Short-term outlook cloudy, yet huge silver-line in its “Cloud” platform..
Not very often one comes across a great business at a great price. It is a rare thing in the investment world. Usually, great businesses have great followings and hence, they come with an expensive price tag. But, myopic markets can do mysterious things many times. It can mis-price a magnificent business to manically low levels. One such compelling story is what we will discuss in detail.
Fascinating thing about investing is that it provides an opportunity to identify and research about businesses with superior economics. Strong economics means high pricing power, durable competitive advantage, sticky and predictable revenue streams with robust free cash flows. Such businesses usually come with superior margin profile and high return metrics measured by ROE and ROCE. They don’t guzzle capital to fund the growth. Because of free cash flows, they usually depend less on debt for their growth.
Here is this business that is IP (Intellectual Property) based, ticking all the above boxes and owns the award winning software products that are running the lending operations of leading global banks. Sample this:
- Global No.1 Lending product award by IBS Publishing (UK) for 7th consecutive year.
- 10 time winner- World’s best selling lending solution.
- Recognized as the one of the five most significant mobile banking solution vendor by Forrester.
- Won the model bank vendor 2016 by Celent.
But on the valuation, it can’t be more compelling. Adjusted for cash, the business is available at half-the-times the sales while globally such businesses are valued anywhere between 3 to 4 times the sales. Even on conventional PE multiple, adjusted for cash, it is going at single digit multiple. At the current price, almost 70% of the market cap is accounted by the cash in the balance sheet. The company is sitting on cash levels of 390cr level while its market cap is barely 600cr i.e. cash in the book is near 125 Rs per share while the stock price languishes around 185 level for a business that throws annual free cash of about 30cr+. Why so much undervaluation for Nucleus Software that owns the globally acclaimed Fintech products?. That too in this bull market that fancies the financial sector frantically (going by surging NBFC valuations).
Market in its wisdom is obsessed with the top line growth which has been a challenge for the company for a while. Top line has been barely growing for last few years, though on profitability and return metrics (adjusted for cash), the company has been on top. Now, with product and sales investment cycle near its end, prospects for growth have brightened. Huge investments have gone in revamping its products over last few years and so is the case with the investments on the sales engine (Senior resources in the sales team).
With its flagship lending solution FinOne Neo available on Cloud now, it could potentially change the entire business landscape for the company. The addressable market could change multifold for this solution. With no upfront investments for cloud solutions and flexibility of phased rollout etc, it could make the solution affordable for many small NBFCs which hitherto did not have access to high end solutions like the FinOne Neo. Take the recent case of Shubham Housing Finance which has gone live on Cloud with this solution. This is first small sized NBFC that has adopted this solution for many years thanks to the cloud offerings. With NBFC and microfinance sector soaring on growth prospects, it will be matter of time before this translates to higher growth for the company. Not to forget that the business from cloud offerings is sticky and scalable. The economics of business will go from good to great for Nucleus with the cloud business gaining traction.
Nucleus stands out on another critical account. That is on management’s credentials on corporate governance and integrity. It is run by a first generation technocrat. It has been consistently rated high on corporate governance. Market, at the current price, has factored negligible value for either cash on the book or for the management credentials. But that will change when the growth prospects turn. Not only the multiple moves up along with earnings, but cash and management quality too get adequately captured in the value by the market.
Going by the price chart for few years, this stock might require a lot of patience, which may not be a challenge for value investors like us. It will be a classical value stock that does nothing on price for long time, but skyrockets suddenly when prospects turn or if the management decides to unlock value thro’ buyback or special dividend (to utilize the large surplus cash in the book). As someone famous quipped, Money is made in the waiting!. Nucleus fits this more than any other stock.
Happy Value Investing!