Ultimate Software Group: A Great Success Story
Summary
- Ultimate Software Group has been acquired in a huge $11 billion deal.
- Unlike many SaaS players, this company has operated relatively under the radar and has combined solid growth with a >$1 billion revenue run rate and real profits.
- The multiples look quite steep if you ask me, as I am congratulating all the long-term believers in Ultimate.
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Ultimate Software Group (NASDAQ:ULTI) had a pleasant surprise for its investors, as it announced that it has reached a merger agreement with Hellman & Friedman under which the company is sold for $331.50 per share in cash, representing an $11 billion valuation!
The multiples look quite steep by all means, although Ultimate is a high-quality business. Therefore, congratulations to all the believers and holders of the shares, as the risk-reward for the new buyers does not look that compelling at these levels, at least to my eyes.
The Deal
Ultimate Software has reached a deal under which it will be sold to Hellman & Friedman at a price which matches the all-time high set in September of last year. This price action was, of course, followed by a fierce sell-off in technology-related names, including that of Ultimate, as shares fell to just $220 in December. Shares recovered to $275 per share in recent days and have jumped to the highs again following the news release of the deal.
Hellman is very much interested in the provider of human capital management solutions which operates in the cloud. It is not just Hellman which is interested in the company, as it has partnered with other large investors as well, including Blackstone, GIC, CPPIB and other names. The deal does not just create a wealth transfer to shareholders but to all employees as well, as they too hold shares in the company.
The deal marks an end to a great run which long-term investors in the firm have seen. Trading at just $10, even during the dotcom bubble, shares have gradually moved higher for a 30 times return in less than two decades, translating into very compelling returns by all means. To make an even better company and offer customers better service, Ultimate Software and management claim that being a private company allows for even quicker pace of innovation, while maintaining high service levels.
Despite the steep premium, with the deal valuing Ultimate at 10 times the sales seen at little over $1.1 billion in 2018, the owners believe that value can be found, thanks to the leading HR and payroll solutions which already serve more than 5,000 companies and having records of nearly 50 million users.
The consortium is confident that the deal will close, having granted the option to Ultimate for a go-shop period of 50 days in which the company and advisers can solicit higher offers for the business.
Long-Term Appeal
The reason why the company is taken private is the promise of the business in the future, as current multiples are simply sky-high. On top of the current recurring revenue growth rate around 25%, with total revenues exceeding $1.1 billion in 2018, the company sees growth lasting, as it rolled out a $2 billion revenue target for 2021. With three years to go and a $1.1 billion revenue number for 2018, that suggests +20% growth for the coming three years to come.
Unlike many other SaaS names, Ultimate is quite profitable, having posted real GAAP operating profits of $58 million in the first three quarters of the year on $836 million in total revenues. It goes without saying that with GAAP earnings power of >$2 per share, multiples are sky-high with net cash holdings just surpassing the $100 million mark, for a net cash position of little over $3 per share.
So, based on the company's current earnings power, multiples cannot be rationalised. The promise is that $2 billion in revenues in 2021 can be achieved and the business becomes very profitable. Assuming 15% growth from 2021 to 2030 suggests revenues might grow to $7 billion. If the company can become really profitable and generate 30% GAAP margins, while working with a 20% tax rate, I see net earnings power of $1.7 billion, but this, of course, is a very ambitious outlook. Note that the earnings projection for 2030 is 50% larger than today's revenue base!
If that is the case, and we do not account for retained earnings, while granting the company a generous 20 times net earnings multiple based on the established businesses which it might become, Ultimate might be worth $35 billion in 2030. With an $11 billion current deal value, that works down to a potential compounded annual growth rate of 11% per annum, without the impact of retained earnings or capital allocation decisions. This does not appear to be too high, as the new owners cannot really saddle the company with a lot of debt (just yet), since the earnings power of the business is rather modest.
Congratulations!
Not having covered Ultimate Software closely in the past, I can only congratulate management, employees and long-term believers in the company with the great trajectory seen in the past twenty years, now being "closed" with such a fantastic deal.
It appears that the new owners clearly have a long-term view on the prospects of the business and believe that Ultimate Software will play a key role in human capital-related software solutions in the future, as current growth is expected to last for many years to come, while earnings should become a lot fatter.
Based on my fairly aggressive assumptions through 2030, I "only" end up with potential gains of 11% per annum, as the risk-reward for the new buyers does not appear to be very compelling in my eyes, yet it has been a great ride for all those involved so far.
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Comments (3)
As a long term buy and holder of ULTI I’m grateful and hope ULTI’s business and cultural success inspires others to stay the course.
