SS&C Stock Can Easily Rise 14.7%
Summary
- SS&C had a nice recovery in adjusted organic sales growth. Yearly growth rose from -2% to 2.9% sequentially.
- The firm is switching clients from traditional Eze to Eze Eclipse which has about a 30% higher ASP.
- Alternative asset management drove growth. Intralinks also had a strong quarter due to the improved M&A market.
- 2021 guidance was raised. The firm now sees 5.6% to 9.7% adjusted EPS growth.
- The stock's forward PE ratio is only 16.1.
SS&C Reports A Boost In Organic Sales Growth
In my last article, I was tough on SS&C (NASDAQ:SSNC) because of its middling organic sales growth in 2020. Its Q1 results were exactly what I hoped they would be. My conviction in the stock has been vindicated. Following its earnings and sales beat, the stock rose 4.13% to a new record high. I will be holding onto this stock for many years.
Specifically, SS&C reported $1.18 in non-GAAP EPS which beat estimates by 8 cents. Sales were up 4.2% to $1.23 billion which beat estimates by $40 million. The all-important adjusted organic sales growth rate was 2.9%. That’s up from -2% in Q4. The end markets are improving.
After a tough year, SS&C is back in business with low positive single-digit organic sales growth. For context, from 2016 to 2019, organic sales growth was about 2.5%, 4%, 4%, and 3%. Solid organic sales growth could be more important than ever because software acquisitions are very expensive in this environment. The company will have a greater ability to focus on driving organic sales growth if it can’t do another deal (fewer distractions).
Even though SS&C is a software applications business, it would probably be helped if investor interest in software waned. SS&C doesn’t trade at a high multiple, meaning its stock shouldn’t fall as much as the average growth software name. Furthermore, lower valuations would give it more opportunities to make acquisitions. That’s why it’s worth owning strong businesses run by great operators through an entire cycle (or multiple cycles).
On the negative side, if higher interest rates were the catalyst for lower software valuations, SS&C would need to pay more in interest payments when it borrows to make an acquisition. I think long term interest rates are headed higher, but not to the point where this becomes a major issue.
SS&C Pushes Clients To Eze Eclipse
According to a hedge fund manager on Twitter, SS&C forced its clients to shift from the traditional Eze products to Eze Eclipse (as of 2020 Eclipse was about $15 million in sales which is a small portion of Eze which was at about $280 million). This is a more advanced service with about a 30% higher average selling price. The manager mentioned this could drive organic growth. Organic growth did end up improving, but not due to Eze products.
It’s great to have contacts in the industry to get the latest results on product changes. Fund managers who are customers of SS&C have firsthand knowledge of the stickiness of its services; it’s a big endorsement when they own shares in their funds.
SS&C isn’t a sexy pick. In fact, I believe this is the most boring stock in my portfolio (which mostly consists of boring stocks). However, investors shouldn’t be trying to use their portfolio as a form of entertainment. We are trying to make the most money while taking the least risk. Funds simply are rarely motivated to change their trading systems, back office, and middle office services. This is evidenced by SS&C’s revenue retention rate which stayed at 95.7% in the quarter.
Alternative Assets Strong and Healthcare Weak
Adjusted operating income was up 7.1% and adjusted diluted EPS was up 14.6%. Operating cash flow increased 25.7%. Remember, last quarter Bill Stone was mad that the company wasn’t getting credit for its EPS and cash flow growth because investors have been focused on organic sales growth. Some software stocks exploded on sales growth alone even without profitability. I’ll stick with SS&C’s strong cash flows and let risk takers invest in the extremely expensive fast growth software stocks.
Adjusted organic sales growth was boosted by Alternative Assets Under Management, Advent, and Intralinks. Specifically, alternatives grew 6.7%. Intralinks grew 10%. Intralinks (secured data rooms to M&A sellers) was helped by the robust M&A market. Black Diamond is an Advent platform for RIAs. It grew 13%-15% in 2020 and is growing strongly in 2021 as well. The trend has been for RIAs to shift from in-house software to outsourced software such as Black Diamond.
As you can see from the chart below, Alternative AUM rose from $1.95 trillion to $2.021 trillion sequentially. This a major milestone. The only minor blip in the past couple years was in Q1 2020. This was a good stress test for how the business reacts to a weak market. SS&C held up admirably.
