CREALOGIX Group — Seeing through the SaaS transition

CREALOGIX is an international leader in digital banking solutions. Based in Zurich, it was founded in 1996 by Bruno Richle, Richard Dratva, Daniel Hiltebrand and Peter Süsstrunk. Messrs Richle, Dratva and Süsstrunk continue to work with the company and together own c 36% of the share capital. With more than 700 employees, CREALOGIX provides front-end banking software solutions that operate across multiple mobile and PC channels. It has implemented projects for more than 550 customers, ranging from comprehensive online banking and Robo Advisory to mobile-only solutions. The company ranks in IDC’s global fintech top 100, having improved its position every year since its initial inclusion in 2016.

The company has a leading position in the Swiss market, where 19 of the 30 largest Swiss banks are using its digital online/mobile applications. It has offices in Germany, Austria, Spain, the UK and Singapore, with plans to extend operations further in Asia and the Middle East. In FY19, 64% of sales were international (ie outside Switzerland), which it expects to rise to 70% or more in the medium term.

The total addressable global market for digital banking software is estimated to be worth $23bn (source: Temenos, August 2019), of which the US represents c $9bn. The digital banking software market remains a fragmented competitive landscape, with competition varying by country and region, including incumbent banking software vendors, specialist front office providers and leading fintech companies.

CREALOGIX is now deep in the middle of the SaaS transition. FY19 revenues increased 17% to CHF101.9m, while FY19 EBITDA fell to CHF1.9m, markedly down on FY18 (CHF7.0m) due to the revenue and profit deferral implicit in the transition to a SaaS model, coupled with a deferral of decision making by potential clients. FY19 net losses amounted to CHF6.3m (FY18: CHF0.7m net profit), including CHF5.1m of amortised goodwill (FY18: CHF2.9m). Looking at H1 vs H2, H219 revenues were broadly flat at CHF50.9m, while H219 EBITDA fell to a loss of CHF1.4m from a CHF3.3m profit in H119.

As well as the SaaS transition, the company noted that uncertainty around Brexit has also had a pronounced negative impact on its UK business, although the UK deal pipeline remains strong. On a positive note, CREALOGIX stated that it is near to closing a number of major international deals which, although they are still live, have not progressed at the speed with which management initially anticipated. Given the transition against an uncertain financial market backdrop (slowing global growth, US/China trade war, Brexit etc), management has withdrawn its explicit forecasts for the business, although it has reiterated that it expects to achieve double-digit EBITDA margins in the medium term.

Despite the short-term pain the SaaS transition entails, we believe it is a necessary and beneficial step for the business to take and that the recurring revenues, increased visibility, higher margins and better client retention will improve the quality of CREALOGIX’s business and earnings in the medium term.

Despite the difficulty in predicting the timing of major contract wins, CREALOGIX anticipates a positive revenue outlook for FY20 (we now forecast 4% revenue growth) with continuing strong underlying market demand and expected major new customer wins in the international banking sector. The SaaS transition will continue to drag on margins and we forecast EBITDA of CHF2.6m and CHF4.7m in FY20 and FY21, before CREALOGIX is able to realise its target of double-digit EBITDA margins in FY22.

Historically, CREALOGIX has offered a range of revenue models to its customers, predominantly a perpetual licence model, with additional annual support and maintenance fees, as well as services income. The new default delivery will be a hosted cloud or rental offering, which involves a recurring annual subscription fee. Clients upgrading their contracts are being encouraged to switch to rental although there will always be some clients that continue to prefer the perpetual licence model.

While this transition results in a temporary negative impact on revenues and profitability, the financial benefit, increased visibility, higher margins and better client retention will improve the quality of earnings in the medium term. In the transition period from licences to SaaS, the company will forego the up-front recognition of licence fees (CHF1m) for a recurring fee spread over the initial contract period (eg CHF0.3m pa). In this respect, although the revenues over the initial contract term are similar or higher, there is an interim period (of around four years) where there is a revenue shortfall versus the traditional licence model. Similarly, under current accounting rules, profit recognition (ie EBITDA) will be spread evenly over the life of the contract, whereas under the licence model, this was largely recognised upfront. Once the ‘breakeven’ point has been reached, the revenue – and therefore also the profitability – of the rental model is substantially higher than under a traditional maintenance fee model.

