Over the last few months, there has been a large sell-off in long-dated bonds.
This has also led to a fall in the prices of growth stocks that have long-dated cashflows. For example, the ASX All Technology Sector Index has fallen by 14% from the record high on 10 February.
We have used this tech sell-off as an opportunity to invest in Class (CL1).
CL1 is a provider of cloud-based accounting software for SMSF/ trust accountants in Australia.
CL1 has 3 main software products:
Class Super: Manage SMSF administration & reporting
Class Trust: Automate investment trust accounting & administrating
NowInfinity: Produce legally backed documentation
The Investment case for CL1 boils down to 2 key points: downside protection on the back of a well-regarded mature core product, and considerable upside potential in the form of 2 reasonable growth products.
We expand on these 2 key points below.
Class Super: Core Mature Product
We believe Class Super is a safe (albeit mature) product which we can confidently value because of its very defensive revenues.
The first element of defence comes from Class Super having very loyal accounting customers (annual churn 1%). Accountants keep using Class Super because it saves them money. Using Class Super will reduce the amount of time spent administering an SMSF account by 40 hours per month. Yet Class Super only costs $220 per year to use (post discounts). The value proposition for Class Super is obvious!
Another reason for Class Super's revenues being highly defensive is the enduring nature of SMSFs. An SMSF allows people to directly control and manage how their retirement savings are invested. This direct control provides tax advantages and visibility which is not available with other superannuation funds. Therefore, one is relatively unlikely to wind up an SMSF once it is set up.
All this explains why Class Super experienced stable growth in revenue and number of accounts during the recent pandemic:
We believe Class Super is a solid product whose valuation underpins the majority of CL1's share price. We estimate Class Super on a standalone basis generates $40m of revenue and $11m of Free Cash Flow in FY20. We think the division is conservatively worth $135m ($1.10 per share).
Because the market cap of CL1 is $210m ($1.70 per share) and the Company is virtually debt-free, we are only paying $75m (60c per share) for the remaining 2 divisions which will be described below.
Class Trust and NowInfinity: Reasonable Growth Opportunities
Given CL1 has such a strong connection with accountants who use its Class Super product, we believe Class Trust and Nowinfinity offer a compelling, low-risk cross-sell opportunity. CL1 acquired NowInfinity in February 2020 and launched Class Trust in October 2020. These 2 products increased the company's Total Addressable Market by 2.5 times. Management have indicated that Class Trust and Nowinfinity each have potential to be as profitable as Class Super. If that's the case, Class Trust and Nowinfinity have combined potential to earn up to $80m in revenue and $20m in Free Cash Flow. This compares to the aforementioned $75m in value attributed to these 2 divisions based on the current market cap of $210m.
Conclusion Over the next few years, there is significant opportunity for CL1 to steadily grow its recurring revenue and earnings power.
Our upside case sees a combined business earning $30m in mature Free Cash Flow based on the 3 products already publicly identified, and possibly addressing new as-yet-unannounced opportunities to service its loyal accountant base. A valuation of $3.00 based on a 15x mature FCF multiple is not an unreasonable scenario. Meanwhile, the risk of a permanent capital loss seems negligible, and this will remain the case regardless of what happens with bond yields!
Till next week, happy investing.
Michael & Kenny