On 19/11/2014 17:32:22,
Business & Thesis
MAM Software is a UK-based company supplying business management solutions (“BMS”) and data services to the aftermarket industry. The business operates primarily in the U.K. and Ireland (through MAM Software Ltd.) and in the U.S. (through MAM Software Inc.).
MAMS delivers products to three major end markets: warehouse distributors (i.e. a regional distributor that supplies hundreds of thousands of SKUs to parts retailers), parts retailers (the equivalent of something like an Autozone store), and service providers (garages, collision repair centers, serviced by a parts retailer).These products generally optimize business management functions – services such as quote preparation, stock management, database solutions, catalogue data, e-commerce applications, CRM, and the whole kitchen sink. While we seem to be rattling off a variety of buzz words which we ourselves find annoying, we think the value of MAMS’ solutions is best encapsulated by 1) MAMS’ 70% market share in warehouse distributors and parts retailers in the U.K., 2) SaaS quarterly churn rates below 2%, 3) 71% recurring revenues, and 4) wins and strategic partnerships with major customers including Munroe Mufflers, Advance Autoparts, Auto Parts Alliance and most recently Autozone (through ALLDATA).
At 14x 2014FY (June year-end) management guided EBITDA of $5 million, MAMS is expensive. However, we believe the current valuation fails to capture the “optionality” of MAMS’ large re-investment in SG&A over the last two years:
• Per the FY2013 10-k (ending June 30, 2013), a majority of the increase in G&Y was due to increased hiring in the U.S. (shy of ~$700,000), and another ~$366,000was due to U.S. S&M. The U.S. was responsible for ~70% of the increase in SG&A ($1.1 million of the $1.5 million)
o In addition, SG&A has gone up another ~$1 million in the 6 months ending 12/31/13 vs. the previous year period. Roughly ~$400,000 of this was in U.S. G&A, with an undisclosed amount of the $680,00 increase in S&M due to the U.S.
o In aggregate, SG&A has gone up ~$2.5 million LTM versus FY2012. We estimate that if half the sales and marketing increase YTD were attributable to the U.S., U.S. costs would have accounted for ~$1.8 million of this increase.
o In the US, LTM COGS is up $1 million while revenues are only up $1.4 million – we believe there is also overinvestment in COGS (referenced later in this report), given that historical gross margins have been just shy of 60% and SaaS margins should be higher. For reference, UK COGS increased just $~900,000 since FY2012 while revenues increased $2 million.
In aggregate, over $2 million of expenses tied to U.S. expansion efforts have been added, while U.S. gross profits have just gone up marginally since FY2012:
Conceptually, we think MAM Software is a story of two businesses – a mature, slow/modest growth U.K. cash cow, coupled with a fast growing, cash consuming “growth venture” in North America (though MAMS has been in the U.S. for a while now, it has only recently begun re-investing in rapid growth in the business – revenues are up 50% since FY2011).
In the undesirable scenario where North America fails to deliver adequate returns, we think it’s reasonable that management strips out the recently added SG&A and MAMS returns to a more sleepy growth rate. If this were to occur, we think the shares are trading at ~10x EBITDA and high single digit FCF % yield (not unreasonable for a low churn, dominant UK business), providing a floor on valuation.
In a more sanguine scenario, we think MAMS has demonstrated the value of its product offerings in its recent partnerships. Simply extrapolating past growth rates in MAMS SaaS divisions imply valuation upside of 30-60%. If we can maintain top line growth rates of ~10% for the next few years, we think shares could trade at $~10 at 10x EBITDA.
MAM Software Products (Value Proposition)
MAMS offers solutions through 3 main product lines – Autopart (and Autopart Online), VAST, and Autowork Online. Autopart is the original business software (traditionally sold as perpetual licenses) sold in the UK/US. The software is on its 20th iteration, and provides (among other things) price management, sales and purchase processing, inventory management, integrated accounts, and CRM. The product is meant for warehouse distributors and parts stores. VAST provides similar functionalities (point of sale, inventory management, electronic purchasing, CRM) to auto service providers and tire chains, particularly those with multiple locations. Autowork Online is a SaaS service for single location service providers, allowing the installer to connect with a parts distributor to purchase components easily. The naming convention is a little bit confusing, but the key points are:
• Autopart -> warehouse and auto part retail stores
• VAST -> auto service providers (multiple locations)
• Autowork -> auto service providers (single locations)
AutoCat+ is a database subscription that maps OEM part numbers to aftermarket manufacture part numbers and is updated constantly (which recently won the product showcase award at the AAPEX auto show). In the UK, AutoCat+ lists ~20 million parts and had 11,700 customers as of December 31, 2013. Average annual cost for subscription seems to be just shy of $600 (not very expensive).
