2023-12-16 07:23:55 ET
Summary
- Manhattan Associates delivered its tenth consecutive record-breaking revenue quarter with EPS increasing by 68% YoY.
- The company is enjoying a strong competitive position with a 75% competitive win rate and invests aggressively in R&D.
- While I acknowledge its high-quality business model with negative working capital despite the fast growth rates, the valuation is demanding.
- I assign it a hold rating with a fair price of $198 per share, anticipating a decrease in price unless the company widely surpasses expectations in both revenues and margins.
Manhattan Associates, Inc. ( MANH ) provides mission-critical solutions for a wide range of clients and has been aggressively investing in product development over the last years while transitioning its business to a financially superior subscription-based model.
As I will show in this article, the company is enjoying strong momentum delivering its tenth consecutive record-breaking revenue quarter, but the current valuation is also at its all-time high multiples and it is hard to justify even surpassing the upper limits of growth expectations.
Company Overview
Manhattan Associates, which I will refer to as MANH, is a technology company founded in 1990 specialized in solutions to optimize supply chains, inventory and operations in various vertical markets, including retail, consumer goods, food and grocery, logistics service providers, industrial and wholesale, electronics, life sciences and government.
Its technology unites information across the enterprise, converging front-end sales with back-end supply chain execution to improve the profitability of its customers.
The company has increased its headcount by 400 new team members during the year, reaching 4,450 employees in Q3. Revenues are generated from five sources:
Source: Author (Data from Manhattan Associates Financial Reports)
The company has been transitioning to a cloud based subscription model since the release of Manhattan Active Solutions in 2017. This transition not only enhances revenue predictability but also improves customer service by enabling the deployment of new features in customer environments without the necessity for scheduled maintenance.
In addition to its software operations, MANH enhances its revenue streams by collaborating with manufacturers, leveraging its direct customer relationships to get some extra sales through computer hardware, radio frequency terminals, chip readers, bar code printers, and scanners.
Financials
The majority of MANH's revenue growth over the last quarters has been generated by the cloud segment, which has been attracting many new clients (50% of new cloud bookings generated from net customers during Q3), and the services segment, consisting in assistance and implementation billed by hours or under fixed-fee contracts. The increase in services is strongly related with the increase in new customers.
Source: Author (Data from Manhattan Associates Financial Reports)
Revenues are mainly generated in the U.S. (78%) and the company has been consistently growing its R&D expenses (mainly conducted in the U.S. and India), which are not capitalized, causing a short-term reduction in income margins.
Source: Author (Data from Manhattan Associates Financial Reports)
R&D is the main way to reinvest in the business, since the company has an asset-light business model and capital expenditures are minimal. This capital allocation has been positioning MANH as a market leader in the supply chain software sector, has facilitated the development of new products, broadened the company's portfolio, and expanded its addressable market.
A notable advantage of running a subscription-based business model is the negative net working capital as the company grow its revenues, causing an increase in cash available.
MANH doesn't use debt, which makes the business resilient to economic downturns even if revenues decrease. While the company has ~$120M in accounts payable, accrued expenses and other short-term obligations, its cash, receivables, and other current assets balance is over $390M.
After investing in organic growth and R&D, the company returns the excess capital to shareholders through share buybacks, resulting in an average reduction of the share count by 2.2% over the past 10 years, which I believe is a top-notch capital allocation.
Management and compensation
MANH is led by Eddie Capel , who joined the company over 20 years ago and has been serving as President and CEO since 2013. Prior to joining MANH, he worked for Real Time Solutions, where he supported supply chain strategies for companies such as Walmart ( WMT ) or Amazon ( AMZN ). He has an extensive experience and has demonstrated his ability to grow the company, adapting successfully to a new technological environment.
The board is compromised of 8 members, with an average age serving of 13 years, which is significantly above the average company and I see as highly positive.
What I don't believe is that positive and has some margin to improve is the compensation structure.
The share ownership guidelines are relatively low, with the CEO mandated to own 4x their base salary in stocks, while other management roles are required to own 2x or 1x, depending on their position. All directors and executive officers combined own less than 1% of the company.
Moreover, they classified the service-based compensation as performance based, I don't see it that way, since they are granted just for staying in the company. Of course, it is highly valuable to have the same person on the role for a long time and its performance should improve due to the cumulative knowledge acquired, but I'd prefer to have a higher percentage linked to company's performance.
To be fair, the annual cash bonus and the performance based compensation I believe have the right metrics, and are based on revenues, new accounts contract value, and adjusted operating income.
While I don't generally like adjusted metrics, after reviewing how the company adjust operating income to calculate variable compensation, I believe the adjustments are fair, since they exclude amortization of intangible assets, equity-based compensation expenses, restructuring charges, and asset impairment charges and related recoveries. There are no amortizations for intangible assets and impairment charges in MANH's financials.
Q3 Earnings Review
In Q3 2023 , MANH's management announced an exceptional performance with all-time records in revenues, increased by 20% YoY, and earnings per share ((EPS)), which increased by 68% (43% excluding tax benefits).
Source: Author (Data from Manhattan Associates Financial Reports)
This quarter marked the company's tenth consecutive record-breaking revenue quarter, showing the strong momentum and the fruits of a long-term view and the R&D investments.
The main drivers for this impressive performance have been the cloud segment, achieving a 44% YoY growth, and the service segment, which increased by 24%.
One of the most positive aspects is the number of new clients. Although MANH has the ability to upsell due to its wide portfolio of products, 50% of new Cloud revenues are generated from new customers, mainly in retail, manufacturing and wholesale (80% of the bookings in the quarter).