Management indicated that the initial impact from the SaaS transition was seen in FY18, with revenues and EBITDA CHF4m lower (part-year effect) than under a licence/maintenance model. The impact increased to approximately CHF7m in FY19 and, assuming a three-year transition period, we forecast a drag of CHF7m and CHF4m (part-year effect) in FY20 and FY21 respectively, before a full year benefit in FY22.

The stock trades on 1.30x EV/Sales in FY20e, falling to 1.18x in FY22e with an FY22e EV/EBITDA multiple of 10.5x and a FY22e P/E of 15.9x. For patient investors prepared to consider a medium-term time horizon, CREALOGIX offers an attractive valuation proposition as it emerges from the SaaS transition, as highlighted by the valuations of its quoted peer group (closest peers, Temenos and Q2 Software). In terms of valuation, looking at CREALOGIX’s trading peers (see Exhibit 11) suggests that a valuation of c 2.5–3.0x revenues and c 15–20x EBITDA could be achievable once the SaaS transition has been successfully negotiated, although we recognise the wide variations in business models and valuation multiples across the peer selection.

As has been highlighted in previous notes, economic and regulatory uncertainties, including Brexit, have the potential to affect decision-making by CREALOGIX’s customers. There is also a competitive risk that fintechs and challenger banks could make significant inroads into the traditional banking sector, leading to consolidation that would reduce CREALOGIX’s addressable customer base. Major back-end software vendors and ERP software providers could become more active in the front end, while specialist direct competitors could develop stronger solutions (eg Temenos/Kony) or more attractive business models. CREALOGIX’s acquisition strategy carries execution risk and increasing currency exposure as the company expands abroad. CREALOGIX has announced (but not yet completed) a fully underwritten convertible bond issue to redeem its maturing convertible bonds as well as to provide sufficient working capital to see the company through its short-term transitional phase.

CREALOGIX develops and implements software solutions that enable digital banking for ‘the digital bank of tomorrow’. This market is dynamic and fast changing, and the group’s solutions are typically used by traditional banks to enable their journey to digitalisation through the provision of a sophisticated, modern, omni-channel offering to their clients.

The group’s products are front-end solutions that integrate with the customer’s back-end systems, such as a core banking system from Temenos, Avaloq or Infosys.

CREALOGIX’s primary target customers are traditional retail, private and commercial banks, as well as wealth managers that need to upgrade their legacy in-house systems. These see the benefits of modular, customisable, single-platform solutions, offering lower maintenance and development costs, better content management and stronger security in a constantly evolving (swiftly digitalising) marketplace. CREALOGIX has a customer-centric focus to optimise the user experience across the areas of mobility, security, personalised advice and education.

CREALOGIX sees itself as a pioneer in digital banking, having launched the first internet banking solution in Switzerland with Credit Suisse in 1997. It has offices in Germany, Austria, Spain, the UK and Singapore, with plans to extend operations further, mainly through implementation partnerships. Despite a market-leading position in Switzerland, 64% of FY19 sales were outside Switzerland and its medium-term target is to raise international revenues to 70%. CREALOGIX also intends to raise its recurring revenues (SaaS and maintenance) from 42% of revenues in FY19 to 60% of overall revenues by FY22.

As well as being recognised in IDC’s fintech top 100 in 2016–19, CREALOGIX’s technology continues to win awards. The group was recognised with two awards at the 2019 Systems in the City Financial Technology Awards, including Best Wealth Management User Interface for its innovative digital wealth management products. CREALOGIX is now a three-time Best of Show winner at FinovateEurope, with its TimeWarp, Gravity and The ARCs products.

To ensure CREALOGIX can sustain its market-leading position, management announced a transformation programme alongside its FY19 results.

This programme involves three key elements:

1. Accelerating transition to a SaaS model – driven by the full acquisition of ELAXY Business Solution & Services (BS&S) in July 2018 (a digital banking advisory business with a German data centre), CREALOGIX is now working with a range of customers, particularly in Switzerland and Germany, as the international banking sector switches to a rental/SaaS model.

2. Increased R&D to support scaling – CREALOGIX continues to invest in its Digital Banking Hub, to make it more modular (eg open banking, user experience, APIs, AI and security) and easier to deploy, with a reduced time to market. Banks will then be able to tailor a suite of functional modules, using a mix of CREALOGIX, in-house and third-party technology to create their own unique solution. This technology investment should help drive sales growth in the medium to long term.

