Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
Agilysys (NASDAQ: AGYS ) , a provider of software-enabled solutions to the hospitality industry, may be off the radar for many investors due to its small size and ongoing business transformation. However, this creates an asymmetric investment opportunity since the company's strong balance sheet provides downside protection while multiple growth catalysts provide significant upside potential.
Competitive advantages in growing market + large untapped markets = Strong growth prospects
There are two primary drivers that should provide strong growth for the foreseeable future.
First, a loyal base of customers including Mandarin Oriental, Yale, and Royal Caribbean (NYSE: RCL ) helps to raise the seemingly low barriers to entry in the software industry. Moreover, long-term customer relationships provide referrals; these are the most effective and lowest cost form of advertising.
The company's leading market position is further strengthened by new service offerings such as mobile apps and software-as-a-service solutions. This provides reduced staff training time, simpler and faster deployment, and a lower total cost of ownership. This also provides the opportunity for new market penetration, as well as cross-selling to the two-thirds of customers who only purchase one product.
The hospitality industry continues to post strong growth since the recession, as evident by the fact that travelers booked a record 1.09 billion U.S. room nights in 2012 according to Smith Travel Research. This underlying growth, along with the multiple value-added benefits of the service offerings, should create sustainable demand. This is because Agilysys helps its customers to increase revenue, reduce costs, and improve guest relations. Moreover, the demand for these services may actually increase during a recession given that the competition for every guest dollar becomes even more intense.
Second, the loyal customer base provides a platform to expand into fast-growing international markets. These markets only account for 10% of the company's revenue, but they rose almost three times as fast as overall revenue in the quarter ended in September . For example, existing customer Mandarin Hotel Group purchased the company's flagship point-of-sale solution for its latest property in Taiwan.
Strong balance sheet and growing high margin, recurring revenue stream
Although investors may be tempted to view Agilysys as a balance sheet play given the $100 million in cash and no debt that it reported, it is the overlooked income and cash flow part of the financials that deserve the most attention.
The highly diverse and loyal customer base of more than 3,100 customers provides relatively high revenue visibility. Moreover, recurring revenue continues to grow; this revenue is driven by the company's greater than 95% renewal rate and now accounts for 50% of total revenue.
The increased focus on subscription and maintenance services should drive additional recurring revenue growth and margin expansion as well. The company's gross margin for products is 59.2%, while the gross margin for support, maintenance, and subscription services is 80.1%. Furthermore, the overall gross margin rose 350 basis points to 65.5%. This "asset light" business model with lower working capital requirements deserves a higher multiple.
A history of "growing by shrinking"
Agilysys continues to maximize shareholder value by expanding into faster-growing and more profitable markets while exiting slower and less profitable ones.
Agilysys is now a pure play on the hospitality industry after selling its retail solutions group in July 2013 for nearly $34.6 million and its technology solutions group in August 2011 for $64 million. Restructurings following these divestitures continue to provide tangible results in the form of a lower cost structure, as evident by the more than 150 basis point decline in total operating expenses as a percentage of revenue.
These recent deals follow a strategic transformation in 2003 in which the company changed its name and shifted away from the low-margin, slower-growth electronic components distribution business and toward the higher-margin, faster-growth software and service markets via a series of acquisitions.
Significant tax assets ignored by investors
Agilysys has a round $169 million of net operating loss carryforwards (NOLs) that can be used to reduce future taxes. These NOLs were used to fully offset the gain from the recent sale of the retail solutions group. Investors appear to view the virtually full valuation allowance against this tax asset as a permanent situation, however.
This tax asset is actually worth more than implied by the market, given that the 2031 expiration provides more than sufficient time for the previously mentioned growth initiatives to produce bottom line results. An encouraging sign is the recent transition to profitability as adjusted income from continuing operations rose to $0.8 million from a loss of $0.4 million.
There are only two pure-play software companies serving the hospitality industry that are publicly traded. As shown in the chart below, Agilysys is more attractive than both from a holistic standpoint.
Agilysys might appear overvalued compared to Par Technology (NYSE: PAR ) , but the latter has a significantly lower gross margin and net cash position. Although the gross margin for MICROS Systems (NASDAQ: MCRS ) is higher compared to Par Technology, the multiple is also higher.
Moreover, Agilysys deserves a higher multiple given the above-market growth cited by management during the most recent conference call.
It's also worth noting that insiders own 27.3% of the company's stock while four institutional holders own a collective 50.3%. This provides a stable shareholder base and a low float.
Agilysys would be negatively affected by the following:
- Lower economic growth, especially considering that the hospitality industry is highly dependent on discretionary spending.
- A failure to update existing service offerings or introduce new ones as the software industry is subject to rapid technological change.
- Increasing competition, especially from in-house software solutions.
Agilysys' small market cap and ongoing business transformation may discourage investors searching for larger companies with more "stability." If this happens, those investors would miss an opportunity to buy a market leader in a growing industry with limited downside and significant upside.
More compelling ideas from The Motley Fool
It's no secret that investors tend to be impatient with the market, but the best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report, "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.