Another dramatic week for Brexit: another deal, another delay. The news of the possible impending deal has had quite a dramatic impact on the exchange rate and UK stock market since the end of last week. From the perspective of my portfolio these two effects have cancelled each other out to some extent. However, my focus on businesses earning in Dollars means I’ve performed relatively worse than the rest of the market.
After a good first half, the last 3-4 months of stagnation and gradual decline is testing my patience a little. This relative underperformance seems to be affecting high quality growth shares as a whole rather than my portfolio in particular. Underlying trading for the vast majority of the shares on my watchlist still seems to be going well and a sizeable minority have share prices that are also still doing well. I believe this period of underperformance for high quality will not last long, so I’m minded to grin and bear it rather than make any changes to my strategy.
I’ve a couple of trades to update on. At the end of last month I sold out of Match for a 10% profit, replacing it with Ansys. This week I sold PayPal for a 13% loss and replaced it with Fabasoft.
Ansys is US-listed business worth about £14bn and a world leader in engineering simulation software. This software is critical for designing, manufacturing and developing all sorts of complex products ranging from semiconductors and electrical components to large machines and physical infrastructure. Ansys software enables its customers to innovate more easily and bring products to market more quickly. Most of Ansys revenues are recurring, coming from renewing licenses to lease its software or from maintenance and support.
Ansys is undoubtedly a very high quality business and markets itself as such in its investor communications, conveniently directly hitting the points in my quality assessment framework below: ‘Ansys is a market leader in engineering simulation with long term secular growth prospects, incredible financial strength and strong cash generation’. My rudimentary inspection suggests these claims are well-founded.
- Business economics: like many software businesses, Ansys has a capital light business model with low capital expenditures and generating lots of cash. It is highly profitable with very stable operating margins of almost 40%. A significant proportion of Ansys’s operating costs are spent on R&D. Returns on capital are decent and consistently in the high teens.
- Track record: from a brief look at the long term share price chart you can see that Ansys has a sparkling track record. The shares have ‘hundred-bagged’ over the last 20 years. This is matched by the financial results, which have shown remarkably consistent growth in revenues and profits. Ansys was relatively unscathed by the financial crisis. The shares did take a hit but bounced back quickly and the result is a small blip looking at the long term chart now.
- Competitive advantage: it seems likely that switching costs for Ansys’s software are high as they become a key part of the design and development process for Ansys customers. Ansys also benefits from close long term customer relationships and a strong reputation, likely to be of high value given the complex nature of the work being undertaken by its customers. Both of these points are supported by the consistently large proportion of recurring revenues Ansys makes. Over the longer term Ansys’s competitive advantage comes from the IP it has developed and the knowledge and experience retained by its staff. It invests heavily in R&D to ensure its products continue to be cutting edge, including the acquisition of smaller businesses with complementary technologies that it can add to its platform. It is clear that it is a market leader and I’m fairly confident that in the kind of markets Ansys operates in, the edge this confers is likely to be considerable.
- Growth prospects: Ansys claims to be well-positioned to benefit from long term secular growth trends. As computing power increases and technology improves, product design and delivery is becoming significantly more complex and harder, increasing demand for engineering simulation.
Recent trading performance has been excellent and Ansys is one of a rare few shares on my watchlist, whose prices have continued to punch new highs. The valuation is not obviously cheap but I think for a business of this quality it seems reasonable.
Fabasoft is an Austrian enterprise IT business, worth about £200m, focused on document, process and records management. Most of its business is in Europe, though recently it has been expanding in the US through its Mindbreeze subsidiary.
Fabasoft’s business is in helping smaller public and private organisations ‘digitise’. Its main product, Mindbreeze Inspire, can analyse unstructured data from multiple sources to extract relevant information and classify it using AI and natural language processing techniques. It sounds not too dissimilar to a search engine but designed for a different use case. Fabasoft has a few other complementary products, such as records management tools.
In common with many other similar businesses, Fabasoft is moving from a perpetual license to a SaaS model with recurring revenues.
- Business economics: Fabasoft has a capital-light business model and generates lots of cash. Its profitability has been increasing as the business has grown over the past few years. Both operating margins and returns on capital are now above 20%, which seems very decent.
- Track record: Fabasoft’s track record is decent. It has been rapidly growing profits and revenues since a little after the financial crash with a couple of minor blips along the way. The share price has followed suit. Prior to that there were several years of stagnation in the wake of the dot.com crash, in common with many IT-related businesses.
- Competitive advantage: as I have often said, I find the markets for enterprise software attractive as switching costs tend to be high and customers tend to be sticky, allowing businesses to generate high proportions of recurring revenues. Fabasoft appears to be no exception to this and is shifting towards a SaaS model along with everyone else. This is a relatively small business that competes globally in a very innovative market with some much bigger players, so the competitive advantages are less clear. However, from digging around in online customer and employee reviews, I’m satisfied that Fabasoft (and Mindbreeze in particular) looks to be a leading product in a smaller niche. I note that Mindbreeze is one of the leaders in the Gartner magic quadrant for Insight Engines. This seems encouraging.
- Growth prospects: this is clearly a market experiencing secular growth. Demand for organisations to digitise their records is likely to grow for years to come. In the nearer term, there appears to be quite exciting growth potential as Mindbreeze seems to be gaining traction in the US.
Momentum is excellent, with the share price near highs and Fabasoft releasing strong quarterly results at the end of August. The valuation seems reasonable given the growth prospects.