Greystone Capital - Sylogist Ltd.: A 'Show Me' Story With The Right Ingredients In Place

The following segment was excerpted from this fund letter.

Sylogist Ltd. (OTCPK:SYZLF)

During the quarter we purchased shares of Sylogist Ltd. and setting the stage (or table, if you will) for this investment are the many cooking shows in my rotation, where I love watching chefs prepare and talk about food. These shows offer many parallels to investing and portfolio management, one of which is that the greatest chefs understand that the best recipes are all about the ingredients. I believe Sylogist is following the recipe for success, with the ingredients consisting of a high-quality business, strong growth prospects, a net cash balance sheet, good management, and free cash flow generation at a bargain price. Sylogist is a public sector software-as-a-service ((SaaS)) business whose stock has been orphaned due to its history of poor corporate governance along with a recently implemented strategy shift and dividend cut that caught investors off guard but was executed with the sole focus of driving shareholder value. This, along with the massive selloff in small companies and software related businesses during 2022 has caused the stock to be left for dead, despite possessing some characteristics that point to an intrinsic value much higher than where the shares trade today. Over time, and with proper execution, I believe our shares could be worth multiples of what we paid.

Sylogist is a Canadian listed SaaS business that provides mission-critical software solutions to nearly 2,000 customers worldwide in three public sector verticals of Non-profits/NGOs through their SylogistMission segment, Government through their SylogistGov segment, and Education through their SylogistEd segment. Within these verticals, software solutions consist of ERP, CRM, fundraising, education administration, and payments products. These products carry high value propositions and sticky customer relationships as they serve a critical need for organizations of all sizes. The areas within the niche that Sylogist occupies have less competition than enterprise level software businesses, who typically avoid these end markets and are not well adapted to offer the customized solutions that Sylogist can. One example would be a growing non-profit that requires more advanced fund accounting and donor management software that integrates with the rest of the organizations applications, thereby eliminating sometimes manual processes for data input and storage. The organization could use Sylogist’s ERP product to address those needs. Historically, despite underinvestment in customer relationships under the previous management team, customer retention has been in the high 90% range as there is reluctancy to switch providers given the integration into their workflows and systems.

Sylogist has three primary revenue segments made up of Cloud Subscriptions (40% of revenues), Maintenance and Support (25%) and Professional Services (29%). Approximately 65-70% of revenues are recurring between Cloud Subscriptions and Maintenance and Support, providing both visibility and resiliency into future revenues, with software gross margins in excess of 75% and cash flow conversion in the 70-80% range. Several of Sylogist’s products are built using the Microsoft Dynamics platform, where Sylogist can not only customize products for specific verticals but can also benefit from the reputation and track record of Microsoft during customer acquisition and when cross-selling adjacent products and services. Moving forward, management’s strategy is to grow both organically and via M&A, while focusing on the organic growth of software subscription revenues.

Software businesses, and among those, Sylogist’s peers, can be great businesses, especially when tied to critical parts of an organization’s operations. They share characteristics such as strong organic growth, high revenue retention, high margins, and strong cash flow conversion, while providing remarkable durability through all economic cycles. Publicly traded peers Tyler Technologies, Blackbaud and Sage have long histories of growth and profitability, while each grew revenues through the financial crisis with no decline in operating margins. Strong fundamentals and durability means that most of Sylogist’s peers trade at valuations of 20x EBITDA or more, compared to <9.0x NTM EBITDA for Sylogist.

For the reasons behind the valuation disparity, I’d point you toward the company’s history. The early version of Sylogist consisted of a low margin, no growth, reseller of software until prior management made some acquisitions in the early 2000’s to capture more of the customer relationship and to focus on building a public market software business. Unfortunately, prior management made it a point to focus on tuck-in M&A, manage acquisitions for cash flow, neglect organic growth, and milk the company for compensation. Poor corporate governance, a company with no business being public, and a management team with no desire to drive shareholder value was going nowhere and would never garner a proper public company multiple. Prior to the former CEO’s retirement in late 2020, Sylogist ran a strategic review (an attempt to sell the business) and emerged with the Board determining that the best path forward would be to pursue the near-term market opportunities for growth in order to drive shareholder value. They also went on a search for a new CEO who would be given an organic growth mandate.

