2023-05-17 17:54:42 ET
Summary
- TYL's transition from on-premise users to the cloud is progressing well.
- TYL benefits from a strong demand for its information management solutions, driven by the increasing complexity and volume of data handled by government organizations.
- While TYL's valuation has returned to historical average levels, the upside remains attractive if the company can accelerate its cloud migration.
Thesis
Tyler Technologies (TYL) provides end-to-end information management solutions and services for local governments in the United States. I am recommending a buy rating for TYL on the back on continuous success in cloud transition, strong underlying demand, and most importantly, a captive customer base. While valuation has rerated back to its historical average level, I believe the upside is still attractive if TYL can accelerate its cloud migration, thereby driving growth and margins.
1Q23 highlights
The $471.8 million in revenue and $1.66 in EPS reported by TYL for 1Q23 were in line with consensus expectations of $471.1 million and $1.69, respectively. The success of TYL's subscription adoption strategy, I believe, is reflected in the company's rising revenue. I think it's important to point out that the tough comps brought on by the pandemic is still having an impact on these figures. For FY23, management has also restated its previous projections, anticipating total revenues of $1.935-$1.97 billion, an increase of 5.5% at the midpoint.
Transition to cloud is progressing well
The main thesis for TYL now is the transitioning of its on-premise users to cloud, which has been ongoing for a while now. Despite being slower than the previous 80+, 1Q23 results showed that the transition is proceeding well, with TYL converting 73. This transition had a direct impact on TYL SAAS revenue, in which SAAS revenue witnessed a substantial 24% increase. Furthermore, the noteworthy aspect of this transition was that new SaaS deals comprised a significant portion, accounting for 87% of the total value of new software contracts during the quarter. Although there is a slowdown in number of customers migrated, I think it will only be a matter of time before all of these users move to the cloud, and management is positive that they can convert over 20,000 existing customers over the next 8-10 years. Assuming 20k and over 10 years, this implies around 167 customers a month, which is twice FY22 rate. I believe we will see an acceleration in migration, driven by 2 key drivers.
The first is that I anticipate government agencies to consider ways to increase productivity as a result of the current tight labor market. In fact, I think the pandemic has prompted the government to adopt technological measures to ensure that workers can provide virtual services to communities. These departments are now becoming more receptive to new technologies through this process (the government is notoriously slow to adopt cutting-edge innovations). So, I think they've finally come around to the idea that cloud solutions are worth it because they allow them to cut back on expensive in-house IT departments and increase opportunities for hybrid and remote workers. My second concern is cyber security, which I see as a major risk for any company or group that conducts its operations online today. Statistics show that the number of attacks has increased dramatically over the past few years. Especially for TYL customers - who are government offices - cybersecurity is paramount. The case for making the switch to the cloud has become much stronger in recent years. A move to the cloud can improve the security of government data, and TYL has made significant investments in the safety of its cloud offerings, including forming a strategic partnership with AWS in 2019 . Both of these, I believe, are already moving the needle, as management has noticed increased cloud momentum even in traditionally slow adopting industries.
Strong underlying demand
Aside from the demand for transition to cloud, I believe the underlying demand for TYL's products remains strong as well. Fundamentally, I think the large amount of data that governments are handling today simply cannot be handled via conventional methods (like excel) anymore. The efficiency of workers using excel to optimize their workflow has reached a maximum point. Furthermore, data are typically siloed and difficult to leverage for insight gathering in a typical government organization. The repercussions of this are far-reaching. To begin, exploiting this massive data set to derive insights is incredibly challenging and complex. Second, it's already difficult for these companies to hire and retain data scientists as they expand their digital capabilities, and this makes it even more difficult for them to work on something that no data scientist would want to work on because it's so much more complex (it's like bringing knives to a gunfight). I believe that TYL will be more successful in capturing new customers and encouraging existing ones to adopt more products and/or switch to the cloud if it maintains its current strategy of investing heavily in improving its products to increase workflow efficiencies and optimizing them for the cloud. These investments, in my opinion, will put TYL in a strong position to maintain steady growth over the coming years, in a market with plenty of room to advance at the expense of incumbents or homegrown offerings.
Conclusion
TYL's successful transition to the cloud is progressing well, as evidenced by the 24% increase in SAAS revenue and the significant contribution of new SaaS deals to the total value of software contracts. Although the pace of customer migration to the cloud has slowed, I believe it is only a matter of time before all users make the switch, and management is confident in converting over 20,000 existing customers over the next 8-10 years. Furthermore, TYL benefits from strong underlying demand for its information management solutions. The increasing complexity and volume of data handled by government organizations necessitate efficient and integrated solutions, which TYL provides. While valuation has rerated to historical average levels, the potential upside remains attractive if TYL can accelerate its cloud migration, driving both growth and margins.
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Tyler Technologies: Transition To Cloud Is Progressing Well