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INVESTMENT ANALYSIS DISSERTATION - Sage™ Group

Summary

  • Growing Computer Software Sector

The United States is the most pivotal market for Sage Group. 40% of Sage Group’s clients are in the U.S. while 38% and 9% are in the UK and Canada respectively. Recently, most U.S. companies particularly small and medium enterprises within the computer software and construction sectors spent more money on various Sage software including Sage 50cloud and Sage ERP. Considering Sage 50 clients by sector, the Construction sector at 5% and Computer Software sector at 6% are the biggest segments as they contribute that percentage to the firm’s revenue. Increasing software prices and restricted access to customers might result in reduced sales. Further, software price pressure may have a reducing impact.

  • Turning to the Cloud and Subscription

Medium and small- sized enterprises will guide the recovery and Sage Group business model of strategic investment within Sage Business Cloud. The company would continue to expedite growth as clients become considerably digitally-enabled and stronger. Also, a shift towards subscription together with business cloud might be a competitive edge for Sage Group.

  • Strong Future Pipeline

Sage Group has a capable and strong future pipeline. Considering Sage Group’s capacity and ability to propel sales together with its future and upcoming pipeline, revenues from subscription and business cloud are projected to increase the firm’s future revenues in respective regions and markets.

  • Sell Recommendation. 673 Tangible book value per share Target Price

Sage Group’s share price estimation was arrived at based upon the various valuation models of the company’s share price. The share value of SAGE Group is more than 10% higher than the average intrinsic valuation of the company. Thus, it is recommended that the shares should be sold. The analysis, therefore, presents a sell-recommendation for the company’s shares. Also, the present overvaluation of the share price is based upon the negative growth as the DDM model indicates. Nonetheless, with the positive forecasts and reduced price to sales value, the stock still presents an attractive investment opportunity for investors which is projected to further increase its prices in the future. Essentially, the stock price’s current overvaluation is justified and is predicted to continue unless a change in the performance of the company’s forecasts and earning or the price to sales value ratio happens.

INVESTMENT ANALYSIS DISSERTATION

Recommendation: Sell

Target Price: 673 CHF

Current Price: 707.40 CHF*

Market Cap: 7.52B

INVESTMENT ANALYSIS DISSERTATION

Figure 1: Share Price Graph for Sage Group Plc. Reprinted from https://www.bloomberg.com/quote/SGE:LN

As of 13th July 2021

 

Table of Contents

Summary                                                                                                                                          2

1.0 Introduction                                                                                                                                4

2.0 Sector Review                                                                                                                              8

2.1 Software Prices                                                                                                                        8

2.2 Customer Access                                                                                                                    10

2.3 Technological and Demographic Trends                                                                                11

2.4 Spending on Research and Development                                                                               11

3.0 Company Assessment                                                                                                                14

3.1 Sector Peers                                                                                                                           14

3.2 Revenue Growth                                                                                                                    15

3.3 Performance                                                                                                                          17

3.4 Solvency and Liquidity                                                                                                          22

3.5 Efficiency                                                                                                                               26

4.0 Financial Analysis and Forecasts                                                                                               30

4.1 Sage Group’s Income Statement Items                                                                                  31

4.2 Balance Sheet Items                                                                                                               34

5.0 Valuation                                                                                                                                   36

5.1      Relative Multiples                                                                                                             36

5.1.1 Forecast of Sales and Earnings                                                                                        36

5.1.2       EBITDA                                                                                                                    37

5.1.3       Dividend and Opening Book Value                                                                           38

5.1.4       P/E and PEG                                                                                                             40

5.1.5       EV/EBITDA                                                                                                              43

5.1.6       Price to Sales Ratio (P/S)                                                                                           43

5.2      Intrinsic Value                                                                                                                  43

5.2.2       Dividend Discount Model                                                                                           43

5.2.3       Discounted Cash Flow Model (DCF)                                                                          44

5.2.4       Converting Earnings forecasts into Residual Earnings (RE)                                       46

5.2.5       Capital Asset Pricing Model (CAPM)                                                                          46

