Description

Based in Windsor, CT, SS&C Technologies Inc. (SSNC) provides software products & services in the financial services industry (~94% of sales) and in the healthcare industry (~6% of sales).  In the financial sector, SSNC provides software and services for fund administration services, portfolio accounting, portfolio management, trading, investment management, bank/lending, etc.  It owns and operates a wide and deep technology stack across securities accounting, front-to-back-office operations, and performance and risk analytics.  In the healthcare sector, SSNC provides software for pharmacy health management solutions and medical claim services. 

SSNC has acquired more than 60 companies in its history, and acquisitions have clearly played a significant role in the firm’s growth strategy.  SS&C’s playbook is to acquire profitable companies with highly recurring revenue streams and mission-critical products for their customers; then, after placing the acquired product portfolios in the SSNC technology stack and gaining increased economies of scale on both the revenue and cost side, sales and margins increase significantly for the acquired business.  SS&C’s revenue is reasonably diversified with its largest customer accounting for less than 5% of revenue.  SSNC generates 72% of sales in the United States, 12% in the United Kingdom, 6% in continental Europe, and 10% elsewhere in the world. 

There are a number of attributes that make SSNC a compelling investment:

• An attractive absolute and relative valuation.

• 96%+ customer retention levels and a high level of customer stickiness.  During the Financial Crisis, customer retention levels remained 90%+.

• Roughly 3-5% organic growth through the cycle based on new customer growth, automatic price escalators, and asset level increases.

• For many investment managers who are typically very well paid, price is not a big factor in the financial software they use; instead, they want the most efficient software that does the job every time.

• Founder, Chairman, & CEO Bill Stone, age 66, owns 13.3% of the Company, which hopefully will continue to lead the Company to maximize shareholder value and only issue shares for accretive acquisitions.

• Attractive asset-light business, reflected by its 8.5% 2022 FCF yield.  Including intangible amortizations as well, the 2022 FCF yield climbs to 12.5%.

• Typically, SSNC has done a stellar job in expanding margins on its acquisitions, speaking to the operational focus of management.

• The long-term market opportunity outside the United States remains quite immature for SSNC.

The Company

Founded by CEO Bill Stone out of his basement in 1986, SSNC first became public in 1996.  It was subsequently bought out by The Carlyle Group in 2005.  Somewhat rare in the private equity world, Carlyle did not take any cash out of SSNC while it owned it, excluding its annual management fee; essentially, Carlyle thought that capital was more valuable reinvested in the SSNC strategy than invested elsewhere.  When SSNC became public again in March 2010 at a split-adjusted price of $7.50, Carlyle did not sell any shares in the IPO and kept their 61% stake for several years afterwards.

Over the last 10 years, SSNC has compounded revenues at a heady 26% pace (~4% organic).  GAAP EPS has increased at a 16% CAGR, while adjusted EPS has grown at a 22% CAGR.  Even including the recent stock price downturn, the stock price has compounded at an 18% CAGR over that time period.

As a financial services software powerhouse with leading franchises in many categories, SSNC serves 9 of the top 10 prime brokers, 75 of the top 100 hedge funds, and all of the top 20 asset managers.  It is the largest fund administrator for alternative investment managers, including hedge funds and private equity funds.  It has the #1 data room with Intralinks, which provides a secure platform for bankers, lawyers, and corporations to share and collaborate on sensitive M&A documents.  It is the leading mutual fund transfer agent with close to 80% of U.S. mutual funds as clients.  SSNC is the third largest retirement services provider of U.S. retirement record keeping and outsourcing solutions.  The Advent business serves 56 of the top 100 registered investment advisors.  As for the healthcare business, it processed 463 million health claims in 2020 (5% market share). 

Since 1995, SSNC has been on an acquisition spree, buying over 60 businesses in total.  It has been able to cut redundant costs such as sales and marketing, administrative expenses, and R&D.  SSNC has also been able to increase the revenues of its acquirees by cross-selling and offering the products to a larger client base.  On average, SSNC has been able to increase the EBIT margin of its larger acquirees from a range of 15-30% to 40-55% in a time span of 2-3 years since acquisition.  From consolidating sales and marketing initiatives to eliminating unnecessary administrative tasks, SSNC is ultimately building one product portfolio and selling it several times with the same fixed cost structure.

Continued consolidation in the fund administration industry should continue, as legacy players seek to exit low-margin businesses, so investors should expect SSNC to continue to buy smaller players who cannot benefit from SSNC’s massive scale.  The space continues to be a competition for scale, and service providers like SSNC that can adapt to a multitude of strategies and needs should be well positioned for growth.  Asset managers are likely to continue to outsource middle and back-office operations in order to reduce overhead as well as keep up with the pace of innovation in financial technology.  Conversely, headwinds in the capital markets are likely to cause budgetary pressures, leading to longer sales cycles and diminished demand.  The investment advisor category has benefited from a secular trend of retail investors increasingly seeking professional management advice, while wirehouses are increasingly seeing their advisors and brokers breaking away to start their own shops and spend money on SSNC products.  Industry growth in end markets will come from adjacent markets, providing more services to existing users, increases in global AUM and trading volumes, as well as opportunities in financial technology created by increased regulations.

SSNC’s healthcare business calls on the target markets of commercial health plans and government programs, and they generate about $375 million in revenue from this segment across 200 customers.  The healthcare business was born inorganically as part of the 2018 DST acquisition.  DST’s healthcare business is the only SSNC business segment that is not in the financial services industry, so it is quite possible that they would either spin it off or sell it at some point in the future.  However, thus far, they have been consistent in demonstrating commitment to the healthcare category. 