To sustain this growth rates, after bringing 150 new employees in Q2, the company hired approximately another 70 team members in Q3.
While specific numbers are not disclosed, the quarter saw the fastest pace of point-of-sale activations, with numerous stores implementing MANH's technology ahead of the Christmas sales season.
In terms of margins, the company demonstrated significant improvement, with operating margins climbing from 18.5% a year ago to the current 22.4%, which I expect to continue improving over the next quarters as revenues grow.
Finally, management raised again its guidance for the full year from the prior revenues expectations of $890M (already increased from $860 in last quarter) to $914M.
The remaining performance obligations (RPO), which are contracted services yet to be delivered to customers and not yet recognized as revenue by the company, are projected to exceed $1.4B at the end of the year and $1.7B in 2024, representing a 25% growth. The 98% of the RPO are cloud native subscriptions with a non-cancelable term greater than one year.
Overall, I believe these are spectacular results that have widely exceeded the consensus estimates , driving the stock price up by over 20% since they were released.
Investing For Growth
MANH has been increasing its R&D expenses over the last years, which has led to a strong competitive position and a 75% competitive win rate during the last quarter.
Source: Author (Data from Manhattan Associates Financial Reports)
While it is true that the company will have to continue investing in improving its products to gain new clients and offer good value to existing ones, once a client is acquired, the switching cost is significant due to the implementation process and associated expenses.
The recent announced that Norway's largest grocery retailer has chosen Manhattan Active Warehouse Management solution for its 1,800 stores and 13 warehouses, I believe highlighters MANH's success.
When comparing the reviews between Manhattan Active Solutions and Oracle's ( ORCL ) Fusion Cloud SCM, one of its main competitors, the outcome matches with its strong competitive win rate announced during last quarters.
Google ( GOOG ) ( GOOGL ) recognized MANH as a Google Cloud Partner of the Year, and the two companies are working close to bring Generative AI solutions to MANH's products.
On the omnichannel segment, MANH just released a new capability called Fulfillment Insights that compares its customer performance against anonymized data from its peers and competitors.
Looking forward, the company plans to continue investing aggressively in R&D and organic growth, strengthening its competitive position and expanding its addressable market. As the company becomes bigger, its competitive position will continue to improve and the ability to invest a smaller percentage of revenues into R&D should improve operating margins without compromising its leadership position.
Valuation
The strong revenue growth over the last years coupled with the transition to a subscription-based business model has brought MANH's valuation to all-time high multiples, surpassing the valuation multiples achieved during the .com bubble in the early 2000s:
While MANH has an outstanding business model that supports a mission-critical aspect of many companies' operations with an increasingly addressable market, the main question is if the valuation is justified, which would require sustained high revenue growth over an extended period with increasing operating margins.
Expectations
For the next year, management is expecting to increase revenues by 10% to $1B, with a 31% YoY growth in the cloud segment, and a slight decrease in operating margins caused by the license and maintenance revenue attrition to the cloud. For RPO, expectations are between $1.7B to $1.8B.
Given management's track record of conservative guidance and the strong momentum of the company, I expect a higher growth rate for the next year and a slight decrease to low-mid double-digit revenue growth for the following years.
Once the transition to the cloud platform is completed and R&D expenses as a percentage of revenues decrease margins will continue increasing over the years.
Assuming a 2.2% annual reduction in shares outstanding, which is in line with historical capital allocation, and a 5% long-term growth rate assigning MANH a significant premium due to the mission-critical nature of the solutions provided and a significant pricing power once sufficient scale is reached, my average fair price is $198 per share , suggesting the stock is overvalued by 10%.
While I believe the revenue growth assumed in my estimates is fair, the company would require a higher margin expansion to justify the current stock price.
Risks
From a financial standpoint, I don't see any major risk even with a decrease in growth rates. From a client concentration perspective, the five largest clients in aggregate account for 11% of total revenue, so the company is well diversified.
The two primary risks I'd state for MANH are those related with product development and competition, and a potential reduction in globalization that could diminish the demand for supply chain management solutions.
Product development
The main risk for MANH would be a lack of innovation since the market for its products is evolving constantly and it is mandatory for the company to continue developing its solutions to remain competitive.
As has been stated during the article, the company is investing aggressively in R&D, and there is no sign that its competitive position will deteriorate on the short term, but this is the main aspect to monitor in future years.
Globalization trends
Despite MANH's diverse range of solutions beyond supply chain management, this segment constitutes an important portion of its revenues, exposing the company to international trade trends.
In the last decade, globalization indicators have shown a swift in international trade trends. An increase in tariffs or a "trade war" would have a significant impact on the demand for MANH's solutions.
Conclusions
The company has successfully transitioned its business to a cloud-based subscription model over the last years and the R&D investments are yielding remarkable results with records in revenues and the tenth consecutive record-breaking revenue quarter.
Undoubtedly, it owns a superior product, which can be stated from the increase in new customers, an impressive 75% competitive win rate, and favorable customer reviews in comparison to its peers.
While I acknowledge MANH as a high-quality business and value its financial strength, superior product, experienced management, and good capital allocation, I find the current valuation to be excessively high.
Although it might be true that I am not viewing the full potential of the company over the long term, at current prices I consider the stock to be overvalued. Consequently, I assign it a hold rating with a fair price estimate of $198 per share, anticipating a decrease in price unless the company widely surpasses expectations in both revenues and margins.
For further details see:
Manhattan Associates: Investing For Future Growth