5.2.6       Sensitivity Analysis                                                                                                     47

5.2.7       Buy-Sell Recommendation                                                                                         48

 

1.0 Introduction

The Sage Group plc was established by Paul Muller, Graham Wylie, and David Goldman in Newcastle in 1981 to develop accounting and estimating software for small enterprises. Commonly referred to as Sage, the firm is a British-based multinational enterprise software firm headquartered in Tyne England. According to Ram (2017), as of 2017, Sage Group was the United Kingdom’s second-biggest technology enterprise and the globe’s third-biggest enterprise resource planning software supplier behind SAP and Oracle, the biggest supplier to micro-enterprises and has an estimated 6.1 million clients globally. Notably, Sage Group has offices within 24 nations and is the Sage Gateshead music venue’s patron in Gateshead. The firm operates within the software industry. Sage Group’s major industry focus comprises HR and Payroll, Healthcare, Real-Estate, Transport, Accountancy, Payment Processing, Manufacturing, Not-for-Profit, Automotive Distribution, and Retail (See Figure 2 below). Considering Sage 50 clients by sector, it is evident that Construction at 5% and Computer Software at 6% is the biggest segments as they contribute that percentage to the firm’s revenue (See Figure 3 below). According to the Sage Group’s Income Statement, its Last Twelve Months’ revenue as of 31st March 2021 was £1.865 billion while its net income during the same period was £232 million. Sage Group’s bearer shares and non-voting equity shares are listed on the London Stock Exchange. On 21st June 2021, Sage Group’s shares were traded at 680.34 GBX closing prices.

INVESTMENT ANALYSIS DISSERTATION

Figure 2: Sage Customers by Industry

Source: Slintel Inc. (2021).

INVESTMENT ANALYSIS DISSERTATION

The business management software together with services for companies’ business is largely focussed on services and software for payroll and accounting, customer relationship management, payments as well as enterprise resource planning. Sage Group is the globe’s third-largest enterprise resource software and services supplier. Accounting, construction, and computer software are the major industries driving Sage Group’s success. A shift to the cloud and subscription comprises part of Sage Group’s business model. According to Sage Group Strategic Report (2019), shifting to a business model in which clients pay and remit a subscription charge for use instead of possessing an asset is getting growingly prevalent throughout all industries and this merged with cloud technology enables vendors to provide considerable value by providing access to the most recent upgrades once they are available. Further, it enhances customers’ retention rates as vendors may enhance their connection with customers. Again, as other stakeholders and governments automate procedures like digitalising tax within the UK, there exists considerable demand from clients to be on the most current software version to make sure they stay compliant. According to Turner (2021), Sage Group performed greatly during the initial half against strong comparators with sustained continual growth and growing levels of new client acquisition largely within cloud-native solutions. Internationally, rates of cloud adoption are projected to trend skywards from 43% to 46% in 2019 and 2020 respectively. Sage Group’s USA market comprises the greatest cloud adoptive forecast and region to get to 55% in the 2020 financial year with France projected to be at 33% and UK and Ireland at 43% (Slintel Inc., 2021). According to Khan et al. (2018), the global software market is influenced by factors such as intellectual property protection, sector safety regulations within the technology sector as well as demographics, and the population’s skill level.

Further, Sage Group’s ERP segment has a 0.27% market share within the ERP market where it competes with 79 rival tools within this category. Top substitutes for Sage ERP tool include M1, Microsoft Dynamics as well as Plex Manufacturing Cloud with 64.05%, 9.72%, and 4.23% market share respectively. Notably, this lower percentage margin within the ERP segment reduces Sage Group’s overall operating profit margin of 17.05%. Sage Group currently seeks to enhance its cloud software within its North America and Northern Europe markets, which collect nearly two-thirds of the software giant’s recurring revenue. Thus, it is the medium and small-sized enterprises that will guide the recovery and the firm’s business model of strategic investment within Sage Business Cloud would continue to expedite growth as clients become considerably digitally-enabled and stronger. Notably, a shift towards subscription together with business cloud might be a competitive edge for Sage Group. 

