SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space – SimCorp A/S (OTCMKTS:SICRF)

Source: cetrixcloudservices.com.

Overview

If you follow me on SA, you know how unattractive I find the asset management industry as an investment candidate. I believe the industry, in aggregate, does not generate value to its customers. After all, 80% of all money managers cannot beat an index, which makes many of their businesses look like a pure marketing- and sales-driven play.

In addition to the questionable business model, regulatory pressure, rising costs and the “race to zero” are among the other secular risks to investors.

One way to play an unattractive industry is to look into its suppliers. In this case, Denmark-based FinTech company SimCorp (OTC:SICRY) (OTC:SICRF) is a good candidate thanks to its high-quality fundamentals. The company provides asset managers globally with front-to-end software solutions, which handle regulatory compliance, enhance efficiency, save costs, and improve performance.

Primarily listed on the Nasdaq Copenhagen Stock Exchange under ticker SIM, the stock is one of the top names in my factor-based quality ranking model.

Recurring Sales

One of SimCorp’s strengths is its so-called “integrated front-to-end solution,” where software modules can handle virtually any task relevant to an investment manager, from front office (e.g., portfolio management, research) to middle office (e.g., risk, reporting), to back office (e.g., accounting, clearing).

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)Source: company website.

While the first sale (i.e., new licenses) generally only includes a few of these modules, SimCorp’s clients may opt to add on more modules (i.e., add-on licenses) throughout the partnership. Additionally, around three-quarters of revenue comes from aftermarket maintenance and services:

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)Source: 2018 annual report.

Therefore, as demonstrated above, almost 90% of SimCorp’s total sales are recurring. This makes the business less exposed to cyclical risk than the overall asset management or technology industries.

Economic Moat

SimCorp builds its economic moat mainly through the high switching cost and mission-critical nature of its software products. Global investment managers increasingly prefer comprehensive, integrated solutions. It is easy to get them now (thanks to the unique offering from SimCorp) but far harder to get rid of them as day-to-day operations and decision-making become heavily dependent on the installed software. Plus, asset managers would not bother spending much time on system integration and staff training or risking any business interruption even if a slightly better and cheaper solution emerges.

The sustainable competitive edges, along with the recurring revenue model, helped SimCorp generate consistent growths in the top line with decent margins and superior returns on invested capital (see below).

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: Morningstar; data as of 9/9/2019.

As a matter of fact, the annual revenue never decreased YoY for a single year for the past decade (including the global financial crisis) at least, according to Morningstar below.

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: Morningstar; data as of 9/9/2019.

Long-term Prospect

As indicated below, only 15% global market share is being captured by SimCorp’s core system, SimCorp Dimension, at the moment, leaving significant room for future expansion.

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: 2018 annual report.

From a geographic perspective, North America (the lowest penetration rate) represents an important growth opportunity for the company, which has been acknowledged by the management. Plus, APAC, whose asset management industry is expected to increase by 9% annually through 2025, could be another long-term driver.

Essentially, SimCorp is a growth company fueled by innovation. To ensure that product offerings are always up-to-date and at the forefront of the industry’s needs, the management aims to invest around 20% of annual revenue back into R&D. In this regard, the company is recently increasing its investments in cloud-based solutions and standard platforms.

As indicated below, FCF closely followed earnings upward over the past decade, implying the decent quality of the business growth.

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: GuruFocus; data as of 9/9/2019.

The balance sheet is currently healthy, with plenty of cash (i.e., a current ratio of over 2x) and minimal debt (i.e., a D/E ratio of less than 0.25), which makes the growth strategy flexible.

With the ongoing trend of industry-wide technology upgrade and the best-of-breed products, SimCorp presents an appealing secular growth story here.

According to SimplyWallSt below, Wall Street analysts predict, on average, a low-teens CAGR in EPS for the next couple of years, which seems a bit underestimated to me from a long-term sustainable perspective.SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: SimplyWallSt; data as of 9/9/2019.

After all, the business has been growing its annual FCF per share by almost 20% since its IPO (see below).

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: GuruFocus; data as of 9/9/2019.

For the first half of 2019, SimCorp achieved a top-line YoY increase of 21% and an EBIT YoY increase of 57%, mainly driven by license revenue growth from new client agreements. Remembering that new clients lead to more follow-on sales thanks to the recurring revenue model, investors may see an even accelerating total-revenue growth going forward.

Valuation

The share of SimCorp is unarguably expensive, with a P/E of over 35x and a free cash flow yield of almost 2.5%. However, if the business can achieve a 20% CAGR, I think that the price may be fair.

Additionally, as described below, while being overvalued against the industry average (largely because of the high qualities mentioned above), the stock appears more reasonably priced compared to its own historical levels.

SimCorp: A Non-Cyclical Secular Growth Play In The Asset Management Space - SimCorp A/S (OTCMKTS:SICRF)

Source: GuruFocus; data as of 9/9/2019.

Of course, investors who demand greater margin of safety may want to wait patiently for a better entry point (e.g., a below 30x P/FCF).

Summary

SimCorp is a good candidate for investors interested in the asset management space. The business is non-cyclical thanks to the recurring sales model and has a decent long-term prospect with secular growth opportunities.

I have to admit that the valuation is a little bit high, but those long-term buy-and-hold investors with a high conviction in the growth story could establish a small position here and accumulate more shares over time.

As always, trading primarily-listed tickers (SIM on the Copenhagen Stock Exchange in this case) is strong recommended for better liquidity.

Disclosure: I am/we are long SIM ON COPENHAGEN STOCK EXCHANGE. 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.

Additional disclosure: Mentioning of any stock in the article does not constitute investment recommendations. Investors should always conduct careful analysis themselves and/or consult with their investment advisors before acting in the stock market.