Bill Stone described the catalyst of increased assets under management as governments pumping money into economies. We can debate how monetary policy impacts financial markets another time. The point here is fund flows are strong which is increasing fund launches, new strategies, and new investment types. It doesn’t matter to me if I would invest in the strategy. I’m just happy for SS&C to service these new clients.
The weak parts of the business in the quarter were institutional asset management, healthcare, and Eze products (front end trading systems). Specifically, the Eze business had trading volume declines which caused sales to fall 3%. It’s possible that the switch to Eze Eclipse the hedge fund manager I know tweeted about may have occurred outside of the quarter. He tweeted that point on March 23rd. Let’s see if Eze bounces back next quarter. Obviously, volumes and pricing aren’t always in tune. The firm wants to expand the Eze Eclipse product outside of just hedge funds to large scale asset managers.
DST, which includes its financial & health businesses, was flat. In a fireside chat last year, Bill Stone mentioned that he was most excited by SS&C’s health business, but its results within the DST business have been weak. In a fireside chat in March, the firm’s CFO mentioned health was hurt by consolidation. For example Cigna (CI) bought Express Scripts (ESRX). SS&C is one of the few independent providers. It will focus on middle market healthcare providers. He said the company needed to improve its technology to adjust to this new environment. Growth depends on the timing of new deals.
SS&C’s CFO stated in that chat that DST’s sales were running 5% below projections, but profit margins were $250 million higher than expectations and the retention rate improved strongly (range of 96%-97%).
Bundling Software
The software business was hurt by COVID-19; companies didn’t want to change their infrastructure during the pandemic. That’s changing now that the pandemic is near its end (at least in America). Firms want to transition to new technologies and streamline operations. SS&C is working on bundling their products together. This helps clients lower their number of suppliers and providers like SS&C increase customer stickiness.
Customers want to configure their services to include software applications and outsourced services. In support of this theme, on the call, management said, 90% of the firm’s advance new sales in Q1 included hosting or other operational services.
On one specific aspect of bundling, SS&C integrated its Intelligent Automated Workflow product with Singularity which is its investment analytics, accounting, and reporting solution. It’s great that the company is integrating its various technologies whether they be automation, machine learning, or robotic process automation, to build a complete solution for customers.
The Most Interesting Comment From Bill Stone
Bill Stone is one of my favorite managers to listen to especially among mid and large-cap companies. Microcap management teams tend to be open about their businesses and give answers to the best of their ability. Mid and large cap firms usually are tight lipped and "stick to the script." Bill Stone "tells it like it is" which gives us great sound bites to look over.
One of the key reasons many investors own SS&C is Bill Stone’s capital allocation track record. I want SS&C to do deals, but I want it to be disciplined. In this expensive environment, I understand if a big deal isn’t done. On the prospect of buying a company versus building more technologies in house, Bill said:
“And we have a lot of confidence in our development teams and our sales organization, and we believe we can build almost anything; so the question becomes, is, where do you allocate your capital? And we want to allocate it what we'll give our shareholders as the best risk adjusted return. So, maybe these things that are selling at 20 times revenue; you know, maybe they are going to be moon-shots. But you've been at this long enough, 20 times revenue, that's a big number. So you've got to be -- you've got to do your due diligence, you've got to know how you're going to make that pay off. And so, I would say, yes, of course what we have to raise our prices to get good assets because good assets are selling for higher price.
But we're still disciplined; like I said, we did almost $500 million in adjusted consolidated EBITDA, and that gives us a lot of flexibility. And as Patrick said, we're expecting somewhere around $1.003 billion in free cash flow. So we can use that to do lots of things, and we plan on doing lots of things. And so I think this is a good question and there is no specific answer other than certainly, if you're going to be in the M&A game, you're going to pay more now than you did 5 or 10 years ago.”
Bill knows he will have to pay more to do a deal, but he’s not willing to go crazy and buy a company at 20 times sales. The good news is financial services and carve-outs from large corporations are typically cheaper than pure software companies (private equity prefers software over financial services). I like the concept of building more products in house if the company can’t do a large acquisition.
