An Adventure in VMSaaS Valuation ft. QIS.V
For a value oriented investor, the VMS model is not necessarily intuitive. I evaluate the business and its prospects for returning to consistent growth, the most important key to unlocking value.
Disclosure: Nothing written here constitutes financial advice.
Quorum Information Technologies, Inc
What is the right EV/SaaS ARR multiple for a vertical market software company? If one is partial to the VMS narrative, in which the stickiness of an initially superior product offering - as a function of high switchover costs- engenders long term commitment from customers, then high upfront cash burn for sales, marketing and business development for customer acquisition can be justified. In this case, a superiorly self-evident mission-critical software ARR should trade at a significant multiple.
Stickiness narratives are problematic, however, as they rely on epistemically unsound future expectations of rapidly declining costs in order to unlock cash flows to the firm - all while sustaining or at least maintaining the product offering for long term customer retention. Even if we cannot know future stickiness with a high degree of certainty, high retention rates offer comfort.
A firm could offer all of the above and more:
A superior product at a lower price point
A monopolistic competition environment in which incumbents are either asleep at the wheel or exiting the market altogether
A high degree of product customization and interoperability across a variety of customer mission-critical processes
Extremely low churn as a function of high initial switchover costs for installation and customer training
And yet, without consistent growth, evidence for the veracity of all the above is and should be, easily questioned.
All of what I have just outlined fits the description of QIS.V, a VMS company disrupting the automotive dealership enterprise resource management ecosystem with a highly customizable tech stack of intuitive GUI solutions for ERM, CRM, sales, 2-way communication, servicing & repairs, financing, insurance and even e-commerce.
QIS.V product ranks so highly amongst its customer set that customers have organically acquired some 10% of outstanding shares. While I don’t have hard numbers on this, I believe it is safe to assume that QIS.V has a very high net promoter score.
What QIS.V is lacking at the moment, however, is consistent growth. The pandemic derailed the already arduous sales and marketing cycle, which relies heavily on physical appearances for demos, onsite installations and training.
In my view, the arrest of growth following a bumper 2019 is likely a fair cause for current devaluation, with QIS.V trading for a bottom quartile EV/SaaS ARR multiple of only 3.6 Fortunately, for those willing to put in the work, I think there is strong upside from here, contingent on a return to organic growth by end of fiscal 2021. At the same time, QIS.V has rarely traded below this multiple, leaving new investors with some downside protection.
QIS.V is well capitalized and cash flow positive, but as it is still in a growth stage, the firm continues to reinvest heavily into its core product ecosystem.
See this link for quantitative overview of the last few years along with some speculative projections: https://docs.google.com/spreadsheets/d/1gyyB5flF6J08jhLYMoUVWr-ZOISRsly1VYYg_wmtXbM/edit?usp=sharing
About QIS
QIS is a Canadian vertical market software company focused on the automotive retail industry, specifically for franchised OEM retailers. This is a pureplay OEM dealership VMS opportunity with potential for integration to all major OEM brands, including electric vehicles.
QIS offers a product Suite of 11 different software products, with Xsellerator as its core offering, a dealership enterprise resource planning product integrated with sales, marketing, 2-way customer communication and analytics. All QIS products are designed to stack easily on Xsellerator where Xsellerator churn is traditionally 3%.
Autovance (acquired 2017) is a digital retail to delivery platform, offering greenfield e-commerce solutions for dealerships.
Dealermine (acquired 2018) is a CRM product delivering higher quality service business development for dealerships in a world where servicing and repairs is increasingly the most profitable segment for dealerships today.
CEO Maury Marks is in-tune to the sector having grown up in a family owned dealership.
Note that QIS currently has at least one product in 28% of all Canadian dealerships, demonstrating impressive market penetration while leaving a large available market for growth.
In the US, QIS has products in only 1% of its estimated TAM.
The total North American franchised dealership market value for software is estimated to be $6.0 billion annually. Lots of room to move here.
Market Structure & Competition
There are 700 vendors in the auto software space across 25 different categories. Typical dealer is using software from all 25 categories. Dealerships handle a lot of processes, including regular sales cycles, service & repair with parts inventory, accounting, CRM, and integration to the OEM.
Two largest competitors are publicly traded CDK and privately held Reynolds & Reynolds. As far as I am aware, both these competitors continue to sell Unix or character-based products on greenscreen technology. In the US, these firms operate as a duopoly, in Canada QIS has been rapidly gaining market share.
A critical assumption to the success of this thesis is that CDK and Reynolds are falling into irrelevance either by failing to reinvest in their products and through customer alienation. Competing products don’t have the ability to integrate customer relations enhancements or integrated ERP reporting for all solutions. Even so, switching costs are high and the sales cycle for adding rooftops is long and arduous.
Compared against a dealership using CDK or Reynolds along with a suite of non-integrated third party products, QIS ERP ecosystem is about half the price.
Is QIS cheap?
Click here to see a quantitative overview of the business and some basic scenarios I have modeled. I have added notes to all egregious assumptions and I would encourage you to play around with TV multiples, MRRPU growth and the like.
I am definitely no authority on VMSaaS valuations so if you think I’ve made a mistake, I’d love to know the how and the why.
Using a “conventional SaaS valuation” function of (ARR x customer count x MRRPU x 15% Growth x Churn) QIS is currently undervalued by 25%. Not exactly a compelling mispricing, although note that this does not take into account the BDC business.
For a mission-critical vertical market software business, however, QIS appears very cheap at an EV/SaaS ARR multiple of 3.6
If you believe that QIS can capture customers in its VMS ecosystem for the next ten plus years, then today’s price offers a potential bargain.
Recent Growth History
2017-2018 saw significant inorganic growth through acquisitions, funded by shareholder dilutions and debt. This saw rooftop count double from 419 to 876 from 2017 to 2018.
Taking 2019 as a more representative period for post-acquisition ecosystem, organic growth, QIS added a n impressive 151 new rooftops! However, for a traditional software company, QIS has a very poor LTV/CAC ratio. For 2019, annual LTV was only $23,419 while CAC was $20,987 for a LTV/CAC ratio of 1.12
Unfortunately, QIS does not report monthly customer retention/churn on its own. Alas we can see how sticky the rooftop count is, particularly in 2020 and H1 2021 when the sales cycle elongated, allowing a conclusion that it is in fact very low. I use a 3% churn rate in my own analysis (see link posted above).
SaaS gross margins are typically high for a software business but still have room for improvement. SaaS has been consistently above the 65% range over the last two years except of Q2 2020 when QIS voluntarily offered pricing discounts to its customers as pandemic uncertainty set in, initially leading to layoffs and huge hits to dealership sales. This was a well-received show of goodwill and was relatively immaterial for QIS as pricing returned to normal the following quarter.
BDC is a call centre for the DealerMine product, centralizing and outsourcing dealership customer contact for services and repairs. Margins are low given the relative labour intensity of the call centre business.
Services largely consist of one time line items covering costs of installation. This should not be considered a core revenue vehicle, although growth should correlate with increased customer acquisition or cross-selling.
Valuation
The (unknown) stickiness of the customer base is the only justification for a higher multiple.. but the speculative nature of this unknown-known prevents QIS.V from trading higher on its own.
The nature of the recent dilutive acquisitions, even if we believe they are strongly accretive, make it difficult to project a baseline for future growth. A return to consistent, non-dilutive organic growth would signal confidence to the market, likely arising in a return to investor confidence and potentially higher EV/SaaS ARR multiple.
2019 appears as the critical inflection point, with strong organic growth and a significant cash raise to fuel a potential growth acceleration in 2020. Owing to the pandemic, this resulted in a missed opportunity, a lost inflection point as new customer acquisitions and onsite installations were made impossible.
Valuation occurs when narrative meets numbers: in this case, a return to consistent organic growth would warrant a multiple expansion. QIS.V has rarely traded below its current EV/ARR multiple of 3.6, leaving us with at least some downside protection.
Sales cycle saw a huge slowdown as pandemic made on-premises sales, tooling, learning and installations difficult. QIS has taken the new environment in stride, redeploying their stack to Azure and moving towards offering Virtual Desktop for remote installation capability.
Sales growth could return shortly. A successful sale requires full management buy-in and smoothing to the change. Sales cycles are typically 6-9 months on the ERP system.
Xsellerator is the key, as the other products stack quickly and easily on this system. Adding accretive MRRPU over time.
AutoVance and DealerMine have shorter sales cycles, both displacing competition but also some greenfield opportunity. Less ability to stack and lower MRRPU on their own.
AutoVance is e-commerce for dealerships. Relatively unproven but serious potential to change the vehicle sales experience for the better.
Example: Auto Canada, the largest dealer group in Canada, has all 50 of their stores on DealerMine using BDC services for all their stores. Addition of Xsellerator here alone would be impactful.
Bull Case Assumptions
SaaS margins maintain at 65% or better until cross selling or price increases in 2023 or early 2024 drive expansion above 70%
BDC margins improve towards a consistent 15% or better
A return to consistent 10-15% organic SaaS ARR growth
Altogether, I’m looking for $10-12 million in free cash flow on $40-50 in 2024 revenue. Today’s price offers a strong risk/reward proposition with limited downside.
Growth Levers
Cross-Selling: Increase MRRPU
Management believes cross selling DealerMine, AutoVance and other products to existing Xsellerator customers can drive average MRRPU to $3000 from current $2000. Straightforward opportunity for cross selling to current customers is the most significant current growth lever with huge ROI potential.
Overall, QIS can capture as much as $7000 in MRRPU for a customer using all its products.
Expand Dealer Rooftop Count
New OEM certifications for key brands. Market expansion requires integration with vehicle manufacturers, but 4 key manufactures are outstanding: Honda, Mazda, BMW and Mercedes. CEO is focused on integrating Honda and Mazda as these would expand the Canadian Xsellerator TAM from 49% to 80%.
US market penetration is only 1%, with less OEM integrations at this time. Still a large market with significant opportunity. Sales and marketing spend is targeted to particular US regions. Selling in USD gives a nice exchange lift on the CAD. Long term growth lever with an established bridgehead.
Acquisitions
QIS has a strong accretive acquisition history. They typically engage in strategic partnerships with other VMS providers, bringing the product into their ERP ecosystem, becoming a value-added reseller and offering first level support for a revenue split of 50/50. In four years, QIS has acquired 3 separate businesses: AutoVance (Desking), DealerMine (Sales CRM with BDC), Oasis (Competitor to Xsellerator).
Ownership Structure
Management and Directors own 31% of the float.
CEO estimates that QIS customers have acquired some 10% of the float. Acquired organically at market prices.
Institutional Ownership is above 50% of the float.
That leaves very little available, making this opportunity largely only available for personal accounts or small funds.
Typical daily trade volume is microscopic. One wonders how and when institutional actors would seek to exit this trade. Lack of significant volume also inhibits price discovery.
Risks
Poor acquisitions
Customer stickiness is less durable than thought
High CAC continues with languishing sales cycle
Talent and trouble finding seasoned management/sales team
Competition introduces new products/brings down prices
Too many products dilute vision and execution
Catalysts
Organic growth acceleration/Compounding over time
MRRPU growth
Reporting of backlog or booked orders
OEM certifications for Honda and Mazda Canada
Return to “consistent growth” in rooftop additions along with rising MRRPU from cross selling.