Modelon Q1 2023: Review

Q1 2023: Financial Recap

The report indicates that the pipeline volume during the period remained consistent compared to the previous quarter. Notably, the US market, along with the HVAC&R and Sustainable Energy sectors, displayed notable activity. The latter represents one of the significant trends that Modelon targets and has emerged as a key focus area for the company.

We recognize that Modelon's offerings align exceptionally well with the needs of the energy industry. This is particularly significant as the energy sector, encompassing various subsectors, presents a vast market with a growing demand for innovation. Consequently, we expect an increasing interest from diverse industries, not limited to energy, including aviation and automotive. These Industries, alongside Energy & Process, represent the majority of Modelon's established customer base. Recognizing this opportunity, Modelon has directed more of its marketing and sales efforts towards the energy industry and its subsegments, wherein they possess extensive expertise. Engagements with industry leaders such as Engie, MAN Energy Solutions, Heliogen, and Vattenfall reflect Modelon's experience and its commitment to this strategic approach.

A testament to this focus is the strategic partnership with Iquant Consulting (Iquant), a Brazilian company that has delivered numerous predictive maintenance and asset management solutions. Through the collaboration, Iquant will deliver a comprehensive solution for predictive maintenance and asset management for power plants and the energy infrastructure sector. The offering will combine Modelon Impact with Iquant's predictive maintenance platform and will include licenses, training on both platforms and expert consulting services. This solution is available to companies across the Americas, providing them with an end-to-end digital twin solution for optimizing maintenance processes.

The collaboration between Modelon and Iquant has been made possible, to some extent, due to the successful partnership Modelon established with Engie. Notably, this collaboration involved the development of a digital twin specifically designed for predictive maintenance in Engie's solar plant. The expertise and knowledge gained from the Engie collaboration are invaluable assets that can be leveraged to enhance the collaboration with Iquant, benefiting both Iquant's customers and partners. Furthermore, this particular use case serves as evidence, showcasing the quality and standards of Modelon's service and software capabilities.

We have previously emphasized the value that completed projects, such as the one with Engie, bring to both Modelon and its customers. In addition to expanding business opportunities within the sector, the models developed in completed projects can be repurposed and iterated upon, resulting in increased efficiency and effectiveness in future endeavours. This iterative approach has the potential to reduce research and development costs for both Modelon and its customers.

In the first quarter of 2023, Modelon achieved Net revenues of SEK18.0m, which represented a decline from the previous quarter. However, Modelon's CFO, Jonas Eborn, has shed light on the situation, stating that the company obtained some revenues from paid-up licenses in the preceding quarter, which could explain the deviation from our projections. Historically, revenues from paid-up licenses, primarily obtained from customers in Asia, have been reported in the first quarter as it marks the end of the fiscal year for many Asian clients.

Although the net revenues for Q1 2023 were below our projections with a deviation of -4.6%, it's worth noting that the reported revenue mix was in line with our projections and comprised 67% of net sales in Q1 2023 compared to 65% in Q1 2022. As we have highlighted before, growing the software share in the revenue mix is essential for Modelon's profitability, given that software sales deliver higher margins compared to service revenues.

Additionally, total software revenues grew by 3% y/y. However, there was an 8% decline compared to the previous quarter. As mentioned earlier, this figure includes paid-up licenses from the multi-platform offerings predating Impact, which is still utilized by some of Modelon's customers today.

When comparing the sequential development of paid-up licenses from 2021 to 2022, an inverse trend is observed. In Q1 2022, there was a quarterly growth of SEK1.4m, whereas, in Q1 2023, there was a quarterly decline of -SEK1.6m. This highlights the fluctuating nature of paid-up licenses which should be considered when analyzing the quarterly results.

Total ARR continued to increase in Q1 2023, maintaining the upward trend. The ARR showed a y/y growth of 19% and a sequential growth of 4%. Moreover, the ARR includes an annual growth rate of 41% in recurring revenues for Impact, which was also identified as the primary growth driver.

