@andyat and @capt.sardine.tin, The question of investment in...

@andyat and @capt.sardine.tin,

The question of investment in costs, which you both raise, is a highly relevant one I think, and one which it appears to me the market - with its narrow analytical focus and limited concentration span that go little further than simply what the headline numbers are doing - is failing to appreciate.

As we know, not all "costs" are made equal... there are "good" costs and their are "bad" costs.
Good costs create value and grow businesses; bad costs merely try to paper over fundamental business flaws, but don't add any intrinsic value.

The market being seemingly unimpressed at a flat-ish EBITDA outlook overlooks the fact that, if management wanted to maximise the cosmetics of short-term profitability, it could report as much as $2m or $2.5m in EBITDA this year.

But as shareholders would expect, instead of maximising short-term financial results, management is pursuing the larger shareholder value pie, by incurring the kinds of expenditure that it believes will achieve that higher value outcome.

For those that did not have opportunity to listen to it, from 27:28 in yesterday's result call, the CEO's prognostication on investing in costs (in response to a bit of a Dorothy Dixer question from an analyst) is quoted as follows:

"Yes, sure, sure... so, definitely the home market.. let's say that home market of ANZ... we are increasing some of the headcount around R&D; just to continue to keep our product ahead of market and, obviously as I mentioned, one of the objectives is to integrate additional data sources. So, some additional support for the product in the R&D facility.

We are going to be investing a significant amount more in marketing this coming year, so that's a line item that will definitely be growing and that's, again, part of our stated strategy... we've been very much a sales-focused organisation to this point; marketing has been something that we have under-indexed on and which we are going to be investing appropriately around for next year.

And then, in terms of specific headcount, we are going to be investing in our international markets. The financial year 2019 was very much about putting some more headcount and establishing more of a presence in the US, in the UK markets and we've placed those bets; we've put those headcounts in...we'll continue to do that.., but we expect to see a meaningful contribution from those markets next year, and those headcounts are predominantly in the sales function, so direct sales, but also in sales support functions, customer success and sales engineering."


The other points to emerge from the conference call which I thought were quite salient:

1. All of the Revenue growth to date has been volume-driven; there has been no pricing-related uplift.

2. The bulk of SKF's existing customer base is on basic product packages, implying scope for up-selling opportunity.

3. The "average deal size" per customer is growing with each on-boarded customer


Valuation-wise, SKF's current market value of $47m , a multiple of 8.0 times the $6m Recurring Revenue run-rate at which the company exited FY2019.

As valuing tech stocks at the cusp of turning profitable go, 8.0 times Price-to-Recurring Revenue is admittedly not overly attractive.

But on a 12-month prospective basis, which would include a full-year contribution from the recently-acquired Beonic business (which came with a $1.6m Recurring Revenue run-rate at the end of FY2019), plus organic growth for the company of, say 35% in Recurring Revenue in FY2020 (for context, SKF's Recurring Revenue growth has been 79%, 60%, 50%, respectively, over FY2017, Fy2018 and FY2019), will see the Recurring Revenue run rate for SKF be north of $10m at the end of the current financial year.

On this prospective basis, Price-to-Annualised Revenue multiple drops quite smartly, to a far more appealing 4.7 times.


(PS. As an interesting exercise, consider the following:
By this time next year, if it wanted to wind back the growth throttle, SKF management could manage the company's cost base to a level which would yield up to $4m in run-rate EBITDA and which would probably still grow organically at 10% to 15% pa for several years due to natural business inertia.
You'd then have company trading on a around 12x EV/EBITDA, with residual organic growth still occurring at a reasonably healthy clip.

Of course, this is not a scenario considered to be even remotely likely; rather, the company will continue to allocate resources to driving growth faster and for longer duration.

It was merely a thought bubble to attempt to provide some sort of fundamental valuation marker which is often difficult to see in businesses where strategic cost growth is intentionally high.)


PPS. Another aspect of SKF to consider is the significant amount of latent equity in the form of Employee Share and Plans (37m shares, unvested) and Options (29.5m) in issue. On a fully diluted basis, assuming all 37.3m Employee Share Plan stock fully vested, the Market Cap would be $54m.