In Q3 2022, Modelon saw increased activity from the defence industry, as evidenced by its collaboration with Saab on the Gripen fighter aircraft. The interest has continued, with Modelon recently signing an agreement with the European defence found on energy system technologies for fighter aircraft, valued at SEK11.2m over four years. Management anticipates increasing business opportunities from the defence sector in the coming years.

As Modelon adds functionality and expands its component libraries with each new customer project, its customers can benefit from previously created components and system models in future simulations, leading to increased workflow efficiency and reduced development costs. This creates stickiness and broadens Modelon’s product offering, attracting new customers and indicating further scalability potential for the business.

Modelon is currently prioritizing and working hard to reinforce the cloud scaling aspects of its platform. According to management, this effort will result in significant improvements to its software, with multiple releases planned for H1, including a major release in the summer of 2023. These upcoming releases will introduce substantial new capabilities that will enhance collaboration and sharing within and outside of organizations. We believe that these capabilities have the potential to not only increase customer acquisition rates but also provide up- and cross-selling opportunities. Additionally, customers will also be charged for large computations, which further expands the platform's scaling potential. Overall, Modelon's improved Impact is designed to attract more users to the platform and accelerate ARR growth.

Revenues

Modelon achieved Net revenues of SEK18.6m in the fourth quarter. While this was entirely in line with our estimates the reported revenue-mix deviated by 7 percentage points compared to our estimated figures. The deviation can be explained by the increase of non-recurring software revenues. Moreover, Impact was identified as the primary growth driver, showing an annual growth rate of 63%.  Additionally, total software revenues grew by 35%. This figure includes the multi-platform offerings predating Impact which is still employed by some of Modelon’s customers. The solution service, which aids clients in adopting, using, and scaling the use of Modelon’s software products, generated SEK5.5m in revenues in Q4 2022.

Modelon’s ARR has exhibited a consistent upward trend, with a y/y growth of 12% in 2022. Although this falls short of the company’s medium-term target of achieving a CAGR ARR of 35%, management expects growth to accelerate as Impact matures and gains functionality. In our recent interview with Modelon’s CEO, Magnus Gäfvert, He stated that the company is committed to creating an improved version of Impact that will provide significant new capabilities The updated version of Impact is scheduled to be launched in H1 2023. He also indicated that the updated version is set to accelerate ARR growth in line with the company’s land & expand strategy.  

Modelon has set ambitious financial targets for the short to medium term. One of the primary targets is to accelerate ARR growth to achieve positive operating cash flow before the end of 2026, which implies that a positive EBIT margin will follow shortly after. To achieve this target, Modelon will need to create momentum in its ARR growth and increase the share of recurring revenue in its overall revenue mix. The company's focus on developing its cloud scaling capabilities and expanding its product offerings could potentially drive increased customer acquisition rates and create up- and cross-selling opportunities. Nevertheless, achieving these targets will require a strategic approach that balances investment in R&D, sales, and marketing efforts while maintaining financial discipline to achieve profitability.

Costs

Modelon has two main categories between net sales and EBIT: personnel costs and other external expenses, which include office space, sales activities, consultancy fees, and other similar costs. In Q4 2022, OPEX increased to SEK37m (28), representing a y/y growth rate of 33% and a q/q growth rate of 16%. The increase in spending is primarily due to the accelerated development of Impact.

A significant portion of Modelon's expenses is attributed to the maintenance and upgrading of Impact, with development spending amounting to SEK16.7m for the quarter, translating to a y/y increase of 25% and a sequential growth rate of 27%. The higher development cost in Q4 2022 is partly owing to Modelon employing external consultants to speed up Impact development. As most of these engagements ended in December, the company expect that the investment rate will slow down from Q1 2023. Additionally, the company intends to grow its staff which is also seen in the fourth quarter, represented by an increase in personnel cost of SEK2.2m from Q3 2022 to Q4.

Modelon’s development costs in Q4 corresponded to 128 % of the software revenues, and on a normalized basis, 125% for the full year of 2022. Management explains that the focus of their development efforts remains on enhancing the cloud scalability of Impact, with the aim of releasing a significantly improved version in H1 2023, and this accounts for the increase in development costs. The management team is optimistic about the potential of the upcoming release and expects it to drive and accelerate ARR growth once established.

It should be noted that y/y comparisons of R&D spending prior to Q3 2022 can be misleading due to a co-development project where a customer partially funded the development of Impact. However, as the project was gradually ramped down during 2021, its impact on the comparison numbers diminished. As a result, we observe a more consistent annual run rate from Q1 2022 onwards, as illustrated below.

Furthermore, even though the cloud version of Impact was launched in Q3 2022 and exceeded management's expectations, its full potential has yet to be reached. Modelon is proactively requesting feedback from customers and incorporating their insights into product development, further demonstrating their commitment to meeting customer needs and demands. Additionally, it is important to recognize that R&D expenses accounting for a significant portion of OPEX are not uncommon for software companies. Therefore, we anticipate that the costs associated with maintaining and upgrading Impact is likely to increase as the customer base expands, particularly if Modelon decides to expand its target market by targeting additional industries in the future.

Financials

At the end of 2022, Modelon's cash position stood at SEK111.9m, with cash flow from operating activities being -SEK15.1m in Q4. Based on its current burn rate and cash position, we estimate that Modelon will achieve profitability without requiring external financing. This is significant, as companies in need of funding currently, may have to raise capital at a substantial discount, resulting in high dilution for their shareholders. Therefore, it is encouraging that Modelon’s financial position is solid.

The share

According to Holdings, Modelon had an average daily trade volume of around 2,200 shares in the second half of 2022. The average trading volume can be explained by the fact that only 21% of the company's shares are available for trading due to its controlling owners and strategic investors holding a significant portion of the shares. However, Modelon has recently announced that it has engaged a market maker. The market maker will guarantee a minimum volume of SEK20,000 for both buying and selling, with a price spread of less than 4%, effective March 1st, 2023. This move will lead to reduced volatility in the market and improved price discovery, which makes it easier for market participants to determine the transaction price. As a result, the trading volume is likely to increase from here on.

Estimate Changes  

We have revised our sales estimates for the Solution service, lowering them slightly. However, we have raised our ARR estimates by a few percent due to our anticipation of increased software sales following the release of the new Impact version. Additionally, we have raised our OPEX estimates to reflect the investment pace and anticipated increase in personnel cost.

See below for our updated estimates:

Valuation

We derive our fair value range from a fundamental DCF framework for three scenarios: base case (most likely), bear case (pessimistic), and bull case (optimistic), using a WACC of 10.5% (11.5%) for all scenarios. Although we have revised our estimates, they have had minimal impact on our fair value range. However, we have updated our Rating for Modelon which resulted in a lower WACC. Therefore, our new valuation range is SEK13 – 121. In our Base Case scenario, we estimate a sales CAGR of 26% 2023 – 2026, with an average EBIT margin of -19% that turns positive in 2025. Our DCF model suggests a Base Case fair value of SEK47, which corresponds to a forward EV/sales ratio of 4x for 2023e. Modelon’s current share price of SEK20 implies a valuation of 1x sales, which is low compared to its peer groups. Industry peers are trading at a median EV/Sales multiple of 8x, while Nordic SaaS peers are trading at a median EV/Sales multiple of 3x for 2023e. ARR growth and signs of near-term scalability are key metrics, and we will likely adjust for it going forward.