3. Strengthening its global partner network – as part of its go-to-market strategy, CREALOGIX is building a comprehensive partner ecosystem to allow it to work with customers around the world. Implementation partners have already been executing customer projects in the Asia-Pacific region, freeing up CREALOGIX to concentrate on its core business, the development and sale of digital banking software products.

In its FY19 outlook in September, CREALOGIX confirmed that, despite delays, the sales pipeline continues to look healthy. Europe continues to offer further opportunities for the group, and management identified a specific opportunity in South-East Asia, involving the roll-out of a solution for the entire digital wealth management business for a tier one bank. Management has indicated that other major contracts are also pending.

In FY20, CREALOGIX will continue to focus on the transition to a SaaS model, investing in its Digital Banking Hub and expanding its partner network globally. Management expects the transformation programme to have a positive impact on profitability in the medium term, driving double-digit EBITDA margins and strengthened cash flow once complete.

FY19 revenues increased 17% to CHF101.9m, while FY19 EBITDA fell to CHF1.9m, markedly down on FY18 (CHF7.0m) due to the revenue and profit deferral implicit in the transition to a SaaS model. FY19 net losses amounted to CHF6.3m (FY18: CHF0.7m net profit), including CHF5.1m of amortised goodwill (FY18: CHF2.9m). Looking at H1 vs H2, H219 revenues were broadly flat at CHF50.9m, while H219 EBITDA fell to a CHF1.4m loss from a CHF3.3m profit in H119. As well as the SaaS transition, the company noted that market uncertainty around Brexit had a pronounced negative impact on its UK business.

CREALOGIX suggests a positive outlook for FY20, with anticipated major new customer wins in the international banking sector and high market demand. The SaaS transition will continue to drag on margins in FY20, although the company is confident that the transition will lead to a positive benefit from FY21 onwards, delivering strong cash flow and double-digit EBITDA margins from FY22.

There were delays in new contract wins in FY19 which, according to management, reflected the significantly increased deal sizes that CREALOGIX is signing and the longer sales cycles associated with these deals. Meanwhile, uncertainly over Brexit has led to a deferral of corporate decision making in the UK. Despite these issues, CREALOGIX has a strong deal pipeline but there are uncertainties over the timing and form (SaaS or traditional) of new deals. CREALOGIX is in negotiations with tier one banks and optimistic that it will close several deals in H120.

Management has indicated that the initial impact from the SaaS transition was seen in FY18, with revenues and EBITDA CHF4m lower (part-year effect) than under a licence/maintenance model. The impact on revenue and EBITDA increased to CHF7m in FY19 and, assuming a typical three-year transition period, we forecast a drag of CHF7m in FY20 and CHF4m in FY21 (part-year effect), before a full year under the SaaS model in FY22.

Despite the slowdown in corporate decision making noted above, with a strong deal pipeline, management still expects double-digit EBITDA margins and strong cash flow generation in the medium term. However, until the outlook becomes clearer, it has withdrawn its explicit medium-term guidance.

Despite the challenges of FY19, CREALOGIX continued to win its share of new customers, with notable wins in H219 (the majority of which were SaaS contracts or involved elements of SaaS) summarised below:

CREALOGIX has established a strong track record of delivering software solutions to the banking industry in Switzerland and over the past few years has focused on expanding its international footprint. To achieve this, the group has invested heavily in the development of its software platform to address the competitive challenges to the banking sector, spending 21% of sales on R&D in FY17 and FY18 and 20% in FY19 (costs expensed). We expect these heightened (by historical standards) levels of R&D to continue in FY20 and FY21 as CREALOGIX continues to invest in its Digital Banking Hub, in line with its transformation programme. This should ensure market-leading speed to market and scalability to position CREALOGIX for strong sales growth in the medium to long term.

Historically, operational investment has been supplemented by strategic acquisitions, with Elaxy in FY16 (outstanding shares acquired in FY18) and Innofis in 2018. Elaxy significantly boosted the group’s position in the important German market and added capabilities, notably on the wealth management side with its Digital Financial Advisory solution. Innofis enhanced the group’s product portfolio and expertise in Islamic banking and established the group in the Middle East, paving the way to new opportunities in Asia, eg Malaysia. The group intends to continue to make selective acquisitions and has indicated that part of the proceeds from the CHF20–25m convertible bond refinancing may be used for future M&A.