Customer retention rates in the industry are high which is why deals are done in the first place. However, SS&C can still expand the services it provides current customers. This gets back to the point the hedge fund manager made about the firm switching clients to a better more expensive service. SS&C can "force" customers to switch services because they are stuck with SS&C. The company is monetizing or even weaponizing its high retention rate.
2021 Guidance Was Raised
SS&C stock rose on Tuesday because the firm raised guidance above the consensus. Adjusted organic sales growth guidance for 2021 was originally 0% to 4%. It is now 1.7% to 4.7%. The middle of that range is 3.2% which means it should see accelerating organic sales growth. Q2 will be the start of the acceleration because guidance calls for organic sales growth of 2.4% to 5.9%. Management typically has very high visibility. These numbers are very likely to be hit.
Q2 adjusted sales guidance was from $1.19 billion to $1.23 billion which beat estimates for $1.18 billion. Even at the low end, the consensus was beat. Q2 EPS is expected to be from $1.10 to $1.16 which beat estimates for $1.11.
On a full year basis, the firm raised its adjusted sales guidance from the range of $4.685 billion-$4.875 billion to the new range of $4.825 billion-$4.965 billion. Now sales growth is expected to be 3.1% to 6.1% (prior range was 0% to 4.4%). Growth is about to accelerate from 0.3% in 2020. Last year the company was hit by the pandemic, but sales growth stayed positive. Full year EPS guidance rose from $4.36-$4.64 to $4.54-$4.76. Adjusted EPS growth is now expected to be 5.6% to 9.7% (prior range was 1.4% to 7.4%).
The company broke down how it expects each business to perform this year. The Alternative business continues to outperform as its sales growth is expected to be 4% to 7%. Intralinks will be a little better. The software business is expected to grow 1% to 2%. DST’s financial business is expected to grow organic sales by 2.5%; its health business is expected to grow 1.3% (combined over 2%). Anything positive here would be a plus to me. DST’s financial business’ growth is expected to come from its transfer agency and retirement businesses. DST hadn’t focused on retirement services before the acquisition.
Valuation Is Cheap
If SS&C trades at 18 times the high end of its guidance range, the stock can rise to $85.68 (14.7% increase). That would be a discount to the forward S&P 500 PE ratio which is above 22. I think the company shouldn’t trade at much of a discount because of its high recurring revenue.
SS&C currently trades at 16.1 times the midpoint of its guidance. This stock usually trades cheaply because of its low organic sales growth and its high debt load. That being said, if you think SS&C can hit the high end of its guidance like I do, the stock is cheap.
Buyback, Dividend, and Leverage
The company bought back slightly less shares than last quarter which makes sense to me because the stock was higher this quarter. I still think it’s a deal though. I’m just saying it’s slightly worse of a deal in the $70s than in the $60s. Specifically, in Q1 the firm bought back $181.4 million worth of shares for an average price of $67.15. In Q4, it bought back $227.7 million worth of shares at an average price of $60.99.
SS&C is not a stock owned for its dividend (low yield), but it is a dividend growth stock. It raised its quarterly payout by 14.3% to 16 cents per share in February. If the company can’t find large acquisitions in the next couple years and has a low leverage ratio, it will probably raise its dividend at a quicker pace. That’s a nice consolation prize.
Speaking of leverage, the firm’s leverage ratio fell 4 basis points to 3.35x. It inches lower each quarter. A lower leverage ratio would help the company make a big acquisition, but I think the main roadblock is elevated valuations, not its balance sheet. The CFO mentioned the goal is to get it below 3x.
My Position
SS&C is 5.3% of my taxable account. I love this boring consistent business which has great management. I love the concept of investing in a business that is a hassle to change. Fund managers focus on improving their investing strategy and marketing, not back-office functions. The goal of software is to "disappear" and just work.
The biggest risk factor is that the company can’t find another large acquisition. The small deals it has been doing don’t move the needle much. I plan on holding this stock for a while. I briefly considered selling it a few months ago because I’m bearish on software stocks. However, this isn’t one of the SaaS bubble stocks trading at 20 times sales. It’s a proven winner that’s highly profitable and has a reasonable valuation.
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Disclosure: I am/we are long SSNC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.