Enter current CEO Bill Wood, an industry veteran who was a founding member of Blackbaud, one of Sylogist’s direct competitors, also previously serving as President and CEO of two software businesses during a 17-year span that culminated in both businesses being acquired, one by Constellation Software and the other by a private equity firm. Shortly into his tenure, Bill cut the dividend (a 9% yield), freeing up nearly $12mm in annual cash flow, and formally announced the company’s strategic shift toward growing organically and via M&A. As part of the strategy shift, EBITDA margins would be taken down from the low-mid 50% range to 30%, while maintaining a Rule of 40 posture, with the excess cash flow being reinvested into product development, sales and marketing, and M&A. The company’s credit facility was also increased by 65% to $125mm, providing additional firepower for acquisitions, while a share buyback program was put in place that would allow the company to repurchase up to 10% of shares outstanding. The market, along with yield focused investors, did not like this news. I, however, am thrilled with these decisions, as I tend to seek out management teams willing to endure short-term discomfort in exchange for potential long-term value.

The strategy is working, and investors have been slow to recognize the shift, despite what I believe to be an important inflection point. In just three short years, Sylogist has made tremendous progress toward building a software platform by strengthening the management team, launching and acquiring in-demand products, repairing customer relationships, improving the NPS score, and returning the business to organic revenue growth. To date, efforts to accelerate sales, marketing and product development have been and should continue to prove successful as the sticky products that Sylogist offers, and the collegial nature of their end markets means that a continued organic growth profile shouldn’t be too difficult a hurdle to overcome. In fact, Sylogist is firing on all cylinders, growing bookings, revenues and cash flows effectively, and as of the most recent quarter, reported positive sequential growth in organic software subscription revenue. During the most recent earnings call, management highlighted an attractive sales pipeline and new bookings matriculating at a higher rate than at any point since the current management team was brought on. This, along with the hiring of an experienced Chief Revenue Officer and the continued flexing of marketing muscle bodes well for future organic growth. A recent upgrade to the CFO position should also come with improved communication and disclosures, helping investors better understand the story and strong fundamentals.

Sylogist’s strategy shift will be bolstered by significant tailwinds including the large addressable market among their customer base, low digital penetration among the same customer base, the acceleration of software tools post-COVID, and a fragmented market for products and services that Sylogist can tap into for M&A. Since their hiring, management has completed four acquisitions, all largely accretive and providing both the opportunity for continued organic revenue growth and the opportunity to add valuable products and services to their platform. According to management, the deal pipeline remains incredibly full, with hundreds of potential targets on their list. As private market valuations continue to come down, we should see additional transactions take place that help grow the top and bottom lines over time. Sylogist could also find themselves on the receiving end of an acquisition offer, as the government software space is incredibly acquisitive due to the fragmented nature of these businesses, value to both strategic and financial acquirers, and durability of the business models. In a macro environment where two of the biggest worries are inflation and a recession, the combination of non-discretionary recurring revenue and pricing power makes for an attractive setup. Even share-losing Blackbaud, who has consistently underinvested in the business to the point of declining revenues and margins, finds itself in the midst of a take-private offer from a PE firm.

Sylogist remains a ‘show me’ story but I believe the right ingredients are in place. The company is small. Publicly traded float is minimal. Shares trade over the counter in the US and have zero US analyst coverage. Management is non-promotional and IR efforts could improve. The potential for mispricing here is significant and I believe shares could be worth multiples of what we paid looking out a few years. I like the setup and look forward to discussing Sylogist in future letters.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.