Esker — Update 4 May 2016

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 c 50% from Europe, c 40% from the US and the remainder from Australia and Asia.

The company generated strong organic growth in 2015, boosted by acquisitions and a positive currency effect. 2016 has started in a similar vein, with Q116 revenues showing 16% organic growth. We revise up our FY16 forecasts, incorporating revenue growth of 15.4%, an operating margin of 17.2% and normalised EPS growth of 24.7%. We introduce FY17 forecasts for 10.4% revenue growth, 18.8% operating margin and 16.0% normalised EPS growth. The business is highly cash generative – we forecast net cash increasing to €15.7m by the end of FY16.

On an EV/sales basis, Esker is trading at a discount to DPA companies and at a premium to French small-cap software companies. Esker’s forecast revenue growth is better than both groups, as are its forecast operating margins. On a P/E basis, Esker trades at a premium to the DPA companies and a discount to French small-cap software companies for both years. In our view, the transition to SaaS is likely to suppress operating margins across the software sector (even after transition costs are taken into account). Esker is ahead of many peers in making this transition and is already generating strong growth and margins. The company achieved recurring revenues approaching 80% last year, which gives a high level of revenue and cash flow predictability. Management has confirmed that it continues to assess acquisition targets, preferring businesses that are international, profitable, have an existing customer base and have already made the move to a SaaS business model. The company has a strong net cash position and is forecast to build this over the next two years.

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 compete. 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 document process automation 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 1998-2000 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. In 2011 Esker opened its new mail production facility in Lyon, France. The company’s revenues are well spread geographically, with c 50% from Europe, c 40% from the US, and the remainder from Australia and Asia.

The majority of Esker’s revenues are generated from the Document Process Automation (DPA) software business (92% in FY15). The remainder of the business is grouped into Legacy Products, and consists of the Fax Server business (which automates fax sending and receipt) and the Host Access business (which enables customers to access mainframes from PCs). All development is focused on the DPA business and we expect this to continue to grow and generate an increasing percentage of revenues. While the legacy business continues to be supported, the company is not actively chasing new business or developing new products.

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. He previously worked as R&D team manager for Arthur Andersen Consulting in Lyon. 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: document delivery, procurement, accounts payable, accounts receivable and sales order processing. These can be combined to fulfil two basic cash cycles: order-to-cash (O2C) – to fulfil customer orders and collect payment; and purchase-to-pay (P2P) – to order and pay for goods and services.

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, the UK, the US, Australia, Spain and Singapore.

DPA software for the other four processes 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. The software is self-learning – 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. 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.

Esker’s software has several attractive features:

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. In Latin America, e-invoicing is government-mandated in order to ensure tax compliance and collection. In many countries, suppliers to government organisations are required to use e-invoicing.

DeliveryWare is the longest-standing product and is an on-premise solution. Esker started developing a multi-tenant SaaS product, Esker on Demand, in 2004. This started to gain traction from 2009 as customers were attracted by the lack of upfront investment and the usage-based payment mechanism. Typically, new business is for Esker on Demand, although some customers prefer to use the on-premise solution for security reasons. It is rare for an on-premise customer to convert to the SaaS solution, although they sometimes take the SaaS product for new divisions or processes. The company has more than 5,000 SaaS customers with over five million users.

Esker upgrades the Esker on Demand software on a quarterly basis. Every three years, Esker takes the previous SaaS upgrades and incorporates them into one large upgrade of the DeliveryWare software. The main areas of focus for product development are:

In 2015, Esker made two acquisitions, TermSync and CalvaEDI. TermSync is a US cloud-based invoice processing platform provider. TermSync’s solution is designed to improve the efficiency of the accounts receivable function, and includes the ability to track invoices, schedule reminders, and analyse performance. TermSync’s business model is similar to Esker’s: customers pay a monthly subscription fee plus a fee per invoice processed. Esker is using the TermSync solution to enhance its existing accounts receivable offering in the US, and in France is planning a soft launch in June 2016, with full launch expected in early 2017.

CalvaEDI is an EDI network service provider, providing gateways between its customers’ different computer systems. EDI is defined as the computer-to-computer exchange of information in a standard electronic format and is one of the methods used by companies to communicate with their customers and suppliers (an alternative to fax, paper invoice or email). CalvaEDI has more than 300 customers in transport and logistics, predominantly based in France. The business model is similar to Esker’s on-demand DPA, with customers charged on a usage basis rather than upfront licence fees. EDI has typically been implemented by large customers but Esker sees the acquisition as an opportunity to extend the technology to smaller customers. CalvaEDI continues to trade under its own name and will work with Esker on developing new services over time, in particular, to offer Esker customers with automated order-to-cash cycles the benefit of EDI integration.

The company’s medium-term plan is to provide a business collaboration network and it is progressively adding functionality to achieve this. Currently, Esker provides a portal for each process. The longer-term goal is to connect these portals together to create a networking platform that would allow customers and suppliers to interact securely and could be used for direct exchange of purchase orders and invoices, payment of invoices, early payment discounting, dispute resolution and data clarification. The network should enable full visibility of invoice status (ie it should be possible for both supplier and buyer to see that an invoice has been approved for payment), at which point it should be possible to provide supply chain financing to either party. Several invoice networks are active in this space, for example Taulia and Tungsten, offering invoice factoring, reverse factoring and/or dynamic discounting. Esker is evaluating the financing market, and has yet to decide whether to enter it via partnership or acquisition.