The company intends to scale its platform across a much larger international customer base, and to be at the forefront in providing solutions to meet the needs of the dynamic and fast-changing digital banking markets.

64% of CREALOGIX sales in FY19 (57% in FY18, 50% in FY17) were outside Switzerland (see Exhibit 4), with the group targeting 70%+ in the medium term. Currently, clients are served mainly from offices in its core hub, Switzerland, as well as from the UK, Germany, Spain, Austria and Singapore. Management has reported that it is close to major project wins in Asia but, for the moment at least, the competitive North American market is not a priority.

As part of its go-to-market strategy, CREALOGIX is building a comprehensive partner ecosystem to allow it to serve customers around the world. This approach will help free up resources to allow CREALOGIX to concentrate on its core business, the development and sale of digital banking software products.

On 6 November 2015, CREALOGIX issued CHF25m of convertible bonds, offering a coupon of 2.375% with a four-year term. The remainder of these bonds (CHF8.5m) mature in November 2019. CREALOGIX has announced a fully underwritten convertible bond issue to redeem the outstanding 2015 convertible bonds, to provide sufficient working capital to see the company through the SaaS transition as well as potentially to fund further bolt-on acquisition opportunities.

The 2019 convertible issue has a nominal value of CHF20m, with an option, subject to demand, to increase the issue size to CHF25m. It will have a term of five years and is expected to offer a coupon of 1.5–2.0%, with an expected conversion premium of between 25–33% over the relevant share price.

Final terms for the issue will be confirmed on 30 October 2019 (size of issue, coupon and conversion price), with the convertible bonds due to be listed from 6 November 2019. We have not yet incorporated the announced convertible bond in our model.

CREALOGIX is recognised in IDC’s top 100 global fintech list and a leader in the digital banking space, in particular for mobile banking software solutions.

An Economist Intelligence Unit (EIU) survey highlighted some of the major factors affecting digital banking today as well as the major trends expected over the next few years; with new technologies, changing consumer expectations, increasing competition, regulatory considerations and the macro-economic cycle all driving change in the market.

The total addressable global market for digital banking software is estimated to be worth $23bn (source: Temenos, August 2019), of which the US represents c $9bn.

Digital banking continues its major growth, with increasing use of smartphone and mobile devices around the world. Investment in digital banking has overtaken compliance as the priority area for banking sector IT budgets as customer expectations and increasing competition, as well as regulatory change (eg PSD2) put pressure on banks to upgrade their front-end systems. The transformation process to digital banking remains in its early stages, with traditional banks still dominating despite the proliferation of specialist digital banks now emerging.

In a white paper published by CREALOGIX, the company cites a Visa Digital Payment study, which shows that the number of Europeans who regularly use a mobile device (eg a smartphone, tablet or wearable device) to make payments tripled in 2017 to 54% of respondents compared with 18% in 2016. Smartphones are expected to take 80% of the online banking market by 2020 (source: AT Kearney).

According to Deloitte, the EMEA retail banking market shows a range of digital maturity, highly correlated with internet penetration in each territory. However, feedback from its EMEA Digital Banking Maturity Study revealed that the real driver of digital banking maturity in different jurisdictions was from market pressure – both from customers (ie expectations regarding service levels) and from competitors (ie a banking digital ‘arms race’).

The changing backdrop is driving increasing spend by banks and financial providers on front-end systems and Gartner forecasts that front-end system spend will rise to c 50% of banks’ total IT spend by 2020, from c 10% in 2010. The front-end solutions in this space need to be more agile than the back-end core banking systems and must offer a seamless experience. Innovation is clearly much more prevalent in the front end than at the back end.

In our research, we have identified five primary areas of competition for front-end solutions provided to the financial services industry, with many of CREALOGIX’s closest competitors either privately owned, or part of larger software groups.

Specialist software providers like CREALOGIX have a particular advantage with front-end systems (as opposed to non-consumer facing software). Differentiation in digital is through superior design of the customer experience, understanding the user journey through continuous customer feedback loops, and applying design thinking and intensive research of demographic shifts. Solutions need to be very client-centric and winning propositions are based on building the best user interface, tailored to each client.

In our view, CREALOGIX has a number of advantages over other specialist software providers, including the breadth of its platform, its focus on front-end solutions, its track record and proven position in the Swiss market, its growing international footprint and the transparency associated with being a public company.

