2023-04-26 22:45:00 ET
Summary
- In 2022 Tyler Technologies was down 40% while the S&P 500 was down 18.2%.
- We think TYL currently sits at a valuation favorable to above average returns going forward.
- While the change to a cloud-first, software-as-a-service (SAAS) business model has been a headwind for Tyler, it will lead to more predictable revenue growth and higher free cash flows in the long run.
- Assuming the multiple the market puts on Tyler’s revenue or adjusted profits remains the same, this would potentially produce annualized returns for shareholders in the range of 11% to 15%.
The following segment was excerpted from this fund letter.
ANDVARI HOLDINGS: TYLER TECHNOLOGIES ( TYL )
One of Andvari’s worst performers in 2022 was Tyler Technologies. Tyler was down 40% while the S&P 500 was down 18.2%. We think Tyler currently sits at a valuation favorable to above average returns going forward. Furthermore, Tyler’s recent proxy statement 1 supports Andvari’s view.
The proxy tells shareholders the board is incentivizing management to increase margins by several percentage points by the end of 2025. For context, Tyler’s margins used to be several percentage points higher than today. This is because the company sold more of its software via on-prem licenses as opposed to selling a subscription to use the software hosted “in the cloud” in an off-prem 2 data center. Tyler historically let the customer decide how they wanted to purchase Tyler’s software. Since 2020, Tyler’s agnosticism has changed. Tyler now is a “cloud first” software company and has a partnership with Amazon Web Services (“AWS” is Amazon’s on-demand cloud computing platform). The company has been actively encouraging customers to choose the cloud version of their software products and to have it hosted on AWS.
While the change to a cloud-first, software-as-a-service ((SAAS)) business model has been a headwind for Tyler, it will lead to more predictable revenue growth and higher free cash flows in the long run. In the short term, Tyler has had lower revenue growth and profitability due to selling fewer on-prem software licenses and more subscription agreements. This stems from the fact that Tyler can recognize more revenues and profits up-front with the sale of an on-prem license. A subscription agreement means Tyler recognizes revenues ratably over the life of a contract.
During this transition period, Tyler has also been paying for duplicate costs and one-time expenses. They are optimizing software for the cloud and supporting multiple versions of the same software. However, as Tyler's transition progresses, these costs will decline and the boost to long-term profitability will be significant. Tyler’s management has stated 2023 will be an inflection point for the company. They estimate the adjusted operating margins 3 of Tyler will begin to increase in 2024 at a rate of ½% to a full 1% per year. Based on Tyler’s proxy statement, Andvari thinks management might be sandbagging with these estimates.
For 2023, the Compensation Committee of Tyler’s board of directors approved grants of long-term, performance-based stock units (PSUs) to the CEO. The total target value of awards is divided into two equal parts, with 50% of PSUs granted subject to 3-year cumulative recurring revenue growth performance and the other 50% subject to operating margin performance. If Tyler’s CEO achieves maximum targets of two financial metrics, he stands to earn upwards of $6.5 million worth of Tyler shares. The following tables set forth the criteria that must be met for 2023 PSUs to be earned and eligible for vesting.
For 2022, recurring revenues were $1.47 billion (out of a total of $1.85 billion). Tyler’s adjusted operating margins for 2022 were 23.6% versus 28.0% in 2017. For the CEO to earn 100% of PSUs, the cumulative recurring revenue growth would need to be at least 36.9% and operating margins would need to reach 24.5%. Given that most boards give executives achievable goals, Andvari believes Tyler’s CEO will likely earn 100% or more of the PSUs. This in turn will mean excellent financial performance that hopefully translates into good returns for shareholders.
If we assume recurring revenue growth of 40% as the base case, by 2025 recurring revenues will have grown to $2.06 billion. We’ll also assume non-recurring revenues grew at a slower pace, a cumulative 30%, to $494 million. This would bring total revenues to $2.55 billion. Then, multiplying the revenues by a 25% adjusted operating margin (they had these margins in 2021), this gets us $638 million in adjusted operating profits for 2025 versus $437 million for 2022. Assuming the multiple the market puts on Tyler’s revenue or adjusted profits remains the same, this would potentially produce annualized returns for shareholders in the range of 11% to 15%.
DISCLOSURES AND END NOTES* Andvari performance represents actual trading performance of all, actual clients beginning on 4/12/13. Performance from 12/31/12 to 4/12/13 is actual performance of proprietary accounts, namely the accounts of Andvari’s principal, Douglas Ott. Andvari believes including Ott’s performance figures for the first 4 months and 12 days of 2013 is fair as he managed those accounts similarly to Andvari’s first clients. All performance, including the initial proprietary period, are net of management fees— assumed to be 1.25% per annum, paid quarterly, as currently advertised —net of brokerage commissions and expenses, time-weighted, and includes all cash and other securities. Performance includes realized and unrealized returns and excludes the effects of taxes on incurred gains or losses. Andvari does not certify the accuracy of these numbers. Performance data quoted represents past performance and does not guarantee future results. The index ETFs are listed as benchmarks and are total return figures and assumes dividends are reinvested. The S&P 500 ETF ( SPY ) is an exchange traded fund based on the S&P 500 index, which is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. The Russell 2000 ETF is an exchange traded fund based on the Russell 2000 Index, which is an index of 2,000 U.S. small-cap stocks. It is not possible to invest directly in an index. Because Andvari client portfolios are non-diversified, the performance of each holding will have a greater impact on results and may make them more volatile than a more diversified index. Andvari also engages or may engage in strategies not employed by the S&P 500 or the Russell 2000 including, without limitation, the use of leverage. One may request a list of all securities mentioned or recommended for the preceding year as of the date of this letter. You may contact Andvari using the information below. Actual client results may differ from results depicted in this letter. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the loss of principal. Investment strategies managed by Andvari Associates LLC may have a position in the securities or assets discussed in this article. Securities mentioned may not be representative of the Andvari's current or future investments. Andvari may re-evaluate its holdings in any mentioned securities and may buy, sell or cover certain positions without notice. The discussion of Andvari’s investments and investment strategy (including, but not limited to, current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) represents the views and opinions of Andvari’s portfolio managers and Andvari Associates LLC, the investment adviser, at the time of this report, and can change without notice. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of Andvari. The information contained in this document may include, or incorporate by reference, forward-looking statements, which would include any statements that are not statements of historical fact. Any or all of Andvari’s forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties, and other factors, most of which are beyond Andvari’s control. Investors should conduct independent due diligence, with assistance from professional financial, legal and tax experts, on all securities, companies, and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.
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For further details see:
Andvari Associates - Tyler Technologies: Ready To Run