Prevalence in the U.K.
In the U.K., MAM Software has 70% market share of the aftermarket business and SaaS quarterly churn below 2%. In our search to corroborate the stickiness of the business as portrayed by these numbers, we ran across Value Institute’s phenomenal write-up dating from January of 2013 (a quick search for “MAMs the word” should do the trick). My synopsis simply regurgitates and reinforces the original finding.
MAM Software has long had a standing relationship with one of UK’s largest trade groups, GroupAuto Union (GAU) UK & Ireland. While I can’t date the origination of the relationship, we know MAMS was the recommended supplier of software and catalogue data to its membership by 2009 (“official supplier of I.T. Solutions”). Today, GAU has 299 distributors, 511 points of sales, and 330 garages. While the number of members and P.O.S. seems to have declined (320 members, 523 point of sales from 2009 press release), we believe the trickle will be offset by introduction of new products and migration into alternate verticals (which, as of March 2012, was an astounding .5% market share in builders’ merchants’, .1% in electrical supplies, and .2% in plumbers’ merchants). MAMS has incumbency due to its extensive deployment in the group’s membership and the attached – when GAU opened its new distribution center in 2011, it chose MAMs because of past experience and an existing infrastructure (MAMS’ software) that would avoid third-party integration issues. Furthermore, GAU has acquired some of its own members in a subgroup, and MAMS is the system of choice for all its locations.
Our conversations with management verify this case (MAMS displaced Activant as the de facto IT supplier over 10 years ago. MAMS has actually increased penetration at GAU from mid-60% to >70% over the last 5 years as well). Activant is MAMS’ largest competitor with dominant market share in the U.S. but ~20% market share in the U.K. We believe Activant lost market share in the U.K. to MAMS primarily due to its lack of investment in technology. Most of company’s customer base was signed on during the 70’s and 80’s, and the business failed to launch updates to keep the software fresh (i.e. treating its customer base as a cash cow). Furthermore, as Activant acquired its way into the market, its product portfolio was confusing and not particularly well-integrated. MAMS took advantage of this complacent gorilla and created a deep product range that is constantly updated (v. 20 of autpart) and re-invented every ~10 years. It’s market share today is the result of those pursuits.
The UK Industry
The aftermarket industry in the U.K. is a slowly declining sector. According to MarketLine’s industry profile (2012), the U.K. aftermarket is forecasted to decrease ~2.2% (.4% a year) from 2011 to 2016 to a total value of ~$17 billion, with outlets falling 6.4% (1.3% a year) over the same time span to 42,485. Rivalry in the market is intense due to high exit barriers (because, for example, garages with bays are specialized assets). This would represent a 15% drop from the pre-recession market value of ~$20 billion and ~47,000 outlets. While we would rather wish for a vibrant end market, a slightly declining one could still be spun as a positive, particularly as MAMS has ~70% market share (entry into a declining sector is unattractive, esp. when the cost of R&D is distributed over the number of customers, giving MAMS the incumbent advantage). Furthermore, the U.K. addressable market size is simply not so big to attract much attention – if MAMS’ LTM revenue of $20 million represents 70% market share, the entire market (just for retailers, excluding the likes of tire specialists and whatnot), is less than $30 million total. To rattle off some of the distributor/parts retailer relationships MAMS has:
• Unipart Automotive (UK’s largest part distributor with over 200 network branches supporting 1,000 independent owner operated garages) uses Autopart, which replaced Unipart’s legacy systems
• We were told that Eurocar Parts (#1 distributor of aftermarket parts), LKQ’s subsidiary that operates in the U.K. with 90 locations and 120,000 commercial customers, promotes MAMS’ auto repair solutions to its commercial clients (85% of ECP’s revenues comes from commercial accounts – read: service shops). At the time of acquisition, ECP did ~$420 million of revenues (2010), or roughly 2.3% of the total aftermarket market.
• Motorworld (UK’s largest independent car parts and accessories retailer) selected MAMS to manage its 100 store operations
• MAMS recently announced an eBay module in the U.K. – we were told eBay approached MAMS to add that component to its software
While we aren’t sure who actually is “UK’s largest” parts distributor – we think MAMS has relationships with all the largest retailers. In the October 2011 call regarding the Eurocar Parts acquisition, the CEO of LKQ referenced just Unipart as the “1 major competitor.” Also interesting from the call is the fact that APU usage (alternative parts usage) in the UK is ~10%, vs. >35% in the U.S. and LKQ believes those numbers will increase – if this occurs, more revenues would shift from OEMs (~30% of the market) to independents.
