Why this COVID-hit sector is still attractively priced

I don’t know about you, but my COVID prediction record was woeful. Home furnishings boom? Nope. Motorbike retailer has best year ever? Nope. Funeral homes have their worst year ever? Definitely didn’t see that coming.

Everything is easy to rationalise after the event. But the way different sectors were impacted by COVID surprised me. A lot.

One of those is the enterprise software sector. These companies sell software to other companies. Think accounting, customer relationship management and project planning software. Unlike software sold to individuals or small businesses, where the user simply buys the product and starts using it, most enterprise software is heavily integrated into a company’s operations and customised for each client.

Forager has owned a few of these businesses over the years, including Hansen (HSN) and GBST. There are a handful in the current portfolio too, such as RPMGlobal (RUL), Fineos (FCL) and Gentrack (GTK). Once ingrained in a customer’s operations, they are almost impossible to remove, making for sticky revenues and attractive long-term investments.

It wasn’t any surprise, then, that they were viewed as something of a safe haven in the early months of the COVID panic. In a world where some companies weren’t generating any revenue at all, recurring reliable revenues from large corporates looked relatively attractive.

Yet look at the table below. On the ASX at least, many of these companies are today trading well below their pre-COVID prices.

It turns out that this prediction wasn’t right either. Apparently, some of the revenue isn’t as recurring or reliable as investors had come to believe.

Most enterprise software companies earn significant amounts of upfront implementation revenue. That depends on winning new clients. And some of the “recurring” revenue is related to clients requesting changes or introducing new features. With employees working from home and much bigger problems to deal with, most corporates have moved IT system upgrades down their lists of priorities.

The impact was widespread. The recovery at utilities and airports software provider Gentrack (GTK) took a big step backwards. Bravura’s (BVS) UK wealth management clients have hit pause on new deployments. Sales of Integrated Research’s (IRI) performance monitoring solutions have been slow.

The problems are real, but the share price reactions look overdone. The timing of a recovery is uncertain. But the deals will return, and investor optimism will likely come back alongside them.

Both Forager Funds have had their best ever years of outperformance over the past 12 months. That’s been a result of capitalising on widespread over-reactions and being willing to change our minds as the evidence came to hand. In the enterprise software sector, we’re doing both.

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