TYL - Tyler Technologies Q3: AI And Public Safety Growth Set To Bolster Growth Outlook

2023-11-28 11:06:50 ET

Summary

• Tyler Technologies reported strong 3Q23 results with growing revenue, ARR, and organic revenue across all segments.
• The company's partnership with the Naperville Police Department demonstrates its momentum in the public safety solutions market.
• Tyler Technologies' recent acquisitions of companies with AI capabilities position them well to capture growth in the AI market.

Summary

Readers may find my previous coverage from September via this link . My previous rating was a buy as I believed Tyler Technologies' (TYL) growth would accelerate due to strong demand trends. I am reiterating my buy rating with the following factors. Firstly, with its robust and strong 3Q23 results, showing growing topline revenue, ARR, and organic revenue across all segments. Despite prominent revenue growth, it doesn't come at the cost of margin contraction, as evident by its stable EBITDA margin. Their partnership with the Naperville, Illinois Police department shows their continuing momentum in the public safety solutions market. Further gaining presence in the market that is beneficial to their product branding. Recent acquisitions of companies with AI capabilities enable them to integrate AI into their existing solutions. With the rapid growth of the AI market, these will unlock additional value for end-users and position them well to capture growth in the AI market.

Comments

On November 1, 2023, TYL released its 3Q23 . Revenues increased by 4.5% to ~$494 million year-over-year. Organically, revenues increased by 6.0%. Maintenance and subscriptions' recurring revenue was ~$412 million, which grew 11.0% year-over-year. Organically, recurring revenue grew by 9.8%. Revenues from subscriptions were ~$295 million, representing 16.1% year-over-year growth. Organically, subscription revenue grew by 14.7%. SaaS revenues within subscriptions grew by 26.0% to ~$138 million. Revenues from transactions grew by 8.5% to ~$156 million. Organically, transaction-based revenue grew by 6.0%. Annualized recurring revenue [ARR] grew 11.0% year-over-year to $1.65 billion. Reported adjusted EBITDA from $132.5 million grew by ~4% year-over-year. Overall, TYL reported robust and strong 3Q23 results, as evident by its revenue growth, with organic growth growing relatively strongly. On top of that, adjusted EBITDA margin remains stable, as 3Q23 reported ~26.8% while 3Q22 was also ~26.8%.

As management has observed, the demand has been consistent since 1H23 and the activity level of requests for proposals and demos is robust in comparison to pre-COVID levels. Furthermore, sales cycles are not excessively long, so agreements still go through the procurement process at a normal speed of 12-18 months. From this statement, it is evident that demand remains consistent and healthy, and this robust demand is expected to strategically position them for future growth.

Their recent win in partnering with Naperville, Illinois Police Department for Public Safety Data and Solutions is a noteworthy achievement. A complete package of solutions [Mobility, Record Management System and Computer Aided Dispatch] to help enhance the operational efficiency of the Police Department. With a population of around 150,000, Naperville is the fourth-largest city in the state. This partnership with Naperville PD will form the largest police department in Tyler's Illinois clientele base. The victory, especially against more upscale rivals such as Motorola and Mark43, proves that the expenditure efforts made in the Public Safety portfolio have paid off.

TYL spent about $72 million on three smaller acquisitions. With an acquisition costing $36 million, CSI was the biggest of the three deals. The company's AI system automates document processing. I anticipate that the technology will eventually find use across various business divisions, although the initial use case is within the Courts suite of products. The management team highlighted that the document processing technology can cut workforce expenses by half.

In addition to CSI, another $36 million was spent on the other two acquisitions, ARInspect and ResourceX. Priority-based budgeting, developed and licensed by ResourceX, is an AI tool that helps governments identify key areas to spend according to their stated priorities. This is in contrast to the more conventional approach of using human discretion to establish spending priorities within a line-item budget. The final objective will be the integration of this business into Tyler's ERP division.