The global banking sector is facing unprecedented challenges. Increased regulation in the wake of the global financial crisis means banks must hold increasingly higher levels of capital against their assets, putting pressure on profitability. The implementation of MiFID II and PSD2 in January 2018 has added further complexity. Under PSD2, EU banks are required to provide legitimate third parties with access to their customers’ account data, enabling them to aggregate data and initiate payments.

Open banking APIs are enabling an array of market opportunities, encouraging new business models, innovation, new financial services ecosystems and digital customer connectivity.

This means that credit institutions and banks will need to have the requisite IT interfaces in the form of APIs (as provided by CREALOGIX software solutions). At the same time, their customer bases are being targeted by challenger banks, as well as a range new fintechs offering alternative products (such as peer-to-peer lending, crowd funding, bitcoin and other alternative investment solutions). To maintain competitiveness, traditional banks regularly need to update their propositions. While the large global banks have the financial resources to develop their own solutions in house, smaller institutions have no choice but to purchase technology.

This investment requirement has polarised markets, with the consolidation of banks holding unproductive assets, or unwilling or unable to maintain this high level of investment. This can be seen in the number of banks in long-term structural decline across the globe eg in Switzerland, according to a recent report by EY, the number of banks fell by 33% between 2000 and 2017, while the number of branches was down by 23% and the number of employees down by 12%. Traditional banks have costly branch networks that can be streamlined with the help of digital banking.

A 2017 report from Autonomous pointed out that Germany has over 32,000 bank branches compared with 7,370 supermarkets, and this number is expected to fall dramatically in the coming years. Data compiled by the consumer charity Which?, show that the UK has lost nearly two-thirds of its bank and building society branches over the past 30 years, with the number of branches falling from 20,583 in 1988 to 7,586 in 2018.

Following a period of significant investment, the group launched its Digital Banking Hub in 2015, with subsequent ongoing development and refinement to reflect changing customer requirements. The hub gives small and mid-sized banks the opportunity to offer highly competitive digital banking offerings. The hub is a modular system that has been tailored for customers, having been developed in conjunction with them. It has a modern interface and APIs, and includes pre-built, out-of-the box modules with certain key characteristics offering a comprehensive platform for online banking across all channels (Exhibit 7). The APIs enable it to integrate fintechs, third-party modules and in-house widgets.

The hub enables financial institutions to integrate specific product offerings from fintechs into their complex IT landscape and connect them with existing solutions. Consequently, financial institutions can achieve significant improvements in the banking experience for their customers. An example for this is Gravity, which won the Best of Show at FinovateEurope 2018. Gravity reveals the flexibility that can be provided to banks through the use of APIs. Meanwhile, The ARCs modern virtual reality application combines emotion, creativity and logic in a playful manner, and allows customers to experience their daily banking in a new way – in 3D. This application has the potential to become reality if 3D devices become mainstream.

The platform’s primary verticals are Transaction & API Banking, Mobile Banking and Digital Payment. Customers will take both the flagship online Transaction & API Banking and Mobile Banking solutions to create a multi-channel offering. Additionally, CREALOGIX offers a range of online and mobile security products, and has a strategic alliance with Entersekt, a provider of advanced transaction authentication and mobile app security software.

The Digital Banking Hub is open and can be integrated into all systems; a user-friendly navigation concept can link from various CREALOGIX modules to third-party applications. The product is white-labelled, with each client bank adapting the style to suit its existing design. It is cost-effective, because the system is based on a lean and open architecture and is perfectly compatible with all standard devices. The group uses Java and HTML5 programme languages, with Java in the back end and HTML5 upfront. The product uses modern concepts including responsive design (resizes with different devices) and zero footprint (no software installation required on the device). The product offering has a six-month upgrade cycle.

Digital Banking is the group’s broadest offering and, along with related modules, generated the majority of group revenues in FY19, while Digital Learning generated c 10%. The Digital Learning module is an LMS (learning management system), used by the group’s banking customers to train their clients and employees (typically young professionals) in financial literacy. It replaces paper-based systems, so helps reduce risk.

Additionally, CREALOGIX has the Nova multibanking platform, which is designed for the corporate end-market, to enable customers to aggregate accounts across multiple banks.

The implementation of the group’s solutions helps IT departments of banks shift their focus from development to supporting the business, and this is an attractive proposition for the business end of a bank. This is because banks need greater flexibility to cope with regulatory changes and position themselves strategically to deal with fintechs. They also need the latest technology to help them in the fight to win new customers.

