Zalaris — Simplifying HR and payroll solutions

Zalaris is a leading provider of payroll and HR solutions, enabling corporations to digitise their HR functions through its products and services. Zalaris covers the entire employee lifecycle through its two business segments, Managed Services and Professional Services. Managed Services is Zalaris’s cloud and comprehensive outsourcing solution, centred around its PeopleHub platform, which is hosted on SAP and easily flexed to the client’s requirements. Professional Services represents Zalaris’s consulting, implementation and application maintenance business, which is predominantly focused on SAP software solutions. Its single platform enables it to focus on larger and more complex multi or single-country projects. Currently its solutions and services serve over 1.5m employees across all HR solutions. From a geographic perspective, Zalaris operates in 17 countries through service centres with local expertise. Having grown initially in the Nordics, Zalaris is focusing now on the larger markets of Germany and the UK and Ireland, as well as the recently entered territory of Asia-Pacific (APAC), where it won its first major contract in August 2022.

Zalaris has an attractive financial profile due to its long-term relationships with customers and a low historical churn rate of 2–3%. Both business verticals have high levels of recurring revenue (FY23: Managed Services: 90%, Professional Services: 55%) and attractive adjusted EBIT margins (FY23: Managed Services: 14.0%, Professional Services: 10.8%), with an FY23 group margin of 8.5% due to overheads and the diminishing drag from APAC. In FY23 Managed Services accounted for 73% of revenue and 119% of adjusted EBIT due to central overheads. Professional Services was 26% of FY23 revenue and 33% of adjusted EBIT. Profitability improved in FY23 with the implementation of an EBIT improvement programme, Zalaris 4.0, resulting in a growth in adjusted EBIT margin in FY23 to 8.5% (FY22: 5.2%). Key to this programme is the reallocation of services delivered through nearshore and offshore service centres, greater utilisation within its existing workforce and a reduction in the number of external consultants used within Professional Services. We forecast an improvement in adjusted EBIT margin to 10.7% for FY24 and 11.2% in FY25 as the benefits start to flow through. Management’s mid-term (FY26) targets are for revenue of NOK1.5bn with a margin range of 12–15%. Having refinanced its debt with a €40m five-year senior secured bond with a rate of 5.25% plus three-month Euribor in March 2023, the business remains well capitalised. We forecast a reduction in net debt (including leases) to EBITDA from 2.4x in FY23 to 1.5x in FY24 and 1.1x in FY25.

Our discounted cash flow (DCF)-based approach suggests a valuation of NOK87.1 per share based on an FY26–34 revenue growth CAGR of 4% and an adjusted EBIT margin of 12%, reflecting significant potential upside to the current price on relatively conservative estimates. Zalaris is currently trading at a discount across both FY24 and FY25 EV/sales and EV/EBIT multiples to its payroll software and IT services peers.

Zalaris’s growth and margin progression depend on its ability to win new customers and retain existing clients. Furthermore, it is largely reliant on a strong working relationship with SAP, on whose software its PeopleHub platform is hosted and its Professional Services solutions are centred on. There are other wider risks around data protection and cyberattacks. With a broad geographic reach, foreign currency exposure is another key risk, specifically the Norwegian krone/euro rate due to its euro denominated bond.

Based in Norway and listed on the Oslo Stock Exchange, Zalaris was founded in 2000 by CEO Hans-Petter Mellerud. It is a leading global provider of human capital management (HCM) and payroll solutions. Its products and services cover the entire employee lifecycle, including recruitment, onboarding, compensation, time sheets, travel expenses and performance management. Due to its single platform solution, Zalaris specialises in servicing multinational corporations or large, complex single-country projects that target client cost savings of between 20% and 30%.

Since 2000, the business services outsourcing sector has grown significantly in size, from $45.6bn to $347.4bn in 2023, and now makes up a greater percentage share of the wider IT services sector, as businesses further digitise their administrative and back-office functions. Through a greater level of outsourcing, businesses can focus on core operations to drive growth while also reducing overhead costs. The shift towards business service outsourcing accelerated during the COVID-19 pandemic. CEOs and management teams reorganised and rightsized businesses as revenue generating operations ceased or slowed, seeking greater operational efficiencies within their cost base. Over the past five years Zalaris has outperformed the wider BPO market, delivering a CAGR from FY19–23 of 9% versus the 5% market CAGR. Furthermore, business outsourcing companies such as Zalaris can provide their clients with accurate data to enable management teams to track KPIs or further empower decisions.

