Review of Q3 2023

Group level sales and EBITA was SEK1808m and SEK137m (excluding SEK5m in restructuring costs in PLM) relative to our forecasts of SEK1760m and SEK146m. Organic growth was -9%, better than our forecast of -12%. The deviation was mostly due to stronger sales in PLM and a weaker margin in DM’s Symetri (the Autodesk-related offering).

Sales in DM missed our forecast of SEK1 076m slightly and amounted to SEK1 055m (977), corresponding to 8% growth y/y. The organic growth was -21% y/y, somewhat higher than our forecast of -25%. Thus, the recently acquired TeamD3 had a lower contribution than we anticipated. As in Q2, Symetri saw soft demand from the construction sector and architects in basically all geographical markets. Also, the sales of 3-year deals were lower relative to last year, and sales cycles remain longer.

While we expected continued softness within AEC (Architecture, Engineering and Construction), we did anticipate a stronger contribution from the manufacturing-focused TeamD3. Although the market for TeamD3 is softer as well, management believes it is good enough to do solid business. The soft performance in the quarter is partly due to the integration of TeamD3 into Addnode, taking focus from sales and fewer 3-year deals. Unlike what we have seen in TeamD3 in its first quarter, Addnode has a strong track record of integrating larger acquisitions. While we expect an improvement over the coming quarters, we somewhat reduce our assumptions on TeamD3 in the short-term. The proprietary software companies Tribia and SWG experienced stable market conditions and developed solidly during the quarter.

EBITA in DM was SEK57m, corresponding to an EBITA margin of 5.4% (12.1). Our forecast was SEK75m and 7.0%, and the miss was likely mainly due to a softer development in TeamD3. Addnode has reduced its costs in its US operations by about 8%, resulting in a lower cost base going into Q4. Thus, we expect some margin improvements going forward – the 5.4% seen in Q3 was the lowest level since at least 2017.

Design Management (DM) comprises three companies, Symetri, Tribia, and SWG. Symetri is the largest one, generating most sales in DM. Tribia and SWG have combined sales of SEKc500m.

Symetri delivers Autodesk products, related services, and add-on software to customers within architecture, engineering, and construction (AEC) and manufacturing, mainly in the US, UK and Nordics. As the bulk of the software is third-party (Autodesk), the margins in this business are lower than the division’s average. Recurring revenues generated in this business are reported as non-recurring revenues (i.e., upfront, for accounting reasons). Symetri is one of the largest Autodesk partners worldwide.

Tribia provides cloud-based collaboration software for the architecture, engineering, and construction (AEC) sector. Its main product is a proprietary software called Interaxo. Given the business's mix of proprietary software and services, its margin level is likely above the division’s average.

SWG delivers products and services for property management and maintenance, mainly in the Nordics and the UK, where it is the market leader. Like Tribia, SWG provides proprietary software and related services, so its margins are likely above the division’s average.

Sales in PLM beat our forecast of SEK416m and amounted to SEK484m (393), corresponding to 20% growth y/y. The organic growth was 10% y/y, somewhat above our forecast of 5%. PLM saw a stable demand in the UK, US, and Germany, partly driven by demand from the electric vehicle and life science sectors. On the other hand, demand in the Nordics was softer. A few more significant license deals partly fueled the solid organic growth.

EBITA in PLM, excluding SEK5m in restructuring costs, was SEK48m, corresponding to an EBITA margin of 9.9% (11.5). Our forecast was SEK31m and 7.5%. While the more significant license deals boost profitability, we believe the strong quarter also suggests the cost-savings program is performing well. Management did initiate a cost savings program in H1 2023 that is expected to save SEK40m annually with full effect in Q1 2024. The program is expected to cost SEK20m, which of SEK15m has been taken (SEK10m in Q2 and SEK5m in Q3), and the remaining SEK5m is expected in Q4.

Product Lifecycle Management (PLM) consists solely of the subsidiary Technia, which helps customers with complete product lifecycles. The offerings target various sectors, including telecom, manufacturing, automotive, construction, energy, and life science. Technia provides solutions based on Dassault Systèmes’ platform, related services, and proprietary add-on software, mainly targeting the Nordics, DACH, and the UK. Due to the division’s lack of proprietary software besides add-ons, PLM has the lowest EBITA margin in Addnode.

Sales in PM beat our forecast of SEK275m slightly and amounted to SEK280m (262), corresponding to 7% growth y/y. The organic growth was 7% y/y, somewhat above our forecast and slightly higher than the 5% seen in Q2. In Q2, management mentioned a lower level of procurements in the public sector, and now it sees continued restraint in the willingness to invest from some municipalities and authorities. However, when discussing the market outlook with management, we get the impression that the market is solid enough to produce organic growth but maybe not in the c7-10% range. This market view aligns with what we hear from other software/consulting companies with exposure to the Swedish public sector.

EBITA in PM was SEK53m, corresponding to an EBITA margin of 18.9% (50). Our forecast was SEK52m and 19.0%. PM continues its solid c19% EBITA margin streak seen since mid-2020. Considering the margin was c14% before 2020, it seems like PM improved its efficiency during the pandemic and has managed to sustain the improvement.