Despite the increasing take-up of the SaaS model, CREALOGIX offers a range of revenue models to its customers. The group’s traditional Swiss client base still strongly prefers the perpetual licence model plus implementation, along with annual support and maintenance fees (in the range of 18–21% depending on the overall solution). Many banks in continental Europe prefer an onsite solution, due to attitudes towards security risks as well as regulation. However, attitudes towards SaaS are now starting to change in Europe and most new customers are signing up to SaaS solutions.

The group’s UK clients (c 30 customers acquired via MBA Systems) operate on a hosted SaaS basis, initially committing for five years before moving on to annual rolling contracts. CREALOGIX also offers a SaaS licence for five to seven years, while onsite rental remains an option. CREALOGIX regularly receives change requests from clients (eg adding functionality, acquiring a hub or other changes), which generates additional licence and services revenues.

CREALOGIX also uses systems integration resellers as a route to market, which enables it to cover the entire value chain, through consultancy, conceptualisation, integration and operation. CREALOGIX’s systems integrator partners include Hewlett-Packard Enterprise (NYSE:HPE), CGI (TSE:GIB.A), Cognizant (NASDAQ:CTSH) and Adesso (ETR:ADN1). The systems integrators provide any services required.

The company sells to both the business side and the IT department. However, the position of chief digital officer is becoming much more common in banks and is usually the best point of contact. The sales cycle is normally six to 18 months, with 12 months on average. CREALOGIX will typically be required to develop a proof of concept, but the scale of this will depend on the customer’s requirements. For example, the customer might simply be concerned with the look or feel of the solution for the end-customer. Alternatively, clients may wish to integrate third-party software or in-house widgets, or customise the hub so that it looks and functions like the customer’s other corporate websites. Ultimately, the customer needs to make the decision on whether to invest in-house or in new front-end software.

Recurring revenues consist of support and maintenance (CHF28.1m or 28% of FY19 revenues vs 31% in FY18), along with hosting SaaS services, which have more than doubled from CHF5.9m in FY18 to CHF14.7m in FY19 (FY18: 7% of revenues, FY19: 14% of revenues). In total, these represented 42% of FY19 revenues (vs 37% in FY18), but we expect the proportion to continue to rise on the back of hosted/SaaS growth, with management targeting recurring revenues representing 60% of total revenues by FY23, with 30% SaaS.

Following the FY19 results, we have taken the opportunity to reassess the impact of CREALOGIX’s transition to a SaaS-led business model, and revised our forecasts accordingly.

It is also worth highlighting that although we have made reference to CREALOGIX’s recent announcement of its intention to raise CHF20m (with an option to raise CHF25m, subject to shareholder demand) to refinance its outstanding 2015 convertible bonds (due to mature in November), as well as raising additional funding, we have not yet factored this into our model pending successful completion of the bond issue. However, we do assume that CREALOGIX has access to short-term funding in the interim period.

On the basis of the SaaS transition and management’s assessment of its impact noted above, we have reduced our FY20 and FY21 revenue forecasts by approximately 9% to CHF105.5m and CHF111.1m, implying y-o-y growth of 4% and 5%, respectively.

Underlying the top-line revenue numbers, we expect growth to be led by the maintenance and hosting/SaaS segments, with recurring revenues constituting 46% of total revenues in FY20 and 52% in FY21 (FY19: 42%). Meanwhile, goods and licensing revenues decline materially, both in absolute and relative terms, with services revenues seeing a more gradual decline as the focus shifts to building the recurring revenue base.

Together, this has the impact of reducing EBITDA to CHF2.6m in FY20e and CHF4.7m in FY21e. On the expectation of a typical three-year transition period, we expect to see signs of material margin growth in H221, with a full year of margin contribution (once SaaS revenue and EBITDA recognition catches up with recognition under the licence model) leading to EBITDA of CHF13.1m in FY22. In terms of margin, we expect EBITDA margin of 2.4% in FY20 (vs 1.8% in FY19), rising to 4.2% in FY21 and 11.3% in FY22 as the SaaS transition unwinds and the group moves towards its goal of sustainable double-digit EBITDA margin in the medium term.

In line with its transformation programme, we anticipate capex of CHF3m in each of FY20 and FY21 (ahead of an office relocation in FY21), before it starts to normalise in FY22.