Zalaris operates through two business verticals, Managed Services and Professional Services. The Managed Services business (72.5% of FY23 revenue) is Zalaris’s cloud-based software HR system and service offering, predominantly through its PeopleHub solution. The PeopleHub solution can be scaled from a software-as-a-service (SaaS) business all the way to a BPO solution through a full outsourcing of HR and payroll suite of service, and as such has a high level of recurring revenue. The Managed Services business enables companies to outsource their HR and payroll functions through Zalaris, with the level of service scaled up or down to the needs of the clients. Managed Services’ PeopleHub platform operates on SAP software; Zalaris has a strong and long-term commercial relationship with SAP. Given the BPO/SaaS model and long-term relationship, Managed Services has a more attractive operating profit margin profile than Professional Services.

Zalaris’s second business segment is Professional Services. Through this segment, Zalaris helps clients to plan and implement HR and payroll solutions for businesses, predominantly through an SAP-based solution. Zalaris is an SAP Gold Partner and has SAP Expert Level certification for HCM. However, for those clients who may be using other non-SAP HR software providers, for example Oracle or Workday, Zalaris is able to integrate these into its solutions. Professional Services includes SAP consulting, as well as application management services, which is essentially application maintenance. Although these services may seem one-off in nature, over 50% of the segment generates recurring revenue due to the application maintenance services (AMS) offering, as well as long-standing customer relationships.

Both Managed Services and Professional Services are highly integrated within the SAP ecosystem.

Given the relatively high set-up costs of system implementation and resources required in either a first-case HCM and payroll outsourcing or switching from one provider to another, contracts are typically for around five years. Historically, Zalaris has had long-term relationships with customers with high levels of retention and an average churn rate of 2–3%. This should provide Zalaris with good revenue visibility, providing management with a greater ability to manage profitability and cash flows. Furthermore, the contract structure is made up of an element of the fixed costs in setting up the system or project and an additional charge per payslip. There are inflationary-linked terms within the contract to provide resilience against inflationary pressures. This resilience is highlighted by the margins since FY20, having only dipped in FY22 due to the expansion into APAC. Furthermore, the recent wins with German states provides stability and greater credibility given the relatively low financial risk of these contracts. The profile for larger contracts is more attractive from a financial perspective as they offer a greater opportunity for economies of scale and operational leverage.

Zalaris benefits from a number of industry barriers to entry: the BPO provider industry requires relatively high upfront capital investment due to proprietary software or service solutions, particularly when offering cross-border solutions hence scale is important; expertise and track-record in the relevant sector is key; the costs and risks of switching provider once a system is embedded are relatively high. Furthermore, through its digital solutions Zalaris targets cost savings of 20–30% for its clients, an attractive proposition for management teams looking to reduce non-core overheads.

In this section we will delve deeper into the business segments, examining the product solutions, services, use cases and financial profile. It should be noted that although the two segments are separate from a financial reporting perspective, there is a broad level of integration between the two.

The Managed Services business is Zalaris’s SaaS and outsourcing business, centred around its proprietary PeopleHub single platform. It provides customers with range of HR and payroll services that can be flexed to the client’s requirements and needs. Exhibit 4 provides an overview of the Managed Services offering, ordered by the degree of outsourcing from the client and the subsequent cost savings achieved.

In addition to the direct cost benefits (20–30% saving), Zalaris believes its Managed Services offering supports clients in scaling by enabling them to focus on core business functions. The PeopleHub solution presents a simplified single platform global solution that covers the entire employee lifespan, across HR systems, payroll, workforce management, talent management and travel and expenses. Exhibit 5 demonstrates PeopleHub’s capabilities across these verticals. PeopleHub is Zalaris’s proprietary platform and is the result of integrating SAP’s HCM software with its own advanced solutions, all seamlessly hosted on a combination of Zalaris private cloud, SAP cloud and the Azure cloud. The core payroll engine, powered by SAP HCM, operates on servers owned and managed by Zalaris, ensuring a smooth integration with various HCM systems like SAP SuccessFactors, Workday and Oracle HCM. Additionally, Zalaris offers SAP SuccessFactors on servers directly maintained by SAP. The solid partnership between Zalaris and SAP provides confidence in the reliability and long-term stability in the PeopleHub hosting arrangement.

Within the Managed Services business, Zalaris has 203 clients, of which 103 pay more than NOK1m per annum. The business has an attractive financial profile due to its BPO/SaaS model and an opportunity for operational leverage through process standardisation and right-shoring of service centres.

The business has c 700 professionals working across 17 service locations with three shared services locations in Riga (Latvia), Gdynia (Poland) and Chennai (India). These service locations are categorised as:

The variety of service centres enables Zalaris to deliver its Managed Services proposition to clients with robust local competence while simultaneously generating cost efficiencies. That said, management sees good opportunity to improve profitability through a combination of right-sourcing and mix between the various locations.

Zalaris’s Professional Services business is its consulting, implementation and AMS business. The segment offers a broad range of services for clients, from one-off projects to AMS, which offer a higher degree of recurring revenue. Exhibit 6 demonstrates the range of Zalaris’s Professional Services for clients, with the relative degree of recurring revenue increasing from left to right.

The segment’s advisory and consulting services are focused on, although not exclusively, SAP solutions. The commercial partnership with SAP is beneficial to Zalaris given the size and growth opportunity of SAP software and services. This is explored further in the ‘Market opportunity’ section.

Professional Services serves a total of 225 clients, of which 49 pay over NOK1m per annum. Although some of the projects Zalaris undertakes are one-off in nature, c 57% of its revenues are recurring in nature due to the AMS business function. The mix of projects to AMS has been improving as AMS makes up a greater proportion of revenues, 58% in Q423 versus 47% in Q422. Furthermore, the Professional Services business benefits from long-standing customer relationships, with 83% of Professional Services revenue in Q423 deriving from customers that were customers in the year prior.

Zalaris’s Professional Services expertise is focused on SAP solutions, whether SAP HCM or SAP SuccessFactors. This is exemplified through its certification as an SAP Gold Partner. Other SAP Gold Partners include many of the leading global consultancy firms such as Accenture, PwC, Deloitte and Capgemini. Zalaris also holds an SAP Expert Level certificate in HCM, the highest level for SAP providers.

At present the Professional Services business employs over 295 full-time employees, of which 66% are employees and 34% are external consultants. External consultants are at a higher cost than employees, and hence their use weighs on the operating margin of the segment. Reflecting this, the adjusted EBIT margin for Professional Services in FY23 was 10.8% versus the 14.0% margin in Managed Services.

Management believes that the Professional Services business is vital in providing a solid platform for the Managed Services business and showcasing SAP expertise, as it can act as a pathway to cross sell to existing clients and can add additional value for customers. Although to date cross selling has not been a predominant feature of the Zalaris strategy, management is assessing how this could be improved in the future.

To date, the strategy has been simple: to win multi-country or large single-country contracts, targeting large and medium-sized businesses. Broadly, Zalaris has greater success with projects that are first-generation in nature (ie the business not worked with an outsourcing partner previously). This is typically because second-generation projects (ie taking over from an existing outsourcing project) are more competitive when pitching for business.

Zalaris is relatively sector agnostic and operates across a number of industries. As Exhibit 7 highlights, many of its customers are recognisable names within their respective industries, for example Ryanair, Siemens or Porsche. Although disclosure is varied due to some confidentiality agreements, examples of recent wins that highlight Zalaris’s breadth of clients and delivery include:

Historically, Zalaris has focused on its core geographies of Northern Europe (Norway, Denmark, Sweden and Finland) and Central Europe (Germany, Poland, etc). These geographies are where Zalaris has the strongest brand recognition as well as the most robust client relationships, having operated in the area since 2000.

Zalaris has previously entered new geographies in one of two ways: through an expansion into new countries with existing clients or through acquisitions. When expanding to new geographies, local service centres provide expertise in local and regional regulation, all of which is General Data Protection Regulation (GDPR) compliant and delivered in the local language.

Up to 2017, Zalaris focused exclusively on the Nordics and Baltics, which included Norway, Sweden, Denmark, Finland, Poland, Estonia, Latvia and Lithuania. In 2017, the company entered the DACH region and the UK through two relatively large acquisitions, sumarum (DACH, total consideration of €18.7m) and ROC Global Solutions (UK and Ireland, total consideration of £8.5m). These acquisitions provided Zalaris with a significantly enlarged total addressable market. The German region in particular offered a market size three times that of Zalaris at the time. Those acquisitions have proved largely successful, with revenues from the UK accounting for 8% of FY23 revenue and Central Europe, the lion’s share of which is Germany, 41%.

The company then made two relatively small acquisitions, ba.se in Germany in 2021 for an undisclosed fee and German SaaS business vyble in 2022 for €1.1m. Management announced in Q222 that it was looking to divest the vyble business to focus on its core operations of PeopleHub and SAP-based solutions for medium and large-sized businesses, as opposed to vyble’s SME focus.

In Q122, management announced its entry into APAC with the establishment of local operations in Singapore and Australia. The business is still early stage but has already signed a number of contracts, including a payroll solution for Google Australia and a PeopleHub solution for New Zealand-based seafood brand Sealord. Revenues have grown rapidly to NOK20.5m in FY23 and although the region remains a drag on group adjusted EBIT margins given the early-stage nature of the business, the margin reduced significantly from a negative 70.2% in Q123 to just 6.8% in Q423.

As discussed above, Zalaris’s strategy focuses on the core markets of the Nordics, Central Europe and the UK. There is also the opportunity in APAC, however this remains very early stage.

Now that Zalaris has the ability to cover over 150 countries, management has no plans to enter greenfield sites in the near term through M&A, particularly given the EBIT improvement programme outlined below. Consequently, the group is focusing on organic growth in its core geographies to ensure it achieves its financial targets.

Europe is the second-largest region for BPO services by market size behind the Americas and is expected to deliver a six-year CAGR of 4% from 2022–28 to $119bn. APAC is expected to deliver stronger growth of 6.5% from 2022–28, predominantly driven by growth in Asia with more modest growth in Australia (source: Statista).

By country, the UK and Germany represent the second and fifth largest nations by BPO market size and are forecasted to deliver six-year CAGRs of 3.9% and 3.4%, respectively. Despite the relative maturity of these geographies, the robust growth forecasted in these markets presents a good opportunity for Zalaris. The German HR and payroll market is three times the size of the Nordics combined and deal values are typically 2.5x higher. Zalaris currently has a relatively small presence in the UK and Ireland, with just 5% of its revenue derived from the region. Given the size of the UK and Ireland we believe there is significant market opportunity for Zalaris to tap into if it starts to win multi-national deals with large brands.

Although Zalaris has been relatively acquisitive to date, management does not expect to make any major acquisitions nor expand into greenfield territories in the near future.

At the time of the Q322 results management announced an updated EBIT improvement programme, targeting an increase in adjusted EBIT by FY23-end of NOK40–50m, while maintaining its stated FY23 adjusted EBIT (before APAC) margin target of 10%, using Q222 as the base. In addition to incremental EBIT from new client wins and customers going live, management is targeting a number of cost efficiencies and changes to the operating model, including:

Management named this reviewed operating model, with a greater proportion of headcount deriving from nearshore or offshore locations, greater capacity utilisation and a reduction in the number of external consultants used in Professional Services, management Zalaris 4.0.

Turning to its mid-term FY26 targets, management anticipates delivering an 11% CAGR between 2023 and 2026 to deliver revenue of NOK1.5bn. This will be driven by an increase in the mix of Managed Services increasing from 73% in FY23 to a targeted 77% in FY26, while Professional Services will decline from 26% in FY23 to 23% in FY26. Management is targeting adjusted EBIT margins of 12–15%, adjusted EBITDA margins of 18–24% and 70% conversion of operational cash flow.

Zalaris 4.0 represents an industrialised approach to HR and payroll, as it increases process standardisation to create more predictable outcomes and enable a greater level of right-shoring of its service centres. As the business fully digitises its processes and increases the level of automation, this should enable greater capacity utilisation alongside the right-shoring. Ultimately the shift towards the Zalaris 4.0 operating model should create greater productivity and improve profitability. Since the introduction of the Zalaris 4.0 model and the EBIT improvement strategy, adjusted EBIT has improved from 5.2% in FY22 to 8.5% in FY23. Consequently, we forecast an improvement in adjusted EBIT margins to 10.7% in FY24 and 11.2% in FY25 as we expect the benefits from the strategy to flow through alongside operational leverage as the revenue base grows.

As with many technology-enabled businesses, Zalaris has had AI embedded into its workflow and offering for a number of years, predominantly within data insights and improvements. However, the company is expanding its use cases of AI, improving security functions as well as user experience. In Q123 a new helpdesk app was introduced, which includes a conversational AI chat-bot named Zally.

The implementation and enhancement of AI capabilities within Zalaris’s service offering will be implemented by way of a continuous integration and continuous delivery model (ie incremental changes to software made frequently). As Zalaris continues to integrate AI into its processes and service offering, this should provide scope for a greater degree of automation and subsequent cost efficiencies.

Since Zalaris’s inception in 2000, the business outsourcing market has grown significantly from $45.6bn to $347.4bn in 2023 and is expected by Statista to continue growing to $436.3bn by 2028, a five-year CAGR of 5%. Our forecasts within the DCF reflect a 7% CAGR over the same period, slightly ahead of the market but achievable given Zalaris’s momentum and track record. The HR and payroll segment represents a significant portion of this market, as shown in Exhibit 10.

The historical and prospective growth of the business outsourcing market has been and continues to be driven by a number of important structural trends:

Zalaris has had a strong commercial relationship with SAP since its inception and is integrated within SAP’s ecosystem. In this section, we explore the SAP market and why it represents a significant growth opportunity for the company.

Over the past 10 years SAP has delivered robust revenue and EBIT growth at CAGRs of 6% and 5%, respectively. Ultimately, SAP’s position as the global leader in enterprise resource planning (ERP) software and other business applications benefits companies that work within its ecosystem due to its scale. Its software and services cover the full suite of business outsourcing, including ERP, financial management, planning and reporting, customer relationship management, HCM and supply chain and procurement. SAP’s total addressable market is expected to grow from $420bn in 2021 to $670bn by 2025 (source: Equitec), as it continues to enter new markets and offer clients additional services and updates. Of the 100 largest global companies, 99 are SAP customers and the company has a market share of 29%. Exhibit 11 demonstrates SAP’s considerable growth in market capitalisation and revenue since Zalaris’s inception in 2000.

There are over 22,000 companies globally that operate within the SAP Professional Services ecosystem. Recent research shows that companies that operate within this ecosystem are expected to generate 5x as much revenue as SAP by 2024.

With current vendor support from SAP to 2040 and a strong historical relationship, Zalaris is set to benefit from the trickledown effect of SAP’s continued growth through to its ecosystem. SAP is forecasted to deliver revenue growth in FY24 and FY25 of 8% and 11%, respectively, highlighting the continued demand for its products.

One area of particular focus for BPO service businesses is the development of ESG regulation. In December 2022, the European Union finalised the Corporate Sustainability Reporting Directive (CSRD), formalising and standardising detailed sustainability reporting requirements for companies, to increase transparency and accountability of sustainability reporting. These requirements are being phased in for companies operating in the EU from January 2024 that meet two of the following requirements:

Additionally, non-EU companies with revenues greater than €150m within the EU must comply with CSRD. The implementation of CSRD has increased the catchment of companies required to report these metrics from 11,000 under the previous Non-Financial Reporting Directive (NFRD) to 50,000. Key dates for the phasing in of this legislation are:

By outsourcing back-office functions to BPO providers such as Zalaris, companies receive independent third-party authentication of ESG data. Furthermore, Zalaris can assist with or directly provide reports in compliance with new regulations, streamlining ESG reporting processes. Metrics such as workforce composition, supply chain tracing and emissions reporting are all becoming features of regulatory requirements.

Management believes it is too early to quantify the potential revenue uplift from the changing regulation, but we see it as a beneficial tailwind. Much of the employee-related reporting requirements are available in SAP SuccessFactors; however, Zalaris may be able to charge clients extra for analytics.

Zalaris’s board consists of CEO Hans-Petter Mellerud, Non-executive Chair Adele Norman Pran and four independent non-executive directors: Liselotte Hägertz Engstam, Jan M Koivurinta, Kenth Eriksson and Erik Langaker.

Zalaris operates across multiple geographies with a number of long-term contracts. The company has a good opportunity to continue growing its customer base by servicing multi-national corporations or large single-country projects. We see the main risks that face the company as:

Zalaris has delivered robust levels of revenue growth since 2014 as it has developed its product offering and entered into new geographies. Key to this is the long-term relationships with customers, resulting in good levels of recurring revenue visibility with an average contract duration of five years. In FY23 Zalaris delivered very strong revenue growth of 26.7% to NOK1,131m, with substantial growth across each of its reporting segments: Managed Services +27.1%, Professional Services +19.8%, APAC +326.1%. This reflects good momentum in the business, having delivered year-on-year revenue growth in eight consecutive quarters. Revenue surpassed management’s original guidance of NOK1bn, with the expected upgrade communicated in Q323. As Exhibit 12 highlights, Managed Services is Zalaris’s largest division, accounting for 72.5% of FY23 revenue, with Professional services at 25.7% and APAC 1.8%.

