Esker — Robust H1; continuing to invest for growth

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 software-as-a-service (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 57% from Europe, 38% 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 can sign up and on-board customers, it is developing a network of partners to undertake implementation work and resell Esker software.

Esker expects to generate constant currency revenue growth of c 9% for FY20 before reverting to previous growth rates of 15%+ in FY21. It aims to maintain profitability at a similar rate to FY19 despite the disruption caused by COVID-19. We have slightly reduced our revenue forecasts to reflect the longer duration of the pandemic than originally expected. A cut in tax rates due to the first-time application of patent box rules to software in France means that overall, our EPS forecasts increase by 1.5% in FY20 and 6.5% in FY21. Net cash remains strong (€22.9m at the end of H120) and we forecast it will grow to €33.0m by the end of FY21.

The stock is up 50% year-to-date 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. Compared to US SaaS companies, which have a similar business model to Esker, the company trades at a material discount to average EV/sales and P/E multiples. We note that on average US peers are growing faster than Esker, although they are generating lower operating margins. 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 are 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. Success of channel partner strategy: revenue growth and headcount needs will depend on the rate at which partners are able to resell and/or implement Esker software. Rate of decline of on-premise licensing and legacy business: these businesses are very profitable maintenance revenue generators. The rate at which these businesses decline will affect growth and 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’s SaaS delivery model generates high levels of recurring revenue and has proven robust during the COVID-19 pandemic.

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. The company has operations in 13 countries and its revenues are well spread geographically, with 57% from Europe, 38% 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 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 and resell Esker software.

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 (global 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 has developed a unified cloud platform to automate order-to-cash and purchase-to-pay cash cycles. Its DPA software operates in five areas: procurement, accounts payable, accounts receivable, sales order processing and document delivery. These can be combined to fulfil the cash cycles as per Exhibit 1: order-to-cash to fulfil customer orders and collect payment; and purchase-to-pay to source, order and pay for goods and services.

Features of the software include:

Esker’s 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 helping the software to learn. 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 provides a dashboard showing relevant key performance indicators (KPIs) and data analytics to support performance monitoring.

The software has certified integrations with the main ERP vendors, including SAP (including S/4HANA), Cegid, Oracle’s E-Business Suite, JD Edwards EnterpriseOne, Microsoft Dynamics NAV, Sage, Infor and NetSuite. Earlier this year, Esker announced that it had partnered with Cegid to provide its supplier invoice processing software for Cegid’s XRP Flex solution.

Esker’s mobile solution, Esker Anywhere, can be used for procurement, accounts payable and sales order processing.

The business helps buyers and suppliers to collaborate by providing a portal for each process that they can both access, with features such as invoice status and chat. More recently, using AI it has developed a shared database of document recognition models for orders and invoices in pdf format. 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 software offers self-service online payment options such as credit cards, ACH, SEPA and direct debit, or can be integrated with the customer’s preferred payment processor. The software also manages cash allocation automatically. The company recently integrated its order-to-cash software with Stripe Connect to offer the convenience of a single payment provider globally.

In June, Esker launched a credit management solution that allows companies to automate new customer on-boarding and secure their credit approval process. The solution includes customisable credit application templates, workflow rules and a customisable dashboard to monitor application status and tasks. Periodic credit reviews can be automated and a customer repository includes all customer-related documents, credit and business information to make informed decisions. Esker has partnered with Dun & Bradstreet globally, CreditRiskMonitor in North America and Ellisphere in Europe to provide access to external credit data.

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.

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 have been subject to the 2014/55/EU directive since April 2019: 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.

The table above details Esker’s product range for DPA, all of which are SaaS-based. Esker on Demand is the main product; this multi-tenant solution was originally developed by Esker in 2004, ahead of many other software companies’ entries 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. The company has more than 6,000 SaaS customers and 600,000 SaaS users.

Esker upgrades Esker on Demand every 15 days. The software is hosted out of six data centres: two leased by Esker (France, US) and four Microsoft Azure facilities (Australia, Canada, the Netherlands and Singapore).

