existing relationships. To accelerate the pace at which it on-boards customers, it is developing a network of partners to undertake implementation work.

The company is targeting double-digit organic revenue growth (we forecast 12.2% for FY18 and 13.7% for FY19) and investment in headcount such that operating margins are maintained in the region of 15%. H118 results confirmed the company was on track to achieve this for FY18, with 17% constant currency revenue growth and operating margins of 15.7%. We have made minimal changes to our estimates and forecast net cash to increase to €22.6m by the end of FY19.

The stock has gained 37% over the last year and on a P/E basis continues to trade at a premium to both a group of listed global DPA software companies and to French-listed small-cap software companies, in our view justified by revenue growth and operating margins at the upper end of both groups. We note that most companies in both peer groups are not predominantly SaaS companies, whereas Esker has been operating a SaaS business model for more than a decade. Esker trades at a material discount to US SaaS companies on all valuation metrics; we note that on average they are growing faster than Esker, although they are generating operating margins below the level of Esker. The typical growth path for US SaaS companies involves investing heavily in sales and marketing to gain market share as fast as possible, with little focus on achieving profitability in the short term. Esker’s model sits somewhere between low-growth, high-profitability on-premise software businesses and US SaaS companies’ high growth operating model, aiming for a happy medium of double-digit revenue growth while achieving mid-teen operating margins. Esker has the added advantage of a strong balance sheet that does not require additional funding to support growth.

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 continue this. 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 DPA 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 to 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 (since renamed Euronext Growth). The company made bolt-on acquisitions: TermSync and CalvaEDI in 2015 and e-integration in 2017. Esker’s revenues are well spread geographically, with 55% from Europe, 39% from North America, and the remainder from Australia and Asia.

Esker’s DPA SaaS software supports order-to-cash and purchase-to-pay business processes. The company is working to broaden the functionality of its product suite and 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 would consider acquiring complementary businesses. Excluding acquisitions, growth in recent years has come from a combination of adding new customers and existing customers adding new processes and/or pushing higher volumes through Esker’s platform. To accelerate growth, the company is building a network of partners to undertake implementation work.

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 to fulfil customer orders and collect payment; and purchase-to-pay to order and pay for goods and services.

DPA software 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. Esker has used machine learning for many years to train the software. 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; this helps to train the software. 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. The software has certified integrations with the main ERP vendors, including SAP, Cegid, Oracle’s E-Business Suite, JD Edwards EnterpriseOne, and Microsoft Dynamics NAV.

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 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 600,000 SaaS users.

Esker upgrades the Esker on Demand software every 15 days. Every three years, Esker takes the previous SaaS upgrades and incorporates them into one large upgrade of the DeliveryWare software. The software is hosted out of four data centres: two leased by Esker (France, US) and two Microsoft Azure facilities (Netherlands, Singapore).

The table below shows the development of the platform in terms of functionality.

We understand that the company’s main priorities for product development include:

Esker has used machine learning for many years to improve the accuracy of its software in automating invoice processing. It also incorporates robotic process automation into its software in selected areas, for example to automate invoice submission to customers’ accounts payable portals. It is applying deep learning, which requires access to a very high volume of documents, to a limited number of use cases. For example, it is applying deep learning to the classification of documents received in an email inbox. The software needs to be able not only to figure out which department a document is intended for, but also needs to be able to reject documents that are spam. The goal is to achieve an accuracy on a par with a human – this would then free up the software user to focus their attention on exceptions rather than routine email sorting.

As well as in-house product development and acquisitions of companies with relevant technology, Esker has started partnering to provide access to technology that augments its products. It recently partnered with Rimilia, a UK-based company with an SaaS-based product that provides automatic matching of cash receipts to invoices, for Esker’s order-to-cash solution.

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 recently opened an office in Hong Kong to support the Asia-Pacific market. Esker 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 as the business grows. Esker also sells its software to several companies on a white-label basis.

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 also works 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.

To accelerate the pace at which it can sign up new customers, Esker is starting to build a network of channel partners. The company signed a partnership with Optima ECM Consulting in the US in January and with systems integrator Viveris in France in June. Ideally, these partners will start as implementation partners, but could end up as resellers. Management emphasised that the process of building out the network will take time, as even once partners are identified and signed up, their staff will need to be trained in the use of the software.

Esker sold its software on a white-label basis through Neopost in France for several years and in 2015 entered into a joint venture (JV) with Neopost to expand the scope of this agreement. The JV (owned 70% Neopost/30% Esker) is focused on selling Esker’s software, marketed as Neotouch, to SMEs in France and the US, and is planning to launch in the UK by year-end. This is a market that Esker’s direct salesforce tends not to target. In FY17, Esker reported a €232k contribution from its share in the joint venture, and the joint venture generated c 6% of group sales.

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 5,000 companies globally use Esker software, including BASF, GE Healthcare, Heineken, LVMH, Nvidia, Rockwell Automation, Samsung and Siemens. Esker has more than a decade’s experience in SaaS delivery and has achieved various SaaS certifications such as SSAE16, ISAE3402 and ISO27001, 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 Esker’s 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 newest area for Esker is purchasing (launched in 2014), which contributes less than 1% of revenues. This is a sub-set of the procurement software market, which is dominated by cloud provider Coupa. Esker’s purchasing solution covers the procurement process from purchase requisition to invoice payment authorisation, but over time we expect the company to extend the functionality of the solution to encompass the earlier part of the procurement process. Esker typically sells this solution to existing accounts payable customers to support the full purchase-to-payment cycle.

Exhibit 5 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, OpenText and SAP.

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 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: split by business line: DPA (split out as SaaS and licence-based) and Legacy Products, on a quarterly basis; and 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 5 for historical and forecast divisional performance.

SaaS-related revenues (which include traffic and services revenues) have shown significant growth in recent years. On a like-for-like, constant currency basis, these grew 20% in FY16, 21% in FY17 and a further 20% in H118. At the same time, licence-based DPA revenues (licences, services and maintenance revenues) declined 3% in FY16, 23% in FY17 and gained 1% in H118, now making up only 9% of revenues. The company is targeting 20% growth for SaaS-related revenues and we expect a continuing decline in licence-based revenues, which will have a diminishing impact on overall revenues.

In H118, recurring revenues1 made up 79% of the total, versus 78% in FY17 and 79% in FY16. Esker has a strong record of retaining customers – management estimates that churn is less than 1% per year. As each new customer comes on board, this adds another layer of recurring revenues. In H118, the company won orders worth €8.2m (+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 12.2% y-o-y growth in revenues in H118 (17% on a constant currency basis). As previously highlighted, the company increased headcount in consulting and R&D, resulting in effectively flat operating margins on a year-on-year basis, with a 12.4% increase in operating profit. A shift from a small net financial expense to net financial income, as well as a higher contribution from the JV with Neopost (H118: €151k, H117: €67k) resulted in a 16.6% increase at the net income level.

We have made minimal changes to our forecasts. We reflect H118 costs and slightly increase our capex assumptions for both years. We have also increased our FY19 revenue forecast to reflect strong SaaS-based revenue growth, which results in a 1.1% increase in normalised EPS.

With 39% 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. In our cost calculations, we use a rate of 1.20 for FY18 and 1.17 for FY19. Any further weakening of the dollar could have a material negative impact on our FY18 forecasts (as dollar-based revenues outweigh costs).

The company ended H118 with a net cash position of €11.2m, up from €10.0m at the end of FY17. As well as paying the prior-year dividend, the company paid down €2.2m of debt. Gross cash was €22.7m at period end (including €3m recorded in fixed assets), providing ample funds for acquisitions. We forecast that net cash will increase to €15.5m by the end of FY18 and €22.6m by the end of FY19.

The company invests in tangible fixed assets for its mail centres and offices (c €2m a year) and capitalises development costs (€5.2m in FY17). In H118 it capitalised €3.0m of development costs and amortised €2.0m. We expect a gradual increase in both capitalisation and amortisation in FY18 and FY19 reflecting the growing R&D headcount.

We have compared Esker’s valuation to a group of listed global DPA software companies and to French-listed small-cap software companies (Exhibit 9). The stock gained 25% over the last year and continues to trade at a premium to both peer group averages on a P/E basis, in our view justified by revenue growth and operating margins at the upper end of both groups.

We note that most companies in both peer groups are not predominantly SaaS companies, whereas Esker has been operating a SaaS business model for more than a decade. The US SaaS companies in Exhibit 10 on average are growing faster than Esker, although are generating operating margins below the level of Esker. The typical growth path for US SaaS companies involves investing heavily in sales and marketing to gain market share as fast as possible, with little focus on achieving profitability in the short-term. Esker’s model sits somewhere between low-growth, high-profitability on-premise software businesses and US SaaS companies’ high-growth operating model, aiming for a happy medium of double-digit revenue growth while achieving mid-teen operating margins. Esker has the added advantage of a strong balance sheet that does not require additional funding to support growth.