Summary
- Amdocs recently revised its FY23 outlook, raising reported revenue growth to 5.0%-9.0% and non-GAAP diluted EPS growth to 9.0%-13.0%, while reiterating FCF of ~$700 million.
- I believe the company is at an inflection point and is seeing accelerating revenue growth due to the increase in telco spend.
- The company's specialist business model and strategic acquisitions ensure it is well-positioned to continue delivering higher revenue growth relative to its historical average.
- However, the company appears to be fairly valued today based on my intrinsic and relative valuation analysis.
Editor's note: Seeking Alpha is proud to welcome Global Quality Growth as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »
Investment thesis
Amdocs ( DOX ) provides mission-critical OSS (operations support systems) and BSS (business support systems) software and services to telecommunications companies, which makes it a vital component of the global telecom infrastructure. It has gone under the radar of investors for many years now though, due to its low organic revenue growth profile. However, in my view, the company is at an inflection point now. As global telco companies undergo a multi-year investment cycle to upgrade their systems to be competitive in a 5G world, I believe Amdocs is well-positioned to benefit from this increased spend. To me, the upward revisions to FY23 guidance signals that the revenue growth acceleration in FY22 was not a one-off event. Amdocs has made numerous strategic acquisitions over the past few years to strengthen its cloud-native capabilities and stay ahead of the curve in terms of technology and innovation; and this is starting to bear fruit. The company's strong existing relationships with major telecom players, combined with its expertise in OSS/BSS functions. position it as the preferred vendor for telco companies. With 68% of revenue from North America, Amdocs is still relatively under-penetrated in other parts of the world.
Relative to many early-stage SaaS companies experiencing a multiple re-rating due to their inability to turn a profit, Amdocs has built a defensive and profitable software business in a niche industry. The company generates stable, recurring revenue from its long-term contracts with telecom clients, which provides a high degree of visibility and predictability into its future cash flows. Looking forward, I believe Amdocs is well-positioned to continue generating stable, profitable growth in the years to come. The company's recently revised FY23 outlook , which raised reported revenue growth to 5.0%-9.0% and non-GAAP diluted EPS growth to 9.0%-13.0%, highlights the strength of its business model and the positive momentum it is experiencing.
All that said, I believe Amdocs does appear to be fairly valued based on its current share price. In my view, investors that are attracted to the fundamentals of the company could take advantage of share price weakness over the next few months to incrementally build a position in Amdocs.
Introduction
Amdocs is a global specialist provider of software and services to communications and media companies. Its customers include some of the largest telecommunications companies globally including AT&T ( T ), Bell Canada ( BCE ), Singtel (SGD), Telefonica ( TEF ), Telstra (TLGPY), T-Mobile ( TMUS ), Verizon ( VZ ) and Vodafone ( VOD ), as well as cable and satellite providers Altice USA ( ATUS ), Charter ( CHTR ), Comcast ( CMCSA ), DISH ( DISH ), Rogers Communications ( RCI ), and Sky ( SKYAY ). The company is going through an inflection point in its business. The rollout of 5G networks has accelerated the demand for Amdocs' solutions as communications and media companies look to enhance their digital capabilities. Additionally, the ongoing shift towards digital services and cloud-based solutions is creating opportunities for Amdocs to help its customers modernize their operations and improve customer experiences.
Recap of recent results
Amdocs reported its Q1 2023 results on January 1, 2023. The quarter saw record revenue of $1.19 billion, representing a 9.5% year-over-year growth in constant currency, with North American revenue up 9.0%. The company's non-GAAP EPS of $1.45 was above guidance, and its non-GAAP operating margin of 17.7% were up 10 bps quarter-over-quarter and 20 bps year-over-year. Amdocs' consistent execution and efficiency improvement initiatives were reflected in the operating margin improvement. The quarter also saw a record 12-month backlog of $4.09 billion, up $120 million quarter-over-quarter and up approximately 7% year-over-year, demonstrating continued sales momentum.
Amdocs also revised its FY23 outlook, raising its reported revenue growth to 5.0%-9.0% from 4.0%-8.0%, while its revenue growth in constant currency remains at 6.0%-10.0%. Additionally, the company has increased its non-GAAP diluted EPS growth to 9.0%-13.0% from 8.0%-12.0%. Amdocs reiterated its free cash flow estimate at approximately $700 million, which equates to an attractive 6% free cash flow yield.
Source: FactSet
Prior to its revenue acceleration in 2021, the company's revenue growth had been moderate but consistent, with a 5-year CAGR of 2.1%. This reflected the company's stable but low organic growth profile. Amdocs is facing an inflection point now as indicated by the company's revised guidance, as telecommunication companies enter a multi-year investment cycle to upgrade their 5G networks.