Esker’s longest-standing product, DeliveryWare, is an on-premise solution. The company discontinued new sales of this product in September 2019; we would expect related maintenance revenues to slowly decline. In FY19, DeliveryWare-related revenues made up 6% of group revenue.

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:

As well as in-house product development and acquisitions of companies with relevant technology, Esker partners with other companies to provide access to technology that augments its products. One example is Rimilia, a UK-based company with a SaaS-based product that provides automatic matching of cash receipts to invoices for Esker’s order-to-cash solution. Last year, Esker made a 40% investment in the initial seed finance round for a US start-up called B/2BNOW, which has since changed its name to Highview. Highview provides EDI solutions for SAP S/4HANA Cloud ERP systems. Steve Smith, COO of Esker US, joined the board of Highview.

Esker has a direct sales presence in Europe (France, Germany, Italy, Spain and the UK), the US and Asia-Pacific (Australia, Hong Kong, Malaysia and Singapore). 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. 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 go on to use Esker for additional processes. Last year, the company created a customer experience team to strengthen the relationship with customers and to minimise churn.

Excluding the effect of COVID-19 on demand, the main gating factor for Esker’s growth is the availability of consultants. To accelerate the pace at which it can sign up and on-board new customers, Esker is developing a network of channel partners. These partners are providing consulting and implementation services, and in some cases are reselling Esker’s technology.

Key partners include:

The company noted in its H120 results that it has signed several deals in Japan via the Fuji Xerox partnership. While these are small in terms of revenue, they provide Esker with the opportunity to learn and adapt product to suit customers in the Japanese market.

Esker sold its software on a white-label basis through Quadient (previously called Neopost) in France for several years and in 2015 entered into a joint venture (JV) with Quadient to expand the scope of this agreement. The JV (owned 70% Quadient, 30% Esker) is focused on selling Esker’s software, marketed as Neotouch, to SMEs in France, the US and the UK (Esker’s direct salesforce tends not to target the SME market) and to date has c 3,500 end customers. Neotouch is a hybrid mail solution, converting internet mail into physical form for transfer to postal services. In FY19, Esker reported a €0.5m contribution from its share in the JV, and the JV generated 10.2% 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.

Most of the companies that Esker competes with operate in either the order-to-cash or purchase-to-pay markets. 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 6,000 companies globally use Esker software, including BMW, GE Healthcare, Heineken, Microsoft, Novartis, Samsung and Siemens. Esker has more than a decade’s experience in SaaS delivery and has achieved various SaaS certifications such as SSAE18, 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 4 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, the company 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 seeking 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:

SaaS revenues are generated on a per-transaction basis from all SaaS DPA products customers. Licence and maintenance fees are generated from DeliveryWare on-premise licence sales and the fax server and host access businesses (although as DeliveryWare has been discontinued there will no longer be any licence sales from this product). Hardware sales are generated by the fax server business. Consulting revenues are generated from on-premise and on-demand DPA business. Older DPA subscription sales were structured on a traffic-only basis, with consulting 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 SaaS and consulting revenues) have shown significant growth in recent years. On a like-for-like, constant currency basis, these grew 21% in FY17, 20% in FY18, 21% in FY19 and 11% in H120 (SaaS +9%, consulting +15%). Licence-based DPA revenues (licences, consulting and maintenance revenues) declined 23% in FY17, 1% in FY18, 18% in FY19 and 15% in H120, now making up only 5% of revenues.

In H120, recurring revenues3 made up 80% of the total, versus 78% in FY18 and 79% in FY19. 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 H120, Esker won orders worth €12m (+3% 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 per document fees, which can make up the same amount again over the three years. This was a strong performance considering the difficulties in signing new business during Q2.

Esker generated 8.2% y-o-y revenue growth for H120 (7% constant currency), despite COVID-19 disruption. On a quarterly basis, Q120 was 16% higher on a constant currency basis whereas Q220 revenues were flat. Consulting revenues were robust in the period (+15%) as a backlog of projects meant that consultants were fully utilised as they were able to undertake implementation projects from home. SaaS revenues were 9% higher year-on-year; while the US and Asia-Pacific were more robust and benefited from new customers coming onboard, Europe was hit harder by lockdowns in Q2. We note that SaaS revenues are made up of monthly subscription fees, which continued unaffected by COVID-19, and volume-based fees, which declined c 24% in April and May, as companies processed fewer invoices during lockdown.

