Technology One: Making it look easy

Author name:: By Nick Harris
Job title:: Senior Analyst
Date posted:: 23 November 2022, 8:00 AM
Sectors Covered:: Telecommunications, Technology

Technology One (ASX:TNE) delivered an FY22 result that was slightly better than expected. PBT was up 15% YoY (in line with expectations) while NPAT & EPS were +22% (above expectation due to a lower effective tax rate post the Scentia acquisition).
We view this as another high quality result from TNE with rapid SaaS/ARR growth which, assuming trends remain, positions TNE to hit $500m ARR twelve months ahead of their stated FY26 target.
Our Target Price increases 17% to (login to view) following this result. We rate this result, management and the outlook all very positively. However, following an 18% share price run in the last 6 months we move to a Hold recommendation. Buy any dips.

Event: FY22 result delivered an in-line PBT result and an EPS beat

Revenue +18% YoY to $369m, SaaS ARR +44% YoY to $217m, Total ARR (SaaS + Annual License ARR) grew 25% YoY to $320.7m.

CPI escalators (embedded in TNE’s contracts) accounted for roughly 2-3% YoY revenue growth. However currency (NZD/GBP vs AUD) broadly neutralised the uplift, making TNE’s 18% YoY revenue growth even more impressive.

Operating costs (ex D&A) grew at a slower rate than revenue and the EBITDA margin continued to expand. PBT was up 15% YoY while a lower tax rate delivered 22% YoY EPS and DPS growth.

R&D (capitalised and expensed) was up 20% YoY to 25% of revenue. TNE continues to invest heavily in its long-term offerings to sustain its growth runway.

Conversion of FCF (after interest and tax) to NPAT was ~80% which was slightly below our expectations. However given the NPAT beat, TNE ended the year with 2% higher net cash than our forecast. TNE ended the year with $175.9m of cash.

Analysis: Nailed the transition and likely to beat its FY26 ARR target

Management reiterated their target for $500m ARR in FY26. TNE’s SaaS revenue growth run-rate makes this looks conservative and likely achieved in FY25. However the current run-rate is assisted by SaaS flips (boosting revenue growth) and this will slow once all the on-premise customers have migrated to SaaS.

D&A was up 62% YoY to $38m and continues its march towards aligning with capitalised R&D ($50m in FY22). These items should align in FY24 and symbolise the end of the upfront/capex to SaaS transition for TNE. SaaS and continuing business was 96% of total revenue in FY22, showing this has already occurred.

Customer churn broadly halved YoY to 0.58% per annum (99% customer retention). TNE highlighted Net Revenue Retention (NRR) of 116% in FY22 (vs 112% in FY21). This was record NRR despite TNE decommissioning on-premise.

In our view, revenue growth (including contractual CPI escalators) combined with lower churn and higher NRR shows the strength of TNE’s value proposition. It offers great value which makes for happy and sticky customers. This in turn builds a strong competitive position and over time large barriers to entry for TNE.

Forecast and valuation update

We upgrade our EPS forecasts in FY23/24 by ~10%. We roll forward our valuation and refresh our peer compco.

Collectively this lifts our TP to (login to view).

Investment view

Following a strong share price run, TNE now trades within 10% of our TP and we move to a Hold.

TNE is one of the highest quality stocks on the ASX and we continue to rate the outlook. We would see any weakness as a buying opportunity.

Price catalysts

Progress towards $500m ARR in FY26; continued success with UK expansion; and inflation/interest rates normalising causing a technology sector re-rating.

Risks

Investor sentiment. Rising interest rates have resulted in investors reassessing/ de-rating how they value growth and technology stocks and this could continue . However, in our view, we are nearing the bottom of this WACC de-rating cycle.

Operational transition. TNE is >90% of the way through its transition to a SaaS business and management have done an amazing job of this transition. However, it’s not 100% complete and this business transition retains an operational risk.

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