According to Sandle (2020), in April 2020, Sage Group’s sales to its new clients were nearly half the expected levels as it experienced the impacts of a strong economic crisis occasioned by the pandemic. Further, Sage Group is largely operating in the U.S. although generating moderate sales within the UK and Canada (see Figure 4 below). Apart from small enterprises and businesses, Sage Group’s major customers are accounting, construction, and computer software companies that distribute more than a third of the company’s total revenues. The company’s strong recurring revenue growth of 10.8% together with 12.6% ARR growth mirrors its continued and sustained focus on drawing new clients and shifting existing ones to the cloud and subscription. According to Slintel Inc. (2021), specific strength in reoccurring revenue growth in North America and Northern Europe at 12% and 16% respectively, and within the future Cloud Enterprise Cloud Opportunity at 13% (The Sage Group plc audited results for FY19). Further, Sage Group enjoys immense brand awareness. According to B2B Marketing (2017), Sage Group managed a 48% lead generation increase via a brand awareness web-marketing.

INVESTMENT ANALYSIS DISSERTATION - Sage™ Group

Figure 4. Top Nations that Use Sage

Source: Slintel Inc. (2021).

2.0 Sector Review

The following section focuses on the market forces that are propelling demand, prices, cost, and competition within the software industry. These forces include software prices, customer access, spending on research and development as well as economic and demographic trends.

2.1 Software Prices

The United States is the most pivotal market for Sage Group substantially. According to Enlyft (2021), 40% of the company’s clients are in the U.S. while 38% and 9% are in the UK and Canada respectively. In the past few years, most U.S. companies especially small and medium enterprises within the computer software and construction sectors spent more money on various Sage software including Sage 50cloud and Sage ERP. As can be noted in Figure 5 below, despite the global economy and the U.S. economy tanking a year ago and still in their recovery, the Software & Services Sector (S&P Software & Services Select Industry Index) has grown since the beginning of the recovery period in 2021. This was spurred by businesses and customers in various sectors resuming their operations thus able to purchase software and services. Although shareholders and stockholders benefit from surging prices this day, the increase might as well be sustainable considering the shift by business towards the cloud and subscription to remain profitable and have a competitive edge.

INVESTMENT ANALYSIS DISSERTATION - Sage™ Group

Figure 5. Stock Price Graph for Sage Group, Software & Services Select Industry Index, and S&P 500 Index. Reprinted from Bloomberg L.P. (2021)

According to Stratis (2021), Brexit is presenting several challenges for markets in the UK and the software sector is not resistant. From professional qualification recognition to GDPR compliance to transnational service provisions and software vendors having their work stopped to navigate and traverse their new surroundings. Notably, for the software and services, numerous issues regarding how software SaaS would be regulated after Brexit could be a significant challenge that might impact software prices. An increase in software prices will benefit stakeholders in the software sector through increased share prices although it will be detrimental to customers. According to Zhang (2020), ERP software is costly and prices differ based on the deployment type, the number of users as well as customisation levels. Further, Zhang (2020) evaluates the pricing approaches for a software enterprise and a novice software-as-a-service enterprise in two client markets including the market with new clients and one with the incumbents’ previous customers. The author established that it is not often effective for the software enterprise to price discriminate and differentiate between its previous users and new clients. Thus, high software and services prices develop out of two major market forces. They include the availability of architecture components together with the availability of processes, methodology, and tools. Thus, lowering software prices would entail vendor involvement to minimise the complexity and costs of acquiring, utilising, and managing the purchased software. Similarly, increasing software prices within the industry might affect Sage Group plc as it focuses on supplying software to small, medium, and large enterprises.

2.2 Customer Access

Access to customers who can use software products is another important driving factor in the software industry. According to Leins (2019), the American market gains from the software sector significantly including job creation with other states experiencing much considerable growth as opposed to others. Further, software jobs are not just tech jobs; instead, they are healthcare jobs, agriculture, and manufacturing jobs. Also, the regulatory outlook in the U.S. and Europe due to Brexit remains blurred and SaaS providers must review how they assist and support prospective and existing customers, their information policies, as well as data, flows (Stratis, 2021). The duration that it takes for software products from Europe to reach the North American markets should get regulatory approval and permission, which might restrict access to customers especially small, medium, and large enterprises that use Sage products.

