Reckon Ltd (RKN AU Equity)

Trading at 3.1x EBITDA vs similar business they just sold for 8.4x (sold this for $100m when market cap of the whole company was $94m & was ~40% of EBITDA)

+ new cash incentive plan (CEO massively incentivised) only kicks in when a minimum of ~3x the current market cap cash is returned to shareholders

+ current profit would be 60% higher if loss making division sold or turns around (new separate incentive plan for US based mgmt co-investors in this division + showing green shoots)

+ Illiquid microcap & boring slow growing business but get ~7% gross dividend yield, backed by sticky revenues, while waiting for value realisation

COMPANY

Reckon operates through Business Group & Legal divisions.

Business group makes up the majority of earnings. It offers Reckon One, an online accounting software for self-employed & small businesses; Reckon Payroll; Reckon Accounts Hosted, online accounting software for larger businesses.

• This business is 99% subscription revenue. Sticky recurring revenue as too difficult to move and retrain for little benefit

• Reckon is a minnow (173k cloud subs) but "competes" with Xero (2.1m subs in ANZ) & MYOB. The value proposition is price point. They spend little on marketing. https://www.reckon.com/au/accounting-software/compare/. 

• MYOB (Private Equity) and XRO (Needs to show +ve FCF) are raising prices each year now which further widens the expense gap

• This division might grow low single digits as cloud grows slowly but desktop (36% of revenue) slowly reduces (though it’s at the same level as FY17)

• If cloud business was on 5x revenue would be worth >$115m. Lesser cloud businesses trade on 10x. This doesn’t include any desktop subscription revenue (that proved to be very sticky & may transition over to cloud)

Legal group (nQ Zebraworks) develops, distributes, and supports cost recovery, scan, and cloud-based integration platforms primarily to legal market. RKN own 76% with the rest owned by the US based nQ Zebraworks management team.  This team has a track record of creating & selling Legal software, they previously founded Prolaw (sold to Thomson Reuters ) & Exemplify (sold to Bloomberg)

• Loss making (EBIT) since FY18. Any turn around would be significant to FCF/NPAT, and most importantly you're not paying for it at today's price. Some green shoots are showing post the nQ Zebraworks merger in August 2020 (nQueue (Reckon) & Zebraworks) as subscription revenue has grown 10% in 2H22 (on 1H22) & 7% in 1H22 on 2H21. This follows no growth prior.

• If Legal group hits $50m ARR by FY27 the 4 management co-investors get 15% more equity so highly incentivised & as RKN shareholder you are more than happy for them to get this at that level.

Other

• Mgmt are well paid for a $58 market cap. CEO & CFO base salaries are ~$654k & $548k. After STI & LTI they earnt ~$1.7m & $1m in FY22.

• Untapped pricing power? They sell a very sticky product & are lowest cost by far.

Return?

• Downside I think is 7% gross div yield + low single digit EPS (driven by cloud accounting SME software & lower R&D) so maybe >=10% p.a. Excludes any turnaround in Legal division.

• BUT the real return comes from the new management incentives below and the potential sale/disposal of assets/companies within Reckon, or Reckon itself.

  

  • The shareholder cash payment is the cumulative total of the payments received by Reckon shareholders from 24/5/2023 to 31/12/29. It is a negative the length of time this may take obviously.

  • "The new incentive plan focuses solely on the value received by you as a shareholder in terms of dividends and distributions paid on your shares and the consideration you receive for your shares if Reckon itself is acquired, such as under a takeover." - Clive Rabie (Chairman)

  • There are also incentives for the 4 management co-investors of nQ Zebraworks. Reckon will transfer a proportion of its securities in nQueue Zebraworks to certain members of management of nQ Zebraworks if it is sold for more than US$70M.

    

It is rare to see management being so incentivised to liquate/sell their companies.

Valuation

Reckon has been progressively sold over the last 6 years (I believe this has been Clive Rabie (ex-CEO ~9% ownership) & Greg Wilkinson (Founder ~7% ) led;

• In 2017 GetBusy (document management software) was demerged to list on the London AIM exchange ($31m)

• In 2018 MYOB attempted to buy the Accountant Practice Management Group for $180m (9.5x EBITDA) but didn’t proceed because ACCC competition issues

• In 2021 ReckonDocs business was sold ($13m) at a 2.6x FY20 revenue and 4.3x FY21 EBITDA

• In 2022 the Accountant Practice Management Group was sold ($100m) at a 4.6x FY21 revenue and 8.4x FY21 EBITDA

• I believe the Accountant Practice Management Group is a viable comparable to the business group. They sold this for $100m when the market cap of the whole company was $94m. Revenue in FY21 was $21.8m with $11.9m EBITDA & $4.5m EBIT. Over the 4 years to FY21 subscription revenue, EBITDA & EBIT had decreased by 2.4%, 6.1% & 16.8% CAGR. Effected by Reckon Docs sale along with D&A increasing due to the need to rebuild the software for the cloud plus negative organic growth I believe.

• It was/is effectively a duopoly with MYOB for accountants practice management software (~90% market share) thus churn would be very low, vs ~10-20% in Business Group.

• But Business Group is growly slowly (3-4% CAGR Revenue/EBITDA growth over last 5 years) & is well over the mountain in terms of the cloud build spend & still has relatively sticky customers

• Based on the above the Business Group could be worth $176m@8.4x EBITDA (using Accountant Practice Management Group multiple)

• The Legal group could be worth $21m. A 2x Revenue multiple is probably appropriate given the 89% subscription revenue & only very limited evidence of a turnaround (so far.)

• So $200m worth of value for $58m with the CEO & CFO handsomely rewarded for realisation of this value (& exceeding it) along with subsidiary management co-investors significantly incentivised to sell their business for significantly more than the value I have ascribed it.

• Even if these multiples are wrong I’m extremely confident the business is worth a lot more than $58m and management are highly incentivised to actually realise this value. And you get a nice 7% gross dividend yield while you wait.

This isn’t investment advice, I don’t know your circumstances. I obviously like the idea hence I hold a position in RKN at the moment, this could change. This is just to help me be clarify what I think. It’s based on my opinion of things that could happen in the future using publicly available information. Do your own research, I’ve probably made mistakes so do not rely on me.