With regards to Q423, Managed Services delivered growth of 23.1% y-o-y to NOK228.9m, of which 90% is recurring, with 51% of revenue from existing customers and 49% from new customers. Although within the mix Professional Services has a lower level of recurring revenue, 58% of revenue in Q423 was derived from AMS services, which are recurring in nature. Professional Services in Q423 generated revenue growth of 22% to NOK75.3m, 83% of which came from existing customers and the remainder from new customers, highlighting the stickiness of Zalaris’s customers.

The adjusted EBIT profile has fluctuated over the past 10 years, reducing significantly between FY17 and FY19 due to the two acquisitions made, investment in the business and restructuring costs. However, the impact from the EBIT improvement programme, initially implemented in May 2019 and updated in Q322, can be seen as group margins have improved since FY19. The dip in FY22 reflects the entry into APAC.

We forecast revenue growth of 10.7% in FY24 to NOK1,252m and 10.6% in FY25 to NOK1,384m as the group makes steady progress towards its stated revenue target of NOK1,500m by FY26. Underpinning these assumptions is the Q423 annual revenue run rate of NOK1,301m, as new signings go live, coupled with continued growth across Managed Services, Professional Services and APAC. All current contracts signed will be fully implemented by Q125 (ie generating monthly recurring revenue). This is ahead of expected BPO market growth of 6% and 5% in FY24 and FY25 (source: Statista), respectively. Our forecasts seem reasonable, however, given the Q423 revenue run rate mentioned, which does not include any further sales.

We anticipate an improvement in the adjusted EBIT margin (excluding amortisation of acquired intangibles, share-based payments and exceptional items), from 8.5% in FY23 to 10.7% in FY24, growing further in FY25 to 11.2%. Zalaris delivered margin progression throughout FY23, from 7.1% in Q123 to 10.7% in Q423, as the EBIT improvement programme initiatives began to bear fruit. The greater use of nearshore and offshore service locations within the cost mix continues to improve towards management’s stated target of 50% as a percentage of headcount, at 40.4% in December 2023, up from 36.3% in January 2023. Zalaris should enjoy operational leverage as it better utilises capacity, improves the nearshore/offshore mix and lowers the use of external consultants within Professional Services alongside robust revenue growth. Although expected margins in FY24 and FY25 sit above both the median and average IT services peer margins, they are within the middle of the range among the peers.

Key leading indicators on Zalaris’s progress will be delivery in its quarterly financials as well as deal flow news on the signing of new or the extension of existing contracts.

The operational improvements at Zalaris and ongoing cost savings achieved have delivered improved profitability and free cash flow generation relative to revenue.

Management believes it is well capitalised, having invested in its technology, platform and the cost base, with no new plans of expanding into new geographies. With regards to working capital, customers are invoiced on a monthly basis and payment days are between 30 to 90 days, depending on the geography. Management has previously noted that some of its larger German clients tend to extend payment days, resulting in a drag on working capital. However, there are ongoing working capital initiatives underway to address this, hence we forecast an improvement in working capital as a percentage of revenue.

Free cash flow generation dipped in FY22 following the entry into APAC, rebounding in FY23 due to the strong operational performance. We anticipate free cash flow generation to remain strong, with capex remaining broadly stable and within the company’s long-term guided range of NOK15–20m. FY24 free cash flow is boosted due to the sale of its office in Leipzig for NOK43m, which will complete in Q124, which after the repayment of debt and other associated costs will result in net cash proceeds of NOK29m and reflect a net gain of NOK11m.

In Q423 net debt (including leases) fell from NOK386.4m to NOK362.1m, driven by the strong free cash flow post interest in the quarter of NOK24.0m. For the full year, net debt (including leases) increased from NOK338.9m to NOK362.1m, following the issuance of the €40m senior secured bond in March 2023. The issuance of this bond refinanced Zalaris’s previous senior secured €35m bond, which was maturing in September 2023 with a coupon rate of three-month Euribor plus 4.75% per annum. The new bond has a term of five years with quarterly coupon payments of three-month Euribor plus 5.25% per annum.

