Lectra ticks many boxes that define a good business:
- A high proportion of recurring revenue from sticky customers;
- A product offering that faciliates customers’ business processes;
- A negative working capital requirement leading to attractive return on invested capital;
- A strong cash conversion from accrued income and constant free cash flow generation;
- A technological edge in an oligopolistic industry that is growing;
- A long term leadership team that allocates resources efficiently and owns a large stake in the company.
I invested in Lectra three and a half years ago. Operating performance over this period was excellent as you can see from the table below:
To put these numbers into context, revenues and profits were stagnating from 2010 to 2013. Therefore, management created the “2013 to 2016 Strategic Roadmap” which included investments of EUR 50 m (fully expensed in the income statement) in technology, workforce and relationship to customers. Since then operating performance has continously improved. However, to be fair not all props can be given to management. Lectra also benefited significantly from the weak euro during the three year period. That’s because many customers are located outside the euro zone. At the same time Lectra’s cost base is mostly denominated in euro. Moreover, competition mostly uses US Dollar as functional currency.
With the recent 2016 financial results press release, management announced a new strategic road map for 2017 to 2019. Overall, I believe this will be a continuation of the last three year plan with a focus on sustaining technological leadership. Apart from that, two messages are worth mentioning from my perspective.
First, management plans to transform most of the revenues from new software licenses into recurring subscriptions by establishing a SaaS business model. Lectra is not a pure software company and therefore possibly a little late to this transformation process which many software companies have already completed to a large extent. As with other software companies, this transformation might get bumpy as revenue from software sales might decline with profit levels also being lower at the beginning of the transformation.
Secondly, management emphasizes potential acquisitions helping to achieve growth targets until 2019. That makes me somehow worried. I do not know what they are looking for exactly, but I think it will be difficult to find a target company of similar quality and at the same time an adequate price. From my outside perspective, the company is well positioned in its industry and should focus on organic growth.
From a financial view point, there are no worries at all. The company has no debt outstanding, EUR 75 m in net cash and generated EUR 24 m of free cash flow to equity holders in 2016.
While back in 2013 Lectra’s shares were modestly valued, investors have to pay a market premium right now to participate in the qualitative and quantitative strengths of this business. At a 20 times cash earnings ratio (adjusted for net cash on the balance sheet), this might be an adequate price in the current environment where valuations in general are elevated. The company’s valuation is also reflecting optimistic growth targets (provided by management) with revenue expected to increase by 6% to 12% per annum until 2019 while slightly increasing profit margins. If Lectra reaches these targets, the share price will have a total return potential over the next 3 years of 15% to 30% (without multiple expansion and assuming that net cash will be used for acquisitions). However, this implies that everything will work out according to plan. From my perspective that is all but certain.
Therefore, I sell my shares starting from today with a limit price of EUR 19.5 per share. The investment generated a total return of roughly 215% and an IRR of 43% over a 40 month holding period.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!