Senior Fund Manager Colin McQueen of Sanlam FOUR Investments UK Limited says Express Scripts Holding Company’s (ESRX) free cash flow runs historically in a linear fashion.
“Every year, through good times and bad, the free cash flow per share has grown. It has small variations over time, but the overall position is driven by the high return on equity that they have, and by the resilience of the business model, low cyclicality and relatively low reinvestment requirements,” McQueen says.
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McQueen first got involved with the company in 2013, when Express Scripts experienced some hiccups from a merger with Medco and sentiment became negative. McQueen, on the other hand, saw a company in an oligopolistic industry with a lot of free cash generation that was trading at a discount to intrinsic value.
“It has performed pretty well since then,” McQueen says. “We still have 7% free cash flow yield on Express Scripts. So again, for a company with a tremendous track record, to hit our target, it only needs to grow a little bit slower than inflation, and we think it’s more than capable of doing that.”
Doug Mewhirter, Equity Analyst at SunTrust Robinson Humphrey, says that some companies are not going to come out ahead as a result of the sale of GE Capital’s sponsor finance business. In the near term, he says Ares Capital Corporation (ARCC) is likely to be one of those companies.
“Ares Capital has a very successful joint venture with GE Capital that has been a great source of very profitable loans that Ares has shared with GE Capital over the many years,” Mewhirter says. “It has been highly successful, and it is one of the things that many people have tried to copy, and no one has been really able to duplicate it with the success that Ares had.”
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Mewhirter says that joint venture is probably going to end. As a result, Ares is going to need to find a new partner.
“I am very confident they will find a new partner because they are a great company, and a lot of institutional investors will want to work with Ares, but there will probably be a little bit of period of uncertainly until they get all that sorted out,” he says.
Stephens Inc. Analyst Brett Huff says he is observing a trend of bank tech and payment processing companies getting additional products and geographies via acquisition. As an example, he says Fidelity National Information Services (FIS) recently purchased Clear2Pay, a private company based in the U.K.
“We think they bought the company to get a payment hub technology,” Huff says. “This is a product technology in which banks will over time consolidate many silo-ed payments functions into a few, or maybe even one, payment system. This new consolidated system, or payments hub, can be configured to handle different payment types.”
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Huff says the consolidation of the back-office payments infrastructure reduces the cost for banks to serve these payments. And, he says the FIS/Clear2Pay deal also demonstrates the move by bank tech and payment processing companies to expand geographically.
“While FIS is the most internationally diversified bank tech company we cover, they continue to want to bolster their international operations,” he says. “With Clear2Pay they got addition to their European geography.”
Stephens Inc. Analyst Brett Huff says Total System Services, Inc. (TSS) is his best idea at the moment. One of the reasons he is positive on the stock is the company’s recent contract with Bank of America (BAC), in which Bank of America switched from using an in-house system to issue credit cards to an outsourced system provided by TSS.
“This is one of the largest outsourcing deals for credit cards that we’ve seen,” Huff says. “That has really driven some incremental growth that we think investors should pay attention to that will last here for the next three or four quarters.”
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Huff says he also likes TSS because of its capital allocation strategy.
“There’s been a more aggressive shift to being more shareholder friendly in terms of capital allocation, and that really means that TSS management has committed to buying back more stock and buying back stock at a level that we think really utilizes their excellent free cash flow,” Huff says.
Bhavan Suri, Partner and Co-Group Head of the technology, media and communications sector at William Blair & Company, says the rising incidence of cybercrime creates an opportunity for Splunk Inc (SPLK). He says about one-third of Splunk’s revenue is related to security use cases.
“And they’re certainly growing nicely, at roughly 50% for their security offering, and so they’re benefiting from some of these concerns,” Suri says.
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At first glance, Suri says Splunk’s stock may seem expensive. It is trading at the high 30s on a free cash flow basis, he says.
“But they’re growing free cash flow close to 80%,” he says. “And so if you were to look at that relative to its growth rate, it’s trading at a ratio of less than one. We view it as an attractive valuation because that cash flow growth is sustainable for a few years at least.”