Process Management (PM) comprises +15 companies, mainly serving the Swedish public sector. The solutions target a variety of the public sector’s needs, including document and case management and digitalised public services. The +15 units target most public sector-specific needs, and PM’s combined offering is broader than its competitors. Unlike DM and PLM, this division relies solely on proprietary software, meaning it has the highest EBITA margins in the group. However, these are dampened by about 50% of sales from services.

EBITA was SEK137m (excluding SEK5m in restructuring costs in PLM), corresponding to an EBITA margin of 7.6% (11.9). Our forecast was SEK146m and 8.3%, and the miss was mainly due to lower margins in DM, while the strong PLM compensated somewhat. EBITDA – CAPEX, which we typically prefer in software companies where EBITDA and EBITA are boosted by capitalized R&D, was SEK125m (196), corresponding to an EBITDA – CAPEX margin of 7.2% (12.1).

We have decided to exclude leasing payments in our EBITDA – CAPEX numbers, contradictory to what we wrote in our last Update. However, as some companies have an untransparent reporting of leasing payments on a quarterly basis, we excluded leasing payments to be able to compare figures.

Addnode’s net debt was SEK1 106m at the end of Q3, corresponding to 1.4x EBITDA 2023e.

Note the cash flow was negatively affected by net working capital. However, that is mainly for seasonality, as 30 September was a Saturday. We have seen a similar pattern in several IT consulting/software companies.

As for any SaaS business capitalizing R&D, EBITDA and EBITDA margin are unsuitable metrics for Addnode. This, as EBITDA discards a large portion of the company’s R&D costs totally. R&D is typically a high cost for most SaaS businesses. The same holds for EBITA in Addnode's case. Instead, EBIT (where the capitalized R&D is amortized over time) or EBITDA – capitalized R&D/EBITDA – capex are better measures of the underlying profitability as it concerns the company’s full R&D spend. However, as Addnode has amortizations related to M&A, the underlying profit generation is somewhere between EBIT and EBITDA. We believe EBITDA - CAPEX (excluding M&A and leasing payments) is the most suitable earnings metric for Addnode.

Addnode has not made any acquisitions since our last Update.

Addnode’s R12m acquisition activity is currently high, as the large acquisition of Team D3. As usual, we expect additional acquisitions and assume that Addnode will add SEK800m in sales from M&A during 2024 on a full-year basis (zero in 2023). As the larger acquisitions in Addnode tend to occur sporadically, the R12m contribution to sales from acquisitions tends to differ significantly.

Addnode has a strong track record of value-adding acquisition. In addition to significant valuation-multiple arbitrage, Addnode has a track record of extracting value from acquisitions by using its expertise and selling add-on software to the acquired companies’ customers, and cross-selling acquired software to the customer base. The substantial margin improvements in larger low-margin acquisitions such as Transcat, Excitech and Microdesk are evidence of Addnode’s ability to extract value from M&A

We leave our sales growth assumptions flat on the group level for 2023 and 2024. Regarding earnings, we cut EBITA by 1% for 2023 and 2024. We believe the overall market outlook is in line with last quarter.

On the Divisional level, we lower DM while increasing PLM. The cut in DM is mostly related to us expecting a lower contribution from TeamD3. While the strong numbers in PLM, at least partly, were due to the strong license sales, we believe the underlying development was somewhat better than we previously expected, resulting in a slight increase in our PLM forecasts.

We lowered our Base Case to SEK 100 (110) largely because we increased our risk-free rate from 2.5% to 3%, resulting in a higher WACC. However, slightly reduced forecasts have a minor negative impact as well.

Addnode’s valuation of 16x EBIT for 2024e is below the average SaaS business in our peer list. Addnode has a relatively low share of SaaS revenues versus these peers. On the other hand, the group does have a very successful acquisition record. Considering EV/EBITDA - CAPEX, which we believe is a more relevant multiple for Addnode, considering its high M&A-related D&A, it is trading at 13x for 2024e. Also, we believe the uncertainty in the estimates is lower in Addnode compared to many other companies in the list, where analysts expect significant margin improvement. Addnode is trading at a discount to Vitec, another successful software-focused M&A compounder. However, Vitec has solely proprietary software, indicating the potential in Addnode as its proprietary solutions grow. Note the forecasts for Addnode are Redeye’s and include future M&A.

From an EV/Sales versus sales growth and margins perspective, Addnode stands out as attractive versus the other larger companies. However, Addnode’s high share of third-party software and services, which limits its margin potential, likely holds its valuation back. Also, the forecasts include future M&A. On the other hand, the smaller, often unprofitable, and more “pure” software companies trading at an EV/Sales in line with Addnode are often followed by only a single or a few analysts. Thus, considering companies with a long track record of profitable growth, Addnode’s valuation stands out, at least partly justified by its business model with a high share of third-party software and services.

Compared with the successful traditional M&A-compounders, at 16x EBIT for 2024e, Addnode is somewhat below the average and median. As all serial acquirers have a high M&A-related D&A, comparing on EBIT makes sense. EBITA is probably even better, but the number of EBITA forecasts for the peers is not as extensive as for EBIT.