Esker competes against a different group of companies for each business process. 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. 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. More than 11,000 companies globally use Esker software, including BASF, GE Healthcare, Honeywell, Philips, Samsung, Siemens and Whirlpool.

Accounts payable is the most competitive area – when Esker wins business it tends to be for customers who 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 the 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 table below 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 Lexmark, Basware and OpenText. Lexmark built up its position via acquisition (Brainware 2012, Readsoft 2014, Kofax 2015), but has recently agreed to be bought by an Asian consortium for $3.6bn.

Management’s view is that its software has been designed as an end-to-end solution and therefore provides an integrated process flow, whereas some competitors provide a solution made of various disparate products, eg OCR (optical character recognition) plus process flow plus archiving, which require a greater amount of integration work. Esker also believes its SaaS product sets it ahead of competitors that are predominantly focused on on-premise solutions. Esker has 10 years’ experience in SaaS delivery and has achieved various SaaS certifications such as SSAE16 and ISAE3402, providing a level of confidence regarding business continuity and data security.

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 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 need to be hired in the relevant countries once the business grows. 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 will also work with the customer’s IT department, but this is mainly to work on integrating the software rather than to sell to.

Esker has sold its software on a white-label basis through Neopost in France for several years and in 2015 entered into a joint venture with Neopost to expand the scope of this agreement. The JV (owned 70% Neopost/30% Esker) is focused on selling Esker’s software to SMEs in France and the US. This is a market that Esker’s direct sales force tends not to target.

Esker also sells its software on a white-label basis to Paragon, Ricoh Belgium and Asterion International.

Esker’s Legacy Products division includes fax servers and host access products.

Our forecasts and the Esker share price will be sensitive to the following factors:

Esker reports revenues in two ways: 1) split by business line, ie DPA and Legacy Products, on a quarterly basis; and 2) 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 couple of 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 4 for historic and forecast divisional performance.

The company reported FY15 operating profit of €8.7m (14.9% margin). Excluding goodwill and other acquired intangibles amortisation of €0.3m and exceptional costs of €0.2m, Esker achieved a normalised operating profit of €9.3m (15.8% margin, up from 12.4% a year ago). The tax rate on reported PBT was 26%. Reported basic EPS was up 33.6% y-o-y.

The two key cost lines are staff costs and external purchases and other costs. We forecast an increase in staff costs of 10% in FY16 and 8% in FY17. This assumes a 7% increase in headcount in FY16 and 5% in FY17. We forecast increases in external purchase and other costs of 10% in FY16 and 9% in FY17. Operating expenses are partially offset by capitalised development costs: Esker capitalised costs of €3.8m in FY15 and we forecast growth to €4.2m in FY16 and €4.4m in FY17. This results in normalised operating margin forecasts of 17.2% in FY16 rising to 18.8% in FY17. We increase our FY16 EPS forecast by 2.3%, equating to EPS growth of 24.7%. We introduce a forecast for EPS growth of 16.0% in FY17.

Esker has proposed a dividend of €0.30 for FY15 (+20% y-o-y, payout ratio 23%). We increase our FY16 and FY17 forecasts reflecting payout ratios of 20% and 19% respectively.

With 40% of revenues in the US but a lower proportion of the cost base in US dollars, the weakness of the euro versus the dollar had a strong positive effect on FY15 results, contributing 8% to revenue growth. The $/€ exchange rate averaged 1.10 in Q116 (compared to 1.11 for FY15) and Q2 to date has averaged 1.13. Our forecasts for FY16 and FY17 assume a rate of 1.11.

The company ended the year with a net cash position of €9.0m, after paying €11.7m for the two acquisitions. We forecast operating cash flow post tax and interest of €14.0m in FY16 and €15.3m in FY17. Capex is predominantly made up of capitalised development costs, with a smaller amount of expenditure on tangible fixed assets. We forecast that net cash will increase to €15.7m by the end of FY16 and €23.2m by the end of FY17.

We have compared Esker’s valuation to a group of listed global DPA software companies and to French-listed software companies with a market cap of €30-700m. On an EV/sales basis, Esker is trading at a discount to DPA companies and at a premium to French small-cap software companies. Esker’s forecast revenue growth is better than both groups, as are its forecast operating margins. On a P/E basis, Esker trades at a premium to the DPA companies and a discount to French small-cap software companies for both years. In our view, the transition to SaaS is likely to suppress operating margins across the software sector (even after transition costs are taken into account). Esker is ahead of many peers in making this transition and is already generating strong growth and margins. The company achieved recurring revenues approaching 80% last year, which gives a high level of revenue and cash flow predictability. Management has confirmed that it continues to assess acquisition targets, preferring businesses that are international and profitable, have an existing customer base and have already made the move to a SaaS business model. The company has a strong net cash position and is forecast to build this over the next two years.

We have performed a reverse 10-year DCF to calculate what we believe the market is factoring into the current share price. Using a WACC of 9%, long-term growth of 2%, working capital/sales of 0.4% and capex/sales of 8.0% (including ongoing capitalisation of development costs), revenue CAGR of 3.9% for 2018-25 and average EBITDA margins of 25.4% from FY17 are required to reach the current share price. Based on the market potential and current levels of profitability this appears conservative.