ASOZF - Formula Systems Likely To See A Deceleration But Is Still Cheap

Summary

• Formula Systems is a holding company comprised of income from Israeli and US tech and IT businesses, Sapiens International, Magic Software, and Matrix.
• There are substantial non-controlling interests because they have technical control without dominating ownership, so to keep it simple, you have to watch the very bottom line and PE for valuation.
• Taking out some capital gains made by the company, earnings growth was strong in Q3.
• Strength was in non-US geographies, and these companies are more marginal and idiosyncratic, so we believe that while some deceleration may come, growth will remain good.
• From a valuation perspective, the PE is pretty low. It's an interesting company, but if you care about yield, buy the parent company Asseco Poland instead.

Formula Systems ( FORTY ) is a holding company, in turn held by Asseco Poland ( ASOZF ), also a holding company. FORTY is comprised of a few stocks in the IT and tech space in Israel and on the NASDAQ: Sapiens International ( SPNS ), Matrix which trades on the exchanges in Tel Aviv, and Magic Software ( MGIC ). Magic and SPNS are stocks we cover individually as well on SA.

FORTY's structure is such that they consolidate the company's results even though there are high levels of non-controlling ownership, more than 50%, due to control clauses. Therefore, NCIs are an important consideration when looking at this company. We will focus on the very bottom line, and considering the tech business profile, the valuation looks low. Still, Asseco Poland as a vehicle is more exciting with better yield.

Discussing Q3

MGIC and Matrix both have pretty substantial business with the public sector. Matrix is broader in terms of IT, doing cybersec stuff and all sorts of DevOps including with the Israeli border forces as well as other arms of the Israeli government. Magic is more focused on the cloud opportunity, and is one of those typical cloud transition , engineering and integration companies that depend on corporates moving away from on-premises to working on the cloud. Magic continues to grow really well, and their weird receivables situation seems to be stabilising, where we saw lots of receivables bloat suddenly a few periods ago .

Sapiens is an insure-tech company that works primarily with reinsurance and Tier 2 insurance companies across the world. They are upping the sizes of their contracts and are showing success in coming up into higher tier companies where economics of selling enterprise solutions improve. Relative to the US, the results were pressured by strengthening of the US dollar, because foreign business is substantial and was actually more successful than US based businesses, although slower sales velocity was observed across the board. Growth flattened out for SPNS in the Q3, but the secular picture is quite good once the red-shift in sales reverses or gets lapped.

There are other enterprise tech solutions, including some HR and staffing solution within FORTY, and the comprehensive FORTY results align with the ~75% deconsolidated revenue exposure that FORTY has to the controlled interests in MGIC, SPNS and Matrix and a ~100% deconsolidated net income exposure. Excluding a one-off gain from a sale of Matrix shares, the income is up about 25% YoY on a Q3 basis , and the run-rate PE is around 15x.

Looking Forward

Growth will come down in 2023. While two of three of the large properties are growing mostly organically, the less profitable parts aren't growing much organically and aren't building scale. SPNS, which accounts for around ~33% of the deconsolidated net income, has also decelerated as of the Q3, and deceleration is likely to get more obvious in Q4 of 2022 which comes soon. While 2021 is a hard comp, and 2022 will be a little easier to beat, conditions in macro are not improving much in 2023 yet from what they were for most of 2022.

While tech investors, especially enterprise tech investors, need to understand that growth is coming down, the FORTY multiple is low, and its exposures are solid. A 15x TTM run-rate PE is not bad at all, and certainly doesn't imply over the top growth. Moreover, there are resilient parts within FORTY, including relevant cybersec exposures and government contracts. The profile is better than most US mid-market enterprise tech, and the multiple is certainly better.

However, we still lean towards Asseco Poland as the vehicle to play these same assets in. Asseco Poland has their Polish tech consulting business which is likely to keep growing well, since it has consistently bucked trends including those so far emerging in 2022, likely to grow even better than FORTY. Still it trades slightly discounted to FORTY. The only thing is that the Polish consulting business takes over a bit in terms of the Asseco valuation compared to FORTY. On a deconsolidated basis, only about 15% of income comes from FORTY. Still, Asseco has the same exposures just with a more Balkan/Baltic skew, and it pays a dividend above 4% in Polish Zloty. We'd rather take some yield too.

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