Modelon reported five notable customer wins in the quarter, whereof three were in the form of upselling, and while the company reported that new product sales are dominating the sales growth, it also noted that upselling for Impact is increasing. Although Modelon’s CEO, Magnus Gäfvert states that it’s too early to say if this is a significant trend change. Nevertheless, it is still a positive sign as average customer acquisition costs are expected to decrease as upselling increases.

Modelon is actively working towards developing improved capabilities for cloud scaling, with the enhanced software scheduled for release during the second quarter of this year. These capabilities are expected to support Modelos's growth strategy by leveraging cloud functionalities,

In addition, Modelon recently released an improved Impact version with updated model libraries for their targeted industries. This release provides customers with enhanced features and benefits such as updated model libraries,

these developments demonstrate that Modelon is actively pursuing strategies to drive growth and achieve its financial targets. By continuing to invest in new capabilities and technologies, the company is positioning itself for long-term success in the market.

Additionally, Impact follows a sales cycle of approximately six to twelve months. Upon adoption, new customers utilize Impact throughout their project duration, subsequently engaging other departments for evaluation and further assessment. This comprehensive process necessitates a considerable amount of time. According to management, the typical upselling period occurs one to two years after the initial adoption of Impact. Given the software's release in the second half of 2020 and subsequent enhancements, we anticipate an accelerated upselling potential in the latter half of this year.

In the first quarter of 2023, Modelon's Total Operating Expenses (OPEX) amounted to SEK36.3m, which represents a y/y growth rate of 18.6%. Personnel costs accounted for SEK23.5m of the total OPEX figure. It is important to highlight that the reported personnel costs include a one-time cost of SEK1.9m, which was incurred due to people leaving the company with agreements. When adjusted for one-time effects, personnel costs were in line with the previous quarter’s figure of SEK22m.

This change in the organization was aimed at improving efficiency, streamlining operations, and preparing the company for future growth. We believe this demonstrates good cost control measures while still adhering to the company's financial targets, particularly in terms of profitability.

It is worth noting that Modelon has been investing heavily in research and development to enhance its software capabilities and expand its product offerings as evidenced by the spending on development which amounted to SEK15.6m in Q1 2023. This translates, translating to a y/y increase of 16% and a sequential decrease of 6.6%. The elevated development cost in Q4 2022 was partially attributable to Modelon's engagement of external consultants to accelerate the development of Impact. However, as the majority of these engagements concluded in December, the rate of investment has decelerated as planned and previously communicated by management.

In Q1 2023, Modelon's development costs represented 130% of its software revenues, and over the preceding twelve months, the normalized development costs amounted to 128%. The recent increase in research and development expenditures since Q4 2022 is primarily focused on expediting the development of cloud functionality for Impact, to release a significantly improved version in Q2 2023. This upgrade is expected to enable accelerated scalability and margin expansion following the introduction of the enhanced software.

In the immediate future, Modelon intends to implement additional cost-reduction measures and achieve greater stability in the growth of development costs. Additionally, the management team maintains that product sales and ARR are projected to experience faster growth rates than development costs in the short to medium term. The management team maintains an optimistic outlook on the potential impact of the upcoming release and foresees it driving and accelerating the growth of ARR once it is established.

At the end of the reporting period, Modelon's cash position stood at SEK109.9m, with cash flow from operating activities amounting to -SEK1.8m (11.2). this development is attributed to the positive change in working capital of SEK16.5m, stemming from increased software sales and a reduction in receivables.

Based on Modelon’s current burn rate and cash position, we are confident that Modelon will achieve profitability without requiring external financing.