Regarding the service sector, we dug up a BCG report, “European Automotive Aftermarket Landscape.” It doesn’t seem that the U.K. is particularly unique – independent repair shops have 70% market share in Poland, 66% in Great Britain, 62% in Spain, and just over 50% in France and Germany (due to the presence of very large OEMs there that shape the relevant aftermarkets). In the longer term, it seems that OEMS (“authorized repair shops”) will lose share in Great Britain, as independent repair shops capture a disproportionately large percentage of older vehicles (as they run off warranty, for example), as independents win exclusive contract repairs with insurers and the like, and as the gap in quality perception between independents and authorized repair shops narrow. Within independents however, small “truly independent” repair shops that are outside franchised systems are under pressure due to higher procurement costs. Small shops must join larger franchises or trade groups to survive. The trend should be a positive for independent repair shop software providers (as OEMs have internal software), particularly for MAMS VAST and Autowork offerings.
The US Industry
In terms of the U.S. aftermarket industry, I don't think it's worth spending too much time debating the growth or stagnation of the industry. Since MAMS currently has imperceptible market share, its success will depend predominantly on the value of its product and its ability to push into trade groups, regional distributors, or larger clients like Autozone. Whether the end markets are flat or growing at GDP probably won't impact the outcome very much.
Having said that, I will ignore myself and talk about the industry. Based on AASA's 2012 status report, the aggregate market for aftermarket parts was $183 billion in 2010, and is projected to hit $201 billion in 2015 (just about ~2% growth a year). The "sweet spot" of vehicles requiring aftermarket parts (6-10 years) will begin to decline in 2014, as aftermarket dollars will chase newer vehicles and vehicles >10 years old.
The aging of the car fleet has been going on for the better part of the past decade as cars have become more and more reliable. On the flip side, given the complexity, gadgetry, and new safety mechanisms in cars, the cost for repairs have also gone up. This may explain the GDP-esque growth forecasts despite a leveling off of car age (there are also just more cars on the road!). AASA's estimates mesh quite well with TechNavio's estimate of 2% growth from 2014-2018. Again, we don’t believe the growth of the end market is too pertinent to a newcomer with a potentially disruptive set of products. Our bigger worry is more structural and refers to the continued consolidation of the auto parts industry in the U.S. Over the last 10 years, the top 10 auto parts stores have gone from 30% market share to 45%, while the number of retailers has remained flat. While this is a negative for the independent shops (mom and pops), it ought to push survivors to increase efficiency and productivity, which may encourage further adoption of business management software. When we asked management about the presence of aftermarket giants in the U.S, management told us that consolidation stretched throughout the entire industry, and their focus was on the regional level. The Company sees the independent sector at that level as bring vibrant (large/medium size wholesalers and parts distributors) and has had success approaching co-ops and trade groups (a similar approach to GAU in the U.K.)
On the bright side, the top auto retail shops (O'Reily, AAP, Autozone) have all begun shifting their focus to the DIFM segment of the industry ("do it for me"), as increasing parts complexity is driving disproportionate growth in commercial vs. DIFM ("complexity inflation"). This was reiterated at AAP's 2013 investor day. We believe this is where MAMS has the biggest opportunity for growth (the service centers: in MAMS’ most recent presentation, the addressable market for warehouse distributors & auto parts stores in the U.S. was 12,500 outlets, versus 71,700 auto repair shops). While the big retailers have their own internally developed retail business software, the DIFM segment is fragmented and not “controlled” by the big retailers.
Recently, MAM Software announced a partnership with Autozone’s ALLDATA where ALLDATA would push a white-label service of MAMS’ SaaS (Autowork Online) for a revenue share. We think Autozone may be partnering up with MAMS to provide a white label "Manage" service because:
• ALLDATA has a number of modules (Repair, Mobile, etc.) which hooks through the business management software to create the overall ecosystem. ALLDATA developed the “Manage” solution in house, though the on-premise software was never held in high regard. Recently as ALLDATA was considering rolling out a SaaS version of its shop solution, MAMS approached them with its Autowork online platform - which was already adapted to the North American market and ready-to-launch. As a result, ALLDATA could fast track customers rolling off the old platform into the new SaaS platform (as opposed to developing the solution internally and risk losing clients).
