As venture investors, we take a particular interest in evaluating early-stage investment opportunities in software companies. Similarly, since it started, Upland Software’s (UPLD) main growth strategy has been to acquire technology ventures operating in niche markets that can provide a strategic value-add to its enterprise work management suite. Having done so consistently over the years, Upland Software has acquired the expertise and knowledge to stay on the edge of innovation and to grow its business with a lower risk of getting disrupted. Overall, that is why we think that Upland Software is an interesting opportunity.
It made its first acquisition in 2012 when it acquired PowerSteering, a project portfolio management software. Most recently in 2019, it acquired Kapost, an operations platform for sales and marketing, and an email marketing company, PostUp. Over nine years of its operating history, Upland Software has successfully acquired 22 companies, which we think is quite an achievement for a company with a market cap of just a little under $1 billion. Upland Software IPO’d in 2014, and its share price has roughly tripled since then.
Business fundamentals and strategy
In a nutshell, Upland Software wants to provide an enterprise work management suite. This includes anything from customer experience and document automation to knowledge management solution. Through its seven areas of focus, Upland Software has acquired over 1 million users with over 9,000 accounts.
Source: Upland Software Datasheet
What we found to be interesting in Upland Software’s overall business strategy is its M&A-oriented growth approach. Most of its acquisition targets are smaller software companies building niche solutions that could potentially complement its existing software applications. In that sense, Upland Software needs to be able to identify and source strategic M&A targets in a similar way a venture capital investor sources potential investment deals. As per its 10-K:
Acquire complementary software businesses. We intend to pursue acquisitions of complementary technologies, products, and businesses to expand our product families and customer base, and to provide access to new markets and increased benefits of scale.
We think that this approach enables Upland Software to grow with a small chance of getting disrupted, because product-wise, it can always maintain its differentiation through a series of niche acquisitions.
Source: stockrow. Upland’s key financial metrics
Financially, we see the evidence that Upland’s strategy to boost its growth through M&A has been working very well. Its trailing annual revenue growth has trended upwards and has stabilized in between the 45% to 51% range over the last few years. To us, this shows that Upland Software has been strengthening and optimizing its approach in sourcing for micro-cap M&A deals and post M&A integrations.
Since its IPO in 2014, its annual revenue has increased by more than twice as much. In FY 2018, Upland Software’s revenue was $149.9 million. Since the start of FY 2019, it has been on track to deliver $220 million in annual revenue, in which 92% of it is recurring. Bottom line-wise, Upland software has never been profitable, though its annual net loss margin is quite consistent and well managed. Its net loss margin has improved significantly from -33.5% at the lowest point in FY 2014, to -7.2% in FY 2018.
Source: Upland Software’s 10-Q
Based on our observation on its financials as of Q2 2019, we also saw how Upland Software was close enough to achieving operating profitability. With a gross profit margin of 69% in Q2 2019 and 70% in Q2 2018, Upland Software could turn profitable if it could reduce its operating expenses by as much as it spent for M&A-related expenses. Hypothetically, if it were not for M&A activities, its operating margin in Q2 2019 and Q2 2018 would have been somewhere between 6% to 7% instead of -10% and -2% consecutively. As a result, we get a sense that being unprofitable may be just a matter of choice for Upland Software at the moment.
Therefore, we are optimistic that Upland Software is heading towards the best-case scenario where it can achieve both profitabilities while maintaining its growth through M&A sometime in the future. Another key success factor here is the strength of its management team, which the company builds around its thesis of growing through M&As. The key roles in this initiative would be the CEO and CFO, who will both provide strategic M&A direction and access to capital. Upland Software is also one of the few companies that have a specific SPV role focusing on operations and M&A integrations alone. Its datasheet further emphasizes its management’s ability and experience in executing M&A deals:
Upland’s proven team offers a reliable and disciplined M&A process with a combined 42 successful acquisitions over the past 16 years. With access to a $400 million credit facility and the public equity markets, Upland has the buying power necessary to execute our acquisition plan and expand on the 22 successful acquisitions we’ve closed to date.
Risk and valuation
No matter how small it is, there is always a risk of failure in any M&A deal. Also, during the integration phase, M&A always incurs significant expense while carrying another risk in the form of potential conflict between the new and existing management afterward. In terms of expenses, last quarter alone, we learned that Upland Software spent as much as 17% of its $53 million in revenue.
Valuation-wise, Upland Software is trading at a significant discount to its peers when it comes to FWD P/E. Its FWD P/E as of 2019 is 14.71, while the sector median is 22.6. Its FWD PEG is also 58% lower than the sector median of 1.78. However, when we look at its other valuation metrics such as FWD P/S, we have learned that Upland Software trades at a 67% premium in comparison to its peers.
Overall, when we take into account Upland Software’s ability to achieve a 51% YoY revenue growth and its expectation to consistently grow its future revenue at 34% YoY going forward, we think that it is fairly valued. As we discussed above, Upland Software’s most attractive proposition has been its expertise to maintain its growth by successfully acquiring cash-generating technology ventures operating in a niche enterprise market. To us, that is something that does not come cheap.
Upland Software is one of the few enterprise technology companies with a unique growth strategy. Its vision is to build a family of enterprise work management software through a series of M&As of smaller-cap technology ventures. Over time, it has built an expertise in not only sourcing for the most strategic M&A deals but also in integrating the acquired companies to its core operation. Its financials and business fundamentals have both been solid. In the end, we also think that its M&A-focus growth strategy will allow Upland Software to maintain its solid outlook.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.