The company slightly slowed the pace of hiring during H1, but still grew headcount 6% h-o-h and 14% y-o-y. This resulted in staff costs increasing 20% y-o-y. Other operating costs (excluding depreciation and amortisation) fell 6% y-o-y, as travel and marketing costs fell significantly in Q2 and a higher level of development costs were capitalised (although the percentage of R&D costs capitalised remained flat at 63%). Overall, this resulted in a 14% decline in reported operating profit and a 3pp decline in the operating margin year-on-year.

Until March, the JV with Quadient (see above) was on a growth path, but as it involves physical mail, COVID-19 disruption (particularly in France) drove a decline in business for the JV of c 35% in H120. The contribution to Esker of €174k in H120 therefore declined from the €251k in H119 and €272k in H219.

France recently updated its tax rules to allow software companies to take advantage of its patent box regime. This reduces the tax rate on profits from copyrighted software resulting from R&D in France from 31% to 10%. This resulted in a one-off tax credit of €852k for FY19 (reported as exceptional income in H120) and reduced the effective tax rate from 31% to 27% in H120.

In H1, the company generated operating cash flow of €9.5m. As well as paying the prior-year dividend of €1.9m, the company paid down €1.5m of debt and took advantage of a government-guaranteed loan of €11.5m (one-year maturity, 0.5% rate).

The company invests in tangible fixed assets for its mail centres and offices and capitalises development costs. In H1, Esker capitalised €4.0m of development costs and amortised €2.6m and spent €1.2m on tangible assets. We expect a gradual increase in both capitalisation and amortisation in FY20 and FY21 reflecting the growing R&D headcount.

Gross cash was €33.8m at period end (excluding a further €5.7m recorded in fixed assets), providing ample funds for acquisitions and investment. The company ended H120 with a net cash position of €22.9m, up from €21.0m at the end of FY19. We forecast that net cash will increase to €26.0m by the end of FY20 and €33.0m by the end of FY21.

We have slightly reduced our revenue forecasts reflecting company guidance for FY20 for constant currency revenue growth of c 9%. Management expects growth to return to more normal rates in FY21. We have reflected the new tax rates of 27% (down from 31%) for FY20 and FY21. Overall, this results in a 1.5% increase in our FY20 normalised diluted EPS forecast and a 6.5% increase in FY21.

With 37% of revenues from the US but a lower proportion of the cost base in US dollars, the company is exposed to changes in the dollar-euro exchange rate. In our cost calculations, we use a rate of $1.125/€ for FY20 and FY21. Any weakening of the dollar could have a material negative impact on our forecasts.

The stock has gained 50% year-to-date and is trading 22% higher than its pre-COVID-19 peak. We have compared Esker’s valuation to a group of listed global DPA software companies and to French-listed small-cap software companies (Exhibit 8). We have also included aggregate data for a group of more than 40 US SaaS software companies. We note that most companies in the first two peer groups are not predominantly SaaS companies, whereas Esker has been operating a SaaS business model for more than a decade.

US SaaS companies on average 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 re-rated over the last year, with its P/E multiple moving more towards the US SaaS peer group. We believe that this is due to the value placed on businesses with high levels of recurring revenue, providing visibility through a period of economic uncertainty. Esker has the added advantage of a strong balance sheet that does not require additional funding to support growth.

In Exhibit 9 we show how Esker (marked in green) compares to a selection of US SaaS peers when considering next year revenue growth versus next year EV/sales multiple. Exhibits 10 and 11 show how the peer group is trading on a P/E basis compared to revenue forecasts this year and next (we have excluded any companies trading on a P/E above 150 for either year). In Exhibit 12, we compare average revenue growth and average EBIT margins over the next two years.