• Auto retail suppliers make money primarily from...selling auto retail parts! In fact, they are always vying to be the "first call" of any garage, as the business is sticky and high volume (though low margin). O'Reilly delivers 4-6x a day to the same garage (because it is costly for garages to have cars "hanging," given it might only have 3 bays). As such, commercial relationships are generally sticky (according to Bernstein, the average tenure of a "first call" is ~10 years) and more predictable. Per Bernstein survey, “garages stated more than 2/3 of their parts come from their first call. Together the vast majority of parts come from a garage’s first or second call.”
• Given this, large players like Autozone want to provide the best services to the garages in order to build this high volume business. One way to do so is to offer efficient, intuitive management software (if there is better software, why not use it? The risk of lost “first call” business from a lower quality internally developed service is not worth the incremental software dollars). In Autozone’s own words, " ALLDATA® Market [is] a web-based shop marketing tool to bring in new and repeat business " We think ALLDATA’s partnership is recognition of the quality of Autowork Online – otherwise it could be dangerous to introduce a flimsy SaaS to a very valuable customer demographic.
Management told us that they are working through a few iterations of the software to make sure early adapters are happy, and then they will be positioned to push hard on the product. Their goal with the product is to showcase MAM's solutions (given the lack of market share in the U.S., a major successful rollout with the largest auto parts retailer could cement them as a viable player) and to become a "vital partner" to ALLDATA.
This also is not the first time MAMS has played a part in a large U.S. autoparts retailer. Advanced Auto Part ("AAP") acquired their commercial division, Autopart International, which has been a MAMS customer since 2007, and continues to use MAMS today even as the business has more than quadrupled in size (AAP was predominantly retail prior and so there was never a clash over software integration). As stated previously, MAMS is also pushing to break into trade groups.
Even though the shares are quite expensive, we think the Company is high quality, recession resistant, predictable, and well managed (by owner operators with significant ownership stake).
In reference to downside protection - aftermarket parts are counter-cyclical (though it has been on a secular trend which might be ending) and the industry is relatively stable year to year. In addition, MAMS plays a vital function in the management of operational efficiency (as Value Institute puts it: “operational efficiency is a de facto requirement for survival, and that is the opportunity for business management software firms such as MAM.”), evidenced by the dominant market share and sub 2% churn. While that might give us some reprieve that revenues/profitability might have some staying power in the event of another recessionary climate, it surely doesn’t justify a 14x EBITDA multiple. There is no coverage on MAMS and no management guidance for growth, so we try to ascribe some reasonable projections for growth:
• US gross margins in the second 2014 fiscal quarter collapsed (from 60% last year to 43%). In our discussions with management, we were told that the impact was twofold. 1) There was slippage of revenues that had been anticipated in the quarter coupled with 2) ramping up of the U.S. support base in anticipation for the uplift in business. US margins have been somewhat volatile but has historically been in the high 50%, and Charles (CFO) had mentioned in the latest call that they expect margins to improve back to those levels. Over both the U.S. and U.K., The push to SaaS will benefit COGS as adoption continues to increase. In the past, MAM Software needed to maintain a team of engineers/configuring personnel to support a customer base that had services on site or in personal databases. As these customers are transitioned to the hosted cloud, the on-site workforce needs are shrinking (“we will naturally reduce headcount over a period of time.”) – hosted solutions are simply easier to support. While we queried whether the business would ever discontinue its traditional licensing, management stated that they would always offer perpetual licensing for customers who want it, though they have been getting better at persuading customers to go online through a cost of ownership pitch. When we inquired even longer term, management hopes they can get to gross margins of 63-65% (above previous highs) as “Saas margins are good, and data margins are even better.”
• As we spoke about the individual products, management was confident that Autopart Online will overtake Autowork in time (Autopart right now does ~$850k a year in revenue vs Autowork at ~$2 million). This seems reasonable, given the trajectory of growth as well as the higher ARPU. Regrettably, we don’t have much data, but at least we know the monthly subscription cost for Autopart is ~$125 ($1,500 a year). If we add subscribers at the current rate, we will add roughly 704 subscribers a year, which at $125 monthly ARPU comes out to $1.1 million.
• Autowork right now has 3,065 subscribers and makes $1.95 million a year run rate. If we average quarterly additions of ~91 a year, this translates to around $232,000 of incremental revenues a year. It is also important to note the increase in average revenue per subscriber of Autowork. In Q1’2013, revenue per sub was $40. In the latest quarter this was $53. Management told us they were selling more products/modules to the existing base (for example, mobile apps), with added functionalities that would make the platform even stickier. MAMS is working on a new module that it hopes to launch into the ecosystem and management has a view of what they would “ideally like to attain.” We were told this was more than $10 and less than $50 over the current rev/sub number. At $10-$50 a subscriber additional, this would translate to revenues of $.4 to $1.8 million (from the existing subscriber base).