With the company well capitalised following the recent refinancing of its bond, we forecast the strong free cash flow should reduce the level of net debt from NOK362.1m in FY23 to NOK286.9m in FY24 and further to NOK241.6m in FY25. This lowers the level of net debt to adjusted EBITDA from 2.39x in FY23 to 1.47x in FY24 and 1.08x in FY25.

Zalaris has historically paid a dividend, with the payout ratio differing between years. The company did not pay a dividend in FY23 due to covenants on its bond loan as it made a net loss in the year. However, with the expectation of returning to a profit at the net profit level, management expects to pay a dividend in FY24. We forecast a payout ratio of 25%, which is at the low end of management’s expected payout ratio. On our FY24 and FY25 estimates, this would equate to a dividend per share of NOK0.94 in FY24 and NOK1.09 in FY25.

Our 10-year DCF uses a WACC of 8%, reflecting a cost of equity of 9.7% (Norwegian base rate of 4.5%, beta of 1.14 (source: LSEG) and an equity risk premium of 4.6% (source: Damodaran)) and an after-tax cost of debt of 4.1%. We assume the company achieves our revenue estimates out to FY25 and tapers in the mid-term to a 4% CAGR in FY26–34. We also assume EBIT margins expand from 8.5% in FY23 to our estimate of 11.2% in FY25 and are maintained at the low end of management’s guided 12–15% range from FY26.

Our assumptions suggest a value per share of NOK87.1, reflecting substantial upside of 44% to the current share price of NOK60.6. In our view, Zalaris’s current share price does not fully reflect the revenue momentum to date nor expected EBIT improvements, particularly with a strong existing annual recurring revenue contract base notwithstanding expected contracts to be signed.

Due to its broad product offering covering the full HCM and payroll suite, Zalaris has a range of peers that operate in both payroll software and IT services. All the payroll software peers in the table below are US-listed and much bigger in size than Zalaris and may not necessarily represent the best comparison due to their provision of the underlying proprietary software compared with Zalaris’s reliance on SAP software. More broadly we show peers across the IT services sector to give an idea of ratings within the wider BPO environment.

On our estimates, Zalaris trades on FY24e and FY25e multiples of 1.4x and 1.2x for EV/sales and 12.6x and 10.9x for EV/EBIT. The payroll software peers typically trade at higher multiples due to higher levels of profitability, with EBIT margins typically c 22% and above. When excluding TriNet Group and Insperity, average EBIT margins head towards c 27%. Zalaris trades at closer EV/sales and EV/EBIT multiples with relation to its IT services peers, who typically have lower levels of profitability. Despite trading at a discount to both the average and the median of IT services peers on EV/EBIT multiples, our forecasts Zalaris’s revenue growth and EBIT margins of 10.7% in FY24 and 11.2% in FY25 are ahead of the peer group. As the EBIT margin progresses and the business executes on its strategy, this could result in a narrowing in the valuation gap.

Given the continued growth of the SAP ecosystem and the success of businesses that operate within it, the space has historically experienced growing levels of M&A activity. A report from Equiteq shows that the number of deals for SAP Partners has increased from 26 to 56 between 2018 and 2022, with the majority of these being strategic acquisitions as opposed to private equity buyers. The average multiples these transactions have taken place at between 2018 and 2022 are 2.4x sales and 13.4x EBITDA. Despite a more challenging environment for M&A due to rising global interest rates, there have been a number of acquisitions in the space in 2023, including the acquisition of Censio Karamba by KPMG, Terra Information Group by HR Path and Walldorf Consulting by TIMETOACT Group.

In the chart below we show Zalaris’s average EV/sales multiples since its listing in 2014 alongside its prospective multiples for FY24 and FY25. We forecast EBIT margins growing to 11.2% by FY25 as the EBIT improvement programme comes into effect, having previously been as low as 1.8% in FY17 following the acquisitions of sumarum and ROC Global. The prospective EV/sales multiples of 1.4x for FY24 is in line with the average multiple since listing of 1.4x, although FY25 is at a discount at 1.2x. Delivery against sales targets could close the gap to its long-term average.

Looking to Zalaris’s prospective EV/EBIT multiples of 12.6x for FY24 and 10.9x FY25, these are also at a discount to its long-term average of 35.5x. The average is skewed however due to the reduced EBIT margin between FY17 and FY19, resulting in a peak valuation of 118.7x in FY17. The decline in the valuation in recent years again reflects the lower margin, however an improvement in the EBIT margin could lead to an appreciation in the multiple.