I feel the most interesting investment ideas are also the ones which are the most simple. And this is an extremely simple investment idea
The company has two software’s which are its bread and butter.
- FinnAxia typically deals with big banks and institutions. It’s handling more than $15 trillion worth of transactions a year in 20 countries as of now.
- FinnNeo is a product which offers an end-to-end solution for lending businesses
Well-run SaaS businesses when they achieve scale, they become a sustainable cash guzzling machine. I believe that is the case for Nucleus as well:
- High exit barriers for the customer
From my scuttlebutt in talking to different banks and financial institutions, this software has a huge moat in terms of exit barriers as it’s not easy for most financial institutions to opt out of a software that has been deeply integrated in their internal processes. The extent to which this is present is such that some customers feel they would benefit from newer upgrades but are not ready for migration, causing delays and rather stick with the older versions.
The management in concalls claim that customers are very cautious about the solutions that they are choosing and their selection cycles have moved from typical 6 months to a year, sometimes 2 years and so on. Sometimes, even Boards get involved, which is something management did not experience in the past which shows that customers know the exit barriers to a banking solution quite well. Data about customer churn, attrition and new product/feature development-related information is not shared by management. Voluntary churn by customers is less than 5%.
- Pricing Power
Due to the high exit barrier and stickiness of the existing customer base, there is some limited pricing power they can exercise. Nucleus releases a new module/update every year increasing value of product. Being in fixed price contracts, the price escalations take time while wage inflation impacts EBITDA margins. They have some pricing power that they can pass on to the customers in terms of advancements and newer solutions they provide. The contracts are usually 3-7 years long, with repricing followed at the end of the life. The contracts are long term in nature and have a high repeatability rate at the end of tenure. With newer models and upgrades, repricing is available.
I feel the stock is depressed due to a few reasons.
- There is a lack of clarity of growth
The company’s revenues haven’t grown linearly and neither can the market see any fundamental growth from here on with great clarity. The management is very secretive on concalls about potential clients they are trying to acquire. But that is the nature of sales in this business where secrecy is paramount.
- Margins do fluctuate once a while as it did in FY22 primarily due to higher employee costs(usually)
Due to the nature of the business, the revenue growth is bumpy. Management has been spending more on marketing and will continue with marketing spend and hiring. However, since revenue is bumpy, the margin is also going to be bumpy. Margins in FY22 got depressed due to wage hikes, marketing spend and investment on technological functions while it was not compensated with growth in revenue.
- Lack of clarity of cash utilization
There is around 895 Cr of cash equivalents sitting on the Balance sheet has made investors anxious over its optimal utilization
- General market downtrend
The recent correction in markets particularly the smaller capitalization companies has depressed its valuation
Growth in such a company is usually uncertain and lumpy. It is directly proportional to the excellence of their sales and marketing teams. It takes time to get a client onboard and it’s a long, painstaking process. But once customer is acquired, there is a huge exit barrier for the client. This makes their present business extremely consistent and on the flip side, getting new clients to switch over to be extremely hard.
Management claims that they are getting a lot of queries from different players in different geographies including a big player who wants to transform their legacy system. It does not have any presence in the US but it does in a lot other emerging markets which gives them a huge opportunity of growth in coming years. Revenue mix is about 58% domestic and 42% international. They have a 700 Cr Order book executable over next 5 years. My bet here would be that management is able to crack the emerging markets and Indian market better over the next few years. Historically, their revenue growth has always been bumpy and I expect it to be the same in future as well.
The TAM as per management is $20 to $30 Bn since software cost for the lending business is between 0.5% to 1% of AUM but since they aren’t present in the US and some other developed markets, the real TAM for the company will be a lot less.
Conclusion
I feel the business is an interesting one due to customer stickiness, high exit barriers, some pricing power coupled with optimal potential for highly sustainable growth over the longer term.
On top of that they have a clean balance sheet with zero debt and 895 Cr of cash and cash equivalents. Promoter stake is high around 74%. They did a buyback of 150 Cr in 2021 at 700 per share and of 72 Cr in 2024 at a price of 1615 per share. The CMP is at a huge discount to the last buyback.
The market capitalization as of current date is around 2,000 Cr. If we take out cash balance of 900 Cr, the business is available for around 1100 Cr. And it earned 150 Cr last year. Even if we don’t account for any increase in OPM or revenue, the business is available at 7.5x PE and 1.3x PS
I find this company extremely peculiar. I understand why it’s cheap and there is a reality in which it might stay cheap or deliver sub-optimal returns for a long time. But it fits right into the kind of investment I usually look for. Something that has a great margin of safety and some potential of asymmetricity with a low current market sentiment(temporarily of course).
Please share any counter viewpoints please