Business Model
- Other revenue (40% of revenue). License sales form a part of Amdocs 'other revenue' stream. Due to the high levels of integration customers require, the licenses Amdocs sell is not "plug and play". It is labor intensive and requires specialist technical resources. Customizing and tweaking the software is a complex process, and Amdocs typically works with customers for several years. The telco industry globally is currently undergoing a multi-year investment cycle, with customers scrambling to upgrade their systems, which is not discretionary. Amdocs is taking advantage of this trend by putting its solutions to the cloud. However, only a small portion of the company's customer base (probably no more than 10%) is currently making the transition, and it's expected to take 5-10 years for this transition to complete. Despite this, Amdocs has 350 of the world's biggest customers, and the company understands their mission-critical environment very well.
- Managed Services (60% of revenue). Amdocs' managed services segment benefits from telco customers outsourcing their OSS/BSS functions, generating recurring revenue through ongoing maintenance and support. Amdocs stays with customers after project completion, providing upkeep for multi-year agreements that result in a monthly revenue stream. This creates a sticky revenue stream, with high switching costs for customers. The managed services segment is considered higher quality revenue due to its predictability. This segment has hit an inflection point and is accelerating, providing a significant growth opportunity for Amdocs.
Financial Metrics
Amdocs has consistently reported gross margins in the range of 31-35% over the past 5 years. The company has expanded its operating margins over the past 5 years, reflecting operating leverage and operational efficiency as it scales. Amdocs invests in research and development (R&D) not only for its product set but also for its own purposes, such as developing tools to automate processes, reduce costs and increase margins.
Amdocs has achieved double-digit ROIC, but this has fluctuated due to the company's acquisitive nature. These investments have largely paid off, as the company has doubled down on its cloud native capabilities through strategic acquisitions . Current CEO, Shuky Sheffer made the strategic decision to accelerate investments in cloud native products.
Overall, Amdocs' historical financials suggest a stable and predictable business model with consistent profitability and cash generation.
Source: FactSet
Valuation
For my Amdocs valuation, I'm forecasting that the company maintains an elevated growth rate relative to its historical average over the next few years on the back of increased spending by telcos to upgrade their 5G networks. I'm also assuming slight margin expansion over this timeframe, noting that Amdocs expanded its margins from ~12% in 2017 to 15% in 2022. Based on my intrinsic valuation, it appears Amdocs is fairly valued with ~5% downside from today's price.
P/E ratio is another valuation metric to consider for Amdocs given it is an established company with a track record of profitability and is operating in a stable industry with predictable earnings. Amdocs is trading at just above its long-term PE average, in part reflecting the company's higher revenue potential and tailwinds. It's reasonable for the company to trade at a higher premium relative to its historical average given its higher revenue profile over the next few years, but investors will be relying on multiple expansion for stock price appreciation as opposed to further improvement in fundamentals from this point.
Source: FactSet
Risks
High customer concentration is one risk to consider. Amdocs' top 10 customers account for ~70% of revenue in 2022 (AT&T and T-Mobile are 47%). This is partly a function of the telco industry structure that is highly consolidated amongst Tier 1 and 2 companies. Amdocs benefits from having sticky customers. The high switching costs and integration of Amdocs' solutions into its customers' technology stack create barriers for customers to switch to competitors. This gives Amdocs a stable revenue base and provides an opportunity for the company to upsell and cross-sell additional solutions to its existing customer base as we're seeing with its largest customers, AT&T and T Mobile. Additionally, the close integration of Amdocs' solutions into its customers' operations means that it becomes a critical partner in driving operational efficiency and innovation for its customers. This creates a positive feedback loop, with Amdocs becoming increasingly embedded in its customers' operations over time.
Conclusion
In conclusion, Amdocs is a global software and services provider with a strong position in the telecommunications industry, offering solutions that help businesses transform and modernize their operations. The company has a sticky customer base with high switching costs, a growing managed services segment, and significant opportunities to benefit from industry tailwinds. With the current inflection point in the telecom industry, Amdocs is well-positioned to capitalize on the increased spending by telcos to upgrade their 5G networks. The company has been investing in its cloud capabilities, which should further increase its competitiveness in the market. With a solid financial track record, stable margin profile, and a focus on returning value to shareholders through share buybacks and dividends, I am sure Amdocs could be an attractive long-term investment for investors looking for stability and profitability in the tech industry. However, based on today's share price, I believe the company appears to be fairly valued. Investors could take the opportunity to build a position on share price weakness. Overall, the company appears to be well-positioned for growth and profitability in the coming years.
For further details see:
Amdocs: Compelling Long-Term Opportunity But Fairly Valued