2.3 Technological and Demographic Trends

The globe’s population is projected to increase to 8.18 billion in 2025. Further, as the global population grows so are businesses and companies all through. Hence, as the population increases and businesses continue to grow, businesses must adopt several software solutions to cater to the needs of this growing population. Bridgwater (2020) asserts that software will alter in 2020 and also changes yearly, monthly, and even weekly. These changes in technological trends to cater to the needs of the growing population thus requires software providers to tweak, change, augment and update the functionality of various aspects of their service software to remain competitive. Further, changes in business and technological trends are another market force driving costs, margins, and competition in the software industry. According to Bridgwater (2020), among the major trends driving software use currently are initiatives targeting automation, autonomy, and abstraction. Further, following one year of devastating setbacks and shocks, the U.S. economy is expected to boom and its GDP is poised to exceed the projected 

level. When a country’s economy is booming, investors are more likely to establish a business in that country. This means that these businesses and companies must spend on software thus creating demand and competition for software products.

2.4 Spending on Research and Development

R&D is an investigation designed to come up with something different and new and it is thus an invention that will lead to a new service or product. Software is among the most research and development intensive sectors and on average, major software firms invested an estimated 10-15% of their revenue in research and development. Concerning software R&D, new and different software in each market niche gets to the market daily. The U.S also remains the major source for innovative discoveries within the international software sector. According to Rosenbaum (2019), global IT spending was estimated to approach $4 trillion in 2019, and enterprise software comprises the quickest growing segment of technology investment. Further, Statista (2021) nearly $1.9 trillion was spent in technology research and development in 2021. This represents an estimated 47% of total R&D within the global R&D economy spending on technology investment. Research and development have become growingly costly in recent times. Notwithstanding the huge spending on software research and development, the investment scale is growing expeditiously. According to Wyman (2019), during the 2017-2018 financial year, the software sector experienced an average 26% rise in software research and development spending. Like for the entire sector, this research and development investment is focused on software firms based in the U.S.; these firms constitute 73% of the international software research and development spending. Nonetheless, the investment growth rate is even greater somewhere else in the globe topping at 30% within the Asia-Pacific region (see Figure 6 below).

INVESTMENT ANALYSIS DISSERTATION - Sage™ Group

Figure 6: R&D Expenses as a Percentage of Revenues for Software Development Firms, 2018

Source: Wyman (2019) 

The software sector is experiencing an enormous transformation and SaaS is getting preeminent and is well on course to substituting customer-based software shortly. However, it is challenging for companies in the software sector to integrate a holistic transition due to several barriers to the R&D realm, which is a significant driver of competition. Thus, firms must pivot their models of business to SaaS and manage business operations normally.

In conclusion, the global software industry and in particular the U.S. software sector where Sage Group draws a larger part of its revenue is projected to grow because of an expected boom in the country’s economy following the pandemic, an increasing population, and enhanced customer access. Notwithstanding the present economic uncertainty and software price increases noted in the last few years, all these can be handled in the future. The ensuing software price pressures would reduce Sage Group’s current high margins and the Group’s products are more likely to be subjected to such price increases within the software industry.

Pro Forma Analysis

For the following section, pro forma analysis will focus on Sage Group’s pro forma income statement, pro forma cash flow statement, and pro forma balance sheets. Howard et al. (2019) assert that a pro forma analysis comprises an estimation of the possible position of a company based upon an analysis of historical data and information, operating and performance metrics as well as possible cost savings because of expected changes. Sage Group’s pro forma analysis is shown in the attached excel sheets.

3.0 Company Assessment

The following section assesses Sage Group’s historic performance, the present competitive position as well as future prospects against the software sector background. Hence, to assess Sage Group’s historic performance together with future prospects, 5-year trends in financial ratios have been assessed. In the following section, Sage Group’s performance, efficiency, liquidity, and solvency will be analysed and compared with its sector peers.

3.1 Sector Peers

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