Company Overview: ELMO Software Limited (ASX: ELO) is engaged in providing cloud-based HR, payroll, expense management solutions, and operates on a Software as a Service (“SaaS”) business model based on recurrent subscription revenues. ELO has its offices in Australia, New Zealand, and the UK.

ELO Details

Robust SaaS-Based Solutions & Acquisition Synergies: ELO remains on track to broaden its all-in-one solution, thus, providing new modules to its latest and existing customers. These new modules are the source of additional revenue streams, which, in turn, increases its competitive position in the market.

It also aims to broaden its mid-market market penetration in Australia, the UK, and New Zealand, thus, strengthening its position as a leading cloud, Software-as-a-Service, HR, and payroll provider. 

• Acquisition Synergies: The acquisition of Breathe and Webexpenses aids the company to expand its market opportunity and propel its growth strategy. Breathe will be introduced into the Australian market in the 2HFY21, thus leveraging ELO’s infrastructure and expertise. The company also bought Vocam, BoxSuite and HROnboard. These acquisitions lay a strong foundation for long-term and sustainable growth for the company.
• Increase in Total Addressable Market (TAM): ELO’s TAM increased to $12.8 billion across Australia, New Zealand, and the United Kingdom in 1HFY21. Breathe’s scalable platforms increased ELO’s Total TAM by $2.2 billion.
• Mid-Market Expansion: ELO’s mid-market business continued to grow sharply by 95.7% year over year to 2,892 customers in 1HFY21. Mid-market annualised recurring revenue increased by 29.5% on pcp. The mid-market gross profit margin stood at 88.5% in 1HFY21, up from 84.6% recorded in 1HFY20.
• New Module Adoption: The launch of a new module, Predictive People Analytics, in May 2021, aided ELO’s customers to drive beneficial results around employee engagement, insights, and retention. New customers were increasingly purchasing 4.0 modules as of December 2020. 

The company continues its scale of operations, with an enhanced focus on research and development. The company’s ARR skyrocketed 42.8% on pcp and came in at $74.2 million in 1HFY21. Of this, more than 97% of the revenue was subscription-based. The below picture depicts ELO’s growth momentum in ARR since 1HFY18.

ARR Highlights (Source: Company Reports)

1HFY21 Key Findings:

• Higher Investments in R&D: ELO remains committed to investing in research and development with the total spend amounting to 46.5% of statutory revenue in 1HFY21 compared to 44.9% in 1HFY20.
• Rise in Cash Receipts: In 1HFY21, cash receipts stood at $34.4 million, up 25.5% on a year over year basis, aiding the company to achieve its goal and organic growth initiatives.
• Customer Retention: In 1HFY21, customer retention came in at 90%, depicting the strength of the company’s loyal customer base, which enhances its cross-sell potential.
• Top & Bottom-line Details: Statutory revenues increased by 29.3% year over year and came in at $30.6 million in 1HFY21. The company reported a net loss of $12.4 million in 1HFY21, up from a net loss of $8.5 million, owing to higher depreciation and amortisation, impairment loss on trade receivables, R&D and sales and marketing expenses.
• Robust Growth in Small Business Segment: With the acquisition of Breathe, ELO now has a new $2.2 billion opportunity from the small business market segment. As of 31 December 2020, Breathe grew its customer base to 7,146.

Balance Sheet & Liquidity Position: The company’s healthy balance sheet and skilled management team, along with its long-term nature of customer relationships, place the company for considerable long-term growth.

• Cash Rich Company: The company exited 1HFY21 with a cash balance amounting to $71.3 million. The company’s total debt at the end of the period stood at $26.1 million. 
• Rise in Cashflow from Operations: Operating cash inflow in 1HFY21 came in at ~$2.99 million, improving from cash outflow of $1.66 million reported in 1HFY20. 

 Key Metrics: In 1HFY21, the gross margin of the company stood at 85.4%, higher than the year-ago figure of 84.6%.  The EBITDA margins for 1HFY21 stood at -5%, as compared to -12.7% in 1HFY20. In 1HFY21, the company’s cash cycle days stood at 59.6 days compared to 1HFY20 cash cycle days of 71.3.

Profitability Profile & Liquidity; Analysis by Kalkine Group  

Top 10 Shareholders: The top 10 shareholders together form around 59.05% of the total shareholdings, while the top 4 constitutes the maximum holding. Jlab Investments (No. 2) Pty. Ltd. is the entity holding maximum shares in the company at 15.31%. Immersion Capital Master Fund Ltd. is the second-largest shareholder, with a holding of 14.98%, as also highlighted in the chart below: 

Top 10 Shareholders; Analysis by Kalkine Group

Risk Analysis:  

• Mounting Losses: ELO’s net loss is increasing on a year over year basis. Hence, these mounting losses may throw tough challenges at the company’s overall functioning and may dampen margins in the future.
• Integration Risk: ELO continues to acquire many companies, which add to integration risks.
• COVID-19 Led Uncertainties: The company is also exposed to risks associated with general global economic and market conditions, which may cause a delay in shipping products or the launch of new products.
• Stiff Competition: ELO operates in a highly competitive environment, subject to business consolidations, new strategic alliances, market pressures, and regulatory and legislative pressures.  
• Forex Headwinds: Any adverse movement in foreign exchange price may impact the company’s financial performance. 

What to Expect: The company remains on track to invest significantly in its technological capabilities, sales & marketing resources, and expansion of product suite to promote long-term, sustainable growth for the business. Also, higher adoption of cloud-based technology, increase in the number of customers, higher platform usage, and geographical expansion are expected to aid the company in near future.

• ELO expects a decent growth in ARR and revenue in FY21. ELO now expects its FY21 ARR to be in the range of $83 million and $85 million (previously $81.5 million and $88.5 million).
• For FY21, ELO now expects FY21 revenue to be between $68 million and $70 million (previously $65 million and $71 million).
• EBITDA loss is expected to be in the range of $2.5-$3.5 million, compared to the previous guidance of $2.4-$7.4 million.
• The company is set to report its FY21 results on 9 August 2021.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group 

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock Recommendation: Over the last three months, the stock went down by ~16.67%. The stock is currently trading below the average of its 52-week low and high of $4.2 and $7.44, respectively. We have valued the stock using an EV/Sales multiple based illustrative relative valuation method and arrived at a target price of an upside of low double-digit (in percentage terms). We believe that the company might trade at a slight premium to its peer average, considering decent liquidity position, high customer retention rates, focus on delivering organic growth, and encouraging outlook. We have taken peers like Nearmap Ltd (ASX: NEA), Bigtincan Holdings Ltd (ASX: BTH), and Adacel Technologies Ltd (ASX: ADA). Considering the above-mentioned factors, strong management focus toward growth, new module adoption, financial performance, synergies from strategic acquisitions, expansion into new geographies, and positive long-term outlook, we give a “Buy” recommendation on the stock at the current market price of $4.75, as on 30 July 2021.  

ELO Daily Technical Chart, Data Source: REFINITIV 

Note 1: The reference data in this report has been partly sourced from REFINITIV.  

Note 2: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above. 

Technical Indicators Defined:-

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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