• Hence, from Autowork Online and Autopart online (without credit to any vertical segment launches, VAST sales, new warehouse modules, etc.), we believe MAMS can add $1.3 million of SaaS revenues a year based on past growth rates, and another ~$1+ million over the next couple years as they ramp revenue per sub for Autowork Online. In three years, this translates to ~$5 million of revenues. At an estimated 65% gross margin, this would translate to gross profits of ~$3.3. We presume most of this will fall to the EBIT line as 1) we were told the recent SG&A hires in the U.S. would not be duplicated going forward and 2) management is measuring the success of various activities, and if sales don’t pick up even with the recent spike in SG&A investments, we believe they will trim expenses.
• While a linear extrapolation based on historical numbers (and not that many at that) is unwieldy (the future is as rosy as the past), we think that given the recent large ramp in SG&A (which ought to increase subscriber add rates), and the general “ramp” of new sales personnel, a linear extrapolation could be conservative. Upside includes:
o A successful ALLDATA launch will likely increase SaaS subscribers (Autowork) at a much more rapid rate (ALLDATA has 80,000 subscribers). Autowork Online was localized and launched in the U.S. at the end of FY2013, and so it has not been marketed long.
o Success of recent SG&A and marketing maneuvers
o “We are busier in the UK than we have been for some time.” As MAMS has built out its North American product offerings, it has created new modules (for example, a wholesaler BMS) that it is able to introduce in the U.K. to customers they had never previously sold to
o Introduction of AutoCat+ into the U.S. market
o Penetration of more Trade Groups
o Vertical markets we have neglected to talk about, but management told us that they are making progress, are attending major trade shows, and are concentrating on just a few verticals where they have strong functionality (and a good fit)
Assuming we start with FY2014 ending EBITDA of ~$5 million, we think in 3 years, a lower end estimate of EBITDA would be around ~$8.5 million (just based on growth in Autopart and Autwork Online only). Assuming we generate ~70% conversion of EBITDA to FCF, we will build ~$15 million of cash on the balance sheet, bringing our cash to ~$20 million. I think a sticky SaaS business growing EBITDA at mid teen % a year could trade around 10-12x EBITDA, or $85 – $103 million. This implies a market value of $105 million - $123 million, or 36-60% upside.
2009 2010 2011 2012 2013 LTM
FCF ($0.3) $0.5 $1.8 $4.5 $3.5 $3.6
FCF / EBITDA -30% 23% 34% 75% 69% 79%
FCF / Net Income 4% -82% 72% 121% 126% 130%
Given the inherent leverage in the business, an additional million in revenue will generate ~60%+ gross margins (depending on mix) and a minimal amount of operating expenses. We don’t want to throw out an imprecise model, but if we imagine the business:
• grows top line ~10% a year, we will have $39 million in revenues three years out
• gets to 63% gross margins (lower end of mgmt. goals)
• grows opex from $13.1 million LTM to $15 million (roughly ~20% increase in revenues, admittedly a guess)
• Adjusted EBITDA would be $10-11 million
On the same 10-12x EBITDA metric, the market cap of MAMS would be $120 million ($20 cash) to $152 million, or 56%-97% upside. We don’t think this is a particularly aggressive scenario, and it would also mean management’s last 30% chunk of options vest (management recently exchanged in the money stock grants to much higher number of restricted shares that will vest in increments as the shares hit $5, $6, $7, and $8 - with 40% vesting at $5, 15% at $6 and $7, and 30% at $8).
Ultimately, we think MAMS is a good business with dominant share in the U.K. that doesn’t seem likely to be challenged anytime soon. We believe, conceptually, that the business really is two components – a mature, slow growth U.K. cash cow, coupled with a fast growing, cash flow negative venture in North America. The business:
• Is defense and counter-cyclical, has a strong balance sheet, and generates good FCF
• Is seeing poor P&L metrics due to large reinvestments in SG&A, primarily to boost its product offering in North America and which has yet to gain scale (as seen by North America’s gross margins)
• Should have modest downside due to a strong core U.K. business in case the U.S. expansion fails (we estimate ‘mx’ business generates $7+ million EBITDA)
• Has incredible leverage on incremental dollars of revenue, given the cost structure is unlikely to grow much more
• Has a strategic partnership with ALLDATA (and beginning to form trade group partnerships) that could allow MAMS to engage other major players in North America