As noted above, we have not yet factored the convertible bond refinancing into our model pending successful completion of the issue. As such, net interest includes the coupon on the CHF8.5m convertible bonds outstanding, which amounts to c CHF202k per year. We have maintained our tax rate assumptions of 28% going forward.

We forecast operating cash flow before interest and tax of CHF2.5m in FY20, building to c CHF4.6m in FY21. We have forecast no dividends being paid in FY20 or FY21. Thereafter, absent any significant acquisitions, we expect CREALOGIX to show strongly increasing cash generation in line with management’s revised medium-term guidance (double-digit EBITDA margins, strong cash flow generation), with CHF13.0m in FY22.

Despite the consequential margin impact from the SaaS transition, the group remains a leading international digital banking engagement platform provider, operating in a swiftly evolving digital banking market. We believe there are a number of reasons why revenues will continue to grow and margins will recover over the medium term:

In terms of valuation, looking at CREALOGIX’s trading peers (Exhibit 11 below) suggests that a valuation of c 2.5–3.0x revenues and c 15–20x EBITDA could be achievable post successful SaaS transition, although we recognise the wide variations in business models and valuation multiples across the selection. Applied to our FY22 estimates, which assume continued strong revenue growth and margin recovering to a double-digit level, this would suggest an EV (and equity) of CHF250m+, a premium of around 100% to today’s share price. For investors willing to take a medium-term view, CREALOGIX’s valuation at 1.3x FY20e sales is compelling, particularly when compared to its closest peers. However, we would note that restricted liquidity continues to limit exit opportunities.

When considering CREALOGIX’s peer group, we note that it is hard to identify truly comparable quoted companies. There is a range of pure SaaS businesses listed in the US, where the SaaS rental model is most advanced, but in the UK, where the SaaS rental model is increasingly the norm, and Europe (where eg German companies are switching to rental, and Switzerland, which has been slower to switch), there are no pure SaaS businesses listed. On this basis, we focus on financial software providers which, like CREALOGIX, have a partial but increasing exposure to SaaS revenues.

In our view, Temenos (Swiss) – particularly after its acquisition of Kony – and Q2 Software (US) come closest as comparables, although both these companies are substantially larger and more highly rated than CREALOGIX. Of the other two identified digital banking engagement platform providers, Backbase (NL) is a private company and EdgeVerve (India) is part of the Infosys group.

We include a number of larger software companies that have a digital banking engagement platform as part of their offering, while there is also a rationale to look at UK/European financial software businesses of a similar size to CREALOGIX. Finally, we include a number of North American SaaS businesses which highlight the potential valuation to which CREALOGIX can aspire as it transitions to SaaS.

Based on our universe (Exhibit 11), at a high level it is noteworthy that the SaaS business model is more mature and more established in the US than it is in Europe. As such, the North American peer group is valued more highly than its European peers, with higher sales growth (c 25% vs 10%), higher sales multiples (4–5x vs 2.5–3.0x) and EV/EBITDA (15–20x vs 12–15x). This valuation disparity reduces as you move down the P&L, with European peers trading at P/E multiples of c 20–24x FY2 earnings and North American peers at 22–26x.

In August 2019, Temenos, the Switzerland-based banking software company, announced the strategic acquisition of Kony for a total consideration of $580m. In terms of multiples, the deal represents an FY20e revenue multiple of 5x or an 8.4x FY20e recurring revenues, in line with the US public market trading valuations in Exhibit 11.

While CREALOGIX has no immediate intention to expand into the US, Temenos’s acquisition of Kony is noteworthy in that it creates a close competitor for CREALOGIX and provides an additional valuation benchmark.

Kony has a global client base of more than 100 banks across the US, Europe, Middle East and Asia, with 50 US clients including major banks and credit unions. It is expected to generate total revenues of c US$115m in 2020, with over 60% recurring revenue, the majority of which is SaaS revenue with a low mid-single digit attrition rate.

Kony is a leading digital banking SaaS provider in the US. The stated rationale for the deal was to help Temenos build its presence and capabilities in the US to create a market-leading digital banking product, enabling Temenos to accelerate its growth in the digital front office space and become a global leader in digital banking.

According to the release, Kony has been growing rapidly among top tier and mid-market banks in the US and is connected to most third-party cores, offering a suite of mobile banking apps that support conversation, artificial intelligence, augmented reality and wearable technologies.

In assessing the investment case for CREALOGIX, we would highlight the following sensitivities: