- Tyler Technologies has seen huge growth and value creation over the past few decades.
- The company has been well positioned and is a savvy capital allocator in terms of dealmaking and well-timed share buybacks.
- I like the long-term value and track record, yet too much good news has been priced in recent years, despite a recent sound and large deal.
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Tyler Technologies (NYSE:TYL) is one of these steady growth names which has operated under the radar, presumably of many investors. The company has created great value for long-term investors, driven by real operational achievements, savvy deals, and good capital allocation skills, yet the valuation has gotten a bit out of hands in recent years in my belief.
The paragraph header is how the company describes itself in the 2020 investor presentation. The company is the largest provider of software solutions to local and state governments and over the past nearly two decades has grown earnings per share at a compounded annual growth rate of 20%.
The company operates in a global growth market with an estimated size of $21 billion, and while this market in itself is quite compelling with high single-digit revenue growth, the company is gaining market share in this market as well thanks to focus on organic growth, innovative solutions, and bolt-on dealmaking.
The company has 26,000 installations among its customers which include a huge focus on ERP/Financial, as well as other clients like courts, justice, public safety, appraisal and tax, platform technologies, civic and other services. The essence is that much of the revenue base is recurring and growing as the growth trajectory has been huge. After all, revenues of just over a hundred million in 2002 have grown more than a billion in 2019. Much of this is driven by organic growth as well as 30-plus deals having been pursued since 2006. Another key achievement is the allocation skill outside of acquisitions as the company has cut its share count by more than 40%, while the balance sheet strength has been preserved, including a very strong net cash position.
A focus on the public sector and national solutions which are scalable, all while placed in a robust SaaS business model has given the company as a great deal of competitive barriers, lying at the heart of the success of the company. The focus on public and not so sexy areas of the software market is a deliberate one as the company is hereby avoiding competitive competitors which often focus on the commercial side of the market.
These great operational achievements have been fueling incredible value creation as this just a $3 stock rose to $30 in 2011, rose to $100 in 2013 as the transition into SaaS model drove a huge further run in recent years. In fact, shares recently hit a high of $480 per share, only to now trade at $440 per share.
The big news came early in February as the release of the annual results and announced acquisition were the driver behind the shares hitting a high of $480 in the days thereafter. Because of the impact of COVID-19, Tyler saw a slowdown in growth with 2020 sales up less than 3% to $1.12 billion, on the back of a 1% increase in organic sales. Despite the slowdown in sales the percentage of recurring revenues kept increasing as the company grew its operating earnings by roughly double-digit percentages. Reported growth was not impressive, yet the good news is that the backlog rose by $130 million to $1.59 billion as the transition in the business model, evident in increasing deferred revenue balances, indicates that the company continued to grow in a steady fashion, despite the pandemic.
The company guides for 2021 sales at a midpoint of $1.205 billion, suggesting high single-digit revenue growth, with GAAP earnings seen at a midpoint of $4.12 per share and adjusted earnings seen at $5.71 per share. The latter metric improvement just modestly from the $5.52 per share reported in 2020. Note that the adjusted earnings number looks reasonable, as the majority of the discrepancy comes from amortization charges, although it excludes for quite a substantial stock-based compensation expense as well.
The 42 million shares represented a more than $20 billion valuation at the high of $480 in Mid-February. Even after backing out $700 million in cash, or about $17 per share, the valuations were quite high at realistically around 100 times earnings and around 16 times revenues!
A Big Deal
Contrary to many bolt-on acquisitions in the past, Tyler announced a huge acquisition as well alongside the release of the 2020 results. Tyler announced that it would pay $2.3 billion to acquire its publicly listed peer NIC (EGOV) in a deal valued at $34 per share in cash. NIC services governmental and other agents with digital government solutions as well as payments, making it somewhat synergistic with Tyler. This includes services provided for applications for unemployment insurance, license renewals, and secure payments, all online. NIC generated $460 million in sales on a trailing basis which makes that it is valued at just 5 times sales. Net earnings of $69 million results in a 33 times earnings multiple, essentially a third of Tyler's valuation multiple as well.
Tyler likes the accelerated shift to online services and electronic payments and in essence guides for synergies between both companies which operate in adjacent markets. This seems to make sense, yet it reveals that Tyler is moving away from the core operations as well. The other thing is that of a huge gap in the valuation, as the deal will furthermore result in a net debt position of $1.4 billion following the deal (as the $2.3 billion equity value of NIC includes roughly $200 million in net cash as well). That is quite significant as Tyler generated $326 million in EBITDA and while pro-forma EBITDA will jump to more than $400 million, leverage ratios will be quite high at over 3 times in contrast to a traditional net cash position.
With Tyler adding $69 million in earnings on a standalone basis from NIC, the company is incurring net debt of around $1.4 billion. Assuming a 3% cost of debt, we see that incremental interest costs will eat $42 million (pre-tax) in earnings or about $34 million after-tax. Absent synergies, I peg incremental accretion at around $35 million, adding about $0.80 per share to earnings. This accretion, some synergies and a little deleveraging might easily bolster earnings to $6.50 per share quite soon, at least in my opinion.
That said, the net cash position has been gone and with shares now trading at $420, the multiples have compressed a great deal, yet at 65 times earnings and a sales multiple in the mid-teens, valuation remains sky-high. That said, I like the deal and the long-term track record of the company as quality certainly is very valuable in the long run. Operating in a huge growth market being a great skillful capital allocator is very valuable, yet at 65 times realistic earnings, expectations simply remain very high, far too high for me to seriously consider the shares here. That said, a meaningful pullback or years of share price stagnation might trigger my interest, but for now, I am not compelled to the investment case.
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This article was written by
The Value Investor has a Master of Science with specialization in financial markets and a decade of experience tracking companies via catalytic company events.As the leader of the investing group Value In Corporate Events they provide members with opportunities to capitalize on IPOs, mergers & acquisitions, earnings reports and changes in corporate capital allocation. Coverage includes 10 major events a month with an eye towards finding the best opportunities. Learn more.
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