The third and last acquisition is ARInspect, a company that uses AI to enhance field operations efficiency in the public sector. Public sector employees are able to work autonomously and manage all tasks in the field, from pre-arrival setup to reporting and follow-up, thanks to ARInspect's AI and machine learning platform. The capabilities of ARInspect extend beyond process automation and digitization to include some of the following such as historical data analysis, integrated census data, and etc.

I can see that TYL focused on companies with AI capabilities in all three of its acquisitions. In essence, TYL is trying to incorporate AI into its existing SAAS, and I believe this is a good business decision to drive TYL's long-term growth. The global AI market is anticipated to grow to $1.345 trillion by 2030 from its current $150 billion size.

Valuation and Forward-Looking Expectations

Valuation

TYL's direct peer is CentralSquare Technologies, but it is a private company. Therefore, I look for its next closest peers that are operating in the application software industry (like Guidewire Software at 7.4x forward revenue and Blackbaud at 4x forward revenue). TYL now trades at 9.16x forward revenue, and I believe it deserves to be higher as its EBITDA and net margin are much higher. Another reason is that when it comes to information technology stocks, which is the sector TYL operates in, the current investment community seems to put more emphasis on profitability than growth given the rising rates.

Forward-Looking Expectation

Based on my view of the business, I anticipate 5.4% growth in TYL's revenue for FY23, followed by 10% for both FY24 and FY25. For my current model, my revenue growth outlook is the same as for my previous model. My projection is also in line with management's FY23 revenue guidance, where they guided revenue to be within $1.94 to $1.96 billion, and my FY23 estimate uses the middle of the range. The driver for this revenue estimate stems from TYL's robust 3Q23 results, which show robust revenue growth and consistent margins.

Its partnership with Naperville PD effectively strengthens their market presence in integrated information management solutions and services for the public sector. By collaborating with them, it proves the effectiveness, reliability, and trustworthiness of their solutions with the public sector. Thus, this partnership can potentially attract other clients within the public sector to use TYL's solutions, which will drive its future revenue higher.

In my opinion, TYL's strategic acquisition of three AI companies really puts them in a prime position to capitalize on the rapidly growing global AI market. This move is not just about integrating AI into its existing solution; it is also about bolstering future revenue growth. By integrating AI into its current solution, TYL is unlocking value for its current clients, which will help with retention. In addition to the retention rate, it also makes their solutions more appealing to potential new clients. With the AI market expected to grow at a CAGR of 36.8% until 2030, these acquisitions are more than a mere marketing gimmick; they represent management's forward-thinking mindset and approach to capture market share and enhance future revenue growth.

Moving down the model, I have adjusted my forward revenue multiple from 8.4x to reflect its current multiple of 8.52x. Both net debt and shares outstanding have been updated to reflect the latest figures. Net debt has been updated to $657 million, and shares outstanding have been updated to 42.12 million shares. Overall, my implied share price has increased slightly from the previous ~$452 to the current ~$461, which represents an upside of 13%.

Risk & Conclusion

When comparing TYL to other companies in the information management solutions sector, TYL has been lowering its research and development spending.

In the market TYL operates in, it serves the public sector. For customers in this sector, their main priority is reliability and trustworthiness. Hence, they are not exactly looking for the most advanced or expensive solutions in the market. If a competitor were to come up with a more advance solutions with competitive pricing, TYL's R&D complacency might cost them their competitive edge.

In conclusion, TYL's 3Q23 results are very robust, as they show strong growth in its revenue on a year-over-year basis. In addition, all its revenue segments also reported robust growth. Strategically, I believe TYL's partnership with the Naperville Police Department will enhance its footprint in the public safety solutions market, as it shows trust and confidence in TYL's solutions. Furthermore, TYL's acquisition of three AI-focused companies underscores its commitment to integrating AI into its solutions to unlock more value for its end users. This acquisition also aligns well with the anticipated expansion of the global AI market, positioning TYL favorably for future growth. In addition, my anticipation of double-digit upside potential in 2025 further bolstered my recommendation of a buy rating for the company.

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