Since SSNC became public in April 2010 and was private during the Great Financial Crisis, it is not possible to see how the stock price reacted during that period.  However, 2009 sales fell by 3.2%, while revenue retention remained at 90%.  GAAP gross margins were flat at 49%, and EBIT margins grew 200 bps to 38%.  Advent was not part of SSNC at that time, but Advent’s 2009 revenues grew 9.2% and its EBIT margin increased by 400 bps during the same time period.  As for DST, which was publicly traded at the time, 2009 revenues dropped by 4.8%.

During the 2020 coronavirus pandemic, SSNC revenue grew by 0.8% (down -0.8% currency neutral ex-acquisitions).  Adjusted EBIT margin increased by 20 bps to 36.3% (GAAP EBIT margin increased by 190 bps).  GAAP EPS increased by 42%, while adjusted EPS increased by 12.3%.  However, the stock price got decimated during 2020 but bounced back quickly.

International exposure is fairly limited relative to SSNC’s North American exposure.  Certainly, Europe and Asia are small and immature markets for SSNC.  However, they are the fastest growing markets for SSNC.  In the opinion of management, their competitive position is relatively strong in these markets relative to their peers.  There simply is a lot of white space to work with in these markets over time, particularly in the credit space.

Interestingly, despite the fact SSNC’s underlying business has held up, the stock price has been weaker than the S&P 500 or the Nasdaq Composite over the past two years, with most of the weakness in 2022.  There are several potential explanations to this weakness:

• Technology stocks have been hammered, and Fintech stocks have been decimated that much more. 

• SSNC has material leverage on its balance sheet, which exacerbates capital market movements. 

• With higher interest rates, future acquisitions will be harder for SSNC to use as a tool to bolster growth. 

• SSNC has massive exposure to the financial services sector, which is experiencing headwinds this year.  It is possible that the market believes that SSNC will face weakness as a result of this exposure.

• Currency neutral organic growth in 2022 has been a little weak (+2.7% YTD 2022 vs. +6.1% in YTD 2021).  One of the biggest issues impacting topline growth has been a loss of several healthcare customers; healthcare sales (6% of total sales) are down ~20% in Q3 2022 as a result.  Ex-healthcare, Q3 organic revenues were +3.3%.  Revenue growth has stalled, as asset growth from market share gains is being offset by negative market performance.

• With weaker topline growth and a 20% increase in overhead expenses, EBIT margins and EPS have experienced some pressure.  And full-year guidance for revenues remains in line but profit guidance has fallen. 

Balance Sheet & Cash Flows

With a net debt to adjusted EBITDA ratio of 3.3x, SSNC’s leverage appears to be reasonably well suited for its recurring revenue and high margin business model. For a large acquisition (such as Advent), SSNC has shown it is willing to go to 4-5x range, which has proved to be appropriate. After levering up to 4-5x for the GlobeOp, Advent, and DST acquisitions, the Company delevered rather quickly after each acquisition by 2.0-2.5x within a couple of years.  SSNC’s typical acquisition methodology is to pay 10-15x EBITDA for its acquisitions.  For example, DST is the largest acquisition ever completed by SSNC to the tune of $5.4 billion in cash and stock.  They paid 9.3x EV/EBITDA including synergies; without synergies, they paid 12.4x EV/EBITDA. 

SSNC instituted a dividend in 2014 but has not been aggressive with it; the current dividend yield stands at only 1.5%.  The Company targets a 1% dividend, so it is safe to assume that the stock price would have to rise in order to investors to see a material dividend increase in the near term.

Management has been opportunistic with share repurchases and is currently active; SSNC only repurchases shares at a reasonable valuation and when acquisition targets are expensive.  Absent acquisitions, SSNC plans to allocate, after the 1% dividend, 50% of free cash flow towards stock buybacks and 50% towards debt paydown.  SSNC did not repurchase shares in Q1 or Q2 2022 due to valuation sensitivity and due to temporary blackouts caused by acquisition discussions that did not pan out.  In Q3 2022, SSNC repurchased $215 million worth of stock at an average price of $57.62, roughly 8% above the current share price. 

Risks

• Competition.

• Execution.

• Regulatory.

• Balance sheet.

• Acquisitive activity allows the Company to possibly obfuscate core business weakness.

• Given SSNC’s size, attractive acquisitions at reasonable prices might be fewer and further between.

• Acquisition is unlikely, given the lucrative potential change of control payments made to Bill Stone.  But, there is a certain point when Stone will want to ride off into the sunset and retire.

• SSNC’s capital markets exposure is material, albeit is more likely second derivative risk as compared to their customer base.

Valuation

I used EV/EBITDA to value SSNC shares, largely due to the debt on the balance sheet and the significant amortization of intangible assets, which are mostly customer relationships and thus a non-cash cost.  Given SSNC’s strong focus on retaining customers and providing a holistic solution, these intangible assets possibly should increase (not decrease) in value as SSNC invests in more customer support initiatives.  The valuation calculation is set forth below.

With high barriers to entry, SSNC has a customer base that places immense trust in SSNC for their respective mission-critical processes.  Clearly, the intellectual property in investment systems and services creates a very sticky client base.  The business model is fairly defensive, with 96% of revenues contractually recurring.  Revenues only dropped by 3% in 2009, highlighting that fundamentals are resilient in a recession.  With Founder, Chairman and CEO Bill Stone running the business, minority investors get a tremendous owner-operator with whom interests are highly aligned.  The stock market has provided us an opportunity to buy a high-quality franchise at a significantly discounted price. 

Catalyst

• Value will out