William Blair & Company Analyst Bhavan Suri recently started recommending Tableau Software Inc (DATA). He says he has high conviction that the company is headed for solid growth.
“So Tableau is a leading technology in the analytics visualization space,” Suri says. “They’re the clear leader by far in that space and the fastest growing, despite being the largest in the visualization and data discovery market.”
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Suri says Tableau’s investment in R&D is more significant than its competitors. And, he says their solutions address the use cases that traditional business intelligence does not. He says traditional business intelligence requires multimillion-dollar implementation with consultants and takes six to 12 months to get up and running.
“With Tableau, you can point to existing data warehouse infrastructure. You can be up and running in hours, and the costs are materially lower, and more importantly it’s adjustable to every user,” he says. “So you could download it, I could download it, in fact my admin assistant can look at my expenses and analyze spend in Tableau. And that’s something that would have traditionally done in Excel and would have taken a lot of time and manipulation, and this is done in a matter of minutes.”
Bhavan Suri, Analyst at William Blair & Company, says he thinks there is significant opportunity for Veeva Systems Inc’s (VEEV) Vault product. He says the product generates about $60 million in revenue and is growing at about 100%, with just 4% penetration. As such, he says the company’s overall growth rate of 30% is sustainable.
“We just did a proprietary survey of 110 pharmaceutical companies; 4% of those use Veeva’s Vault, the Vault product specifically,” Suri says. “So we’re talking about low penetration; further, 52% of those companies surveyed plan on moving to a cloud-based solution for that functionality in the next 12 months. And the only cloud-based solution in that market is Veeva Vault, and so that’s a positive trend we feel for that product.”
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In addition, Suri says that at 29%, Veeva has one of the highest operating margins in the cloud business. At current market cap of $3.5 billion and growing at 30%, Suri says Veeva could be a $1 billion company in four years.
“If you’d applied a 40% free cash flow conversion, it would yield about $400 million in free cash flow; at a 20 multiple would mean around an $8 billion market cap,” he says. “So we like it.”
Peter Kalan, CEO of CSG Systems International, Inc. (CSGS), says the company recently rolled out Ascendon, an extension to its solutions that draws on the roots of its existing products.
“It integrates them together so that our clients can incrementally change how they engage with their customers, which is everything from changing the way that they package services to the way they think about their end customers and then to how do they sell those services to them,” Kalan says. “We can modularly sell these services to them, whether it’s on top of our own platforms or on top of other existing billing platforms that a client may use.”
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Kalan says Ascendon is in the early stages of coming to market and is being marketed worldwide. The new solution will help CSG Systems’ clients go through the evolution they need to and respond to some of the new incremental services they may want to market to their customers.
“However, at the same time, it also puts us in the position longer term to enable a transformation for clients who aren’t using us for the core billing services,” he says.
Solar Winds Inc (SWI) CEO Kevin Thompson says the company’s recurring revenue as a percentage of total is growing. In most quarters over the last two years, recurring revenue has grown at the same rate or faster than license revenue.
“Now, we’ve added the subscription revenue stream, so it has been grow[ing] very quickly — well over 100% year-over-year growth for the last six or seven quarters,” Thompson says. “And the growth rate of that subscription revenue stream will continue to be very fast, so you should expect that recurring revenue as a percentage of a total will continue to grow.”
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At the same time, Thompson says the company has accelerated the growth of license revenue over the last eight quarters.
“Because we’ve always built a model more focused on lifetime value of a customer rather than an upfront value of a customer, we expect recurring revenue will continue to grow as a percentage of total revenue over the next couple of years.”
Randy Binner, Analyst with FBR Capital Markets, says one of the secular trends he’s observing is that losses for property & casualty insurance companies have been very low.
“That’s something that we continue to look at when we look at reserves,” Binner says. “We think a lot of the property/casualty names have really good reserves.”
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Binner recently upgraded Travelers Companies Inc (TRV).
“We think a lot of the business they wrote in 2011, 2012 and 2013, when the economy was getting better, will end up more profitable than people thought,” Binner says. “Loss trends remain very benign outside of catastrophes. Typical claims are at a very low level in the U.S. for a few years now. We think there will be a lot of reserve benefits there.”