Following Modelon's engaging a market maker, the company's average daily trade volume increased from 6,100 in the first quarter to approximately 8,200 since the market maker was put into effect, an increase of c34%. While the share price has been fluctuating, with a volume-weighted average daily price (VWAP) of cSEK17, the share price grew flat from SEK14.45 on 31 December 2022 to 14.75 on 31 Mars 2023. Since then, the share price development has been better and as of closing on 16 May 2023, it stood at SEK16.50. However, the share's overall performance has been depressing, as it has plummeted by -66% from its listing price of SEK45. We will discuss this topic further in the valuation section of this update.

Based on the insights gained from Modelon's Q1 2023 report, we have revised our medium-term sales estimates. While we anticipate a slower ARR growth in the short term, we have adjusted our projections upwards by a few percent for the medium term. Additionally, OPEX has been adjusted downwards to reflect the company’s cost control measures. Similarly, we expect the EBIT margin to improve, albeit at a modestly improved rate. See below for our updated estimates:

Since its introduction to the market, Modelon’s share price has plummeted by around -66% from its listing price, a sharp contrast to the performance of relevant indexes. Nevertheless, we maintain that the current market valuation does not accurately reflect the company's potential.

average and median EV/sales multiples for Nordic SaaS companies for the year 2023 are 4.3x and 2.6x, respectively. However, it's important to note that there are a few larger, high-quality companies such as Fortnox that drive the average higher. On the other hand, the median SaaS company is more conservatively priced based on its sales. In terms of EV/EBIT multiples, the average and median for Nordic SaaS companies for the year 2023 are 40x and 30x, respectively.

If we focus specifically on consulting- and service-heavy SaaS businesses, the median EV/sales and EV/EBIT multiples for 2023E are 2.3x and 25x, respectively. This suggests that these companies may be more conservatively priced compared to the rest of the Nordic SaaS industry, particularly when it comes to their sales multiples.

Publicly traded companies operating in the PLM market have the inverse arrangement between growth and margins to the Nordic SaaS. These companies are larger and grow more slowly, while their EBIT margins reflect the more mature state of their businesses. The PLM peer group trades at respective average and median EV/sales multiples of 5.6x and 7.7x on 2023E (well above average SaaS companies that are smaller and less mature). Furthermore, they trade at average and median EV/EBIT multiples of 29x and 23x on 2023E, respectively. The average growth rate for this peer group mirrors the overall growth rate in the S&A markets, of about 9% annually. It is worth mentioning, however, that S&A is only part of this peer group’s sales.

As of present, Modelon's market capitalization stands at SEK182m, with an implied enterprise value (EV) of SEK72m and an EV/Sales multiple of approximately 1.1x for the year 2022. Looking ahead, we anticipate that sales will reach SEK80m in 2023, implying an EV/Sales multiple of 0.9x.

Our analysis indicates that, for the year 2023, industry peers are trading at an average and median EV/Sales multiple of 5.6x and 7.7x, respectively. Similarly, Nordic SaaS peers are trading at an average and median EV/Sales multiple of 4.3x and 2.6x, respectively. However, it is important to note that when considering only unprofitable high-growth SaaS companies, the average and median EV/Sales multiples are lower, at 2.5x and 2.4x, respectively. In light of this, Modelon's anticipated EV/Sales multiple of 0.9x for 2023 represents a significant discount when compared to both profitable and unprofitable Nordic SaaS peers, as well as its industry peers.

Using a fundamental DCF framework, we have derived a fair value range for Modelon under three scenarios: base case (most likely), bear case (pessimistic), and bull case (optimistic). We have used a WACC of 10.5% for all scenarios. Our analysis suggests a fair value range of SEK13 – 121 while our base case stands at SEK47.

We believe that the key drivers for an increased market value for Modelon are accelerating ARR growth and signs of near-term scalability. These are key metrics, and we anticipate the second half of this year to be particularly important. Following the launch we expect Modelon to showcase its ability to accelerate its ARR with improved margins, in line with its financial targets. We are thus excited about the coming quarterly reports, and we will continue to monitor Modelon's development closely and adjust our analysis accordingly.