Technology One (TNE.ASX) shares have risen nearly 50% since their February lows as fears of disruption by artificial intelligence have calmed.

Why it matters: While we think the AI disruption narrative was overblown, we believe Technology One’s headwinds extend beyond substitute solutions. We think markets are extrapolating recent top-line growth, which has been artificially boosted by historically high inflation and population growth.

  • Although neither looks under control yet, we think the political climate is shifting, especially on migration.
  • We think a combined through-the-cycle contribution from inflation and population growth is about 4%. The average contribution over the last three years was 7%. Public sector hiring and dwelling price appreciation have also been unusually supportive recently.

The bottom line: We maintain our fair value estimate of $22 per share for narrow-moat Technology One. Shares screen as materially overvalued following the recent rally. Our estimate implies a forward price/earnings ratio of 45 times, supported by a 10-year forecast revenue compound annual growth rate of 11%.

  • We expect revenue growth to moderate from the high teens Technology One has enjoyed over the past three years as underlying drivers normalize, to midteens this year.
  • Moreover, this is still a year with elevated public sector hiring, inflation, and population growth. But dwelling price appreciation is reversing sharply and could become a headwind next year.

Big picture: The primary long-term growth driver is increased product penetration. In the near term, we think the contribution from this will be driven up to high single digits, as the company pushes through price hikes for new AI features. From the medium term, we include a mid-single-digit contribution.

Technology One’s growth increasingly narrowing to the core local Government vertical

We expect Technology One’s strategic focus to revolve around increasing the number of products used by its local government and education customers in Australia and New Zealand, including its SaaS+ and artificial intelligence products. To a lesser extent, we expect Technology One to focus on vertical expansion and geographic expansion into the UK education market.

Technology One has been highly successful in capturing the Australian and New Zealand market for enterprise resource planning software, and we expect this to continue. Technology One’s products are used by councils representing around 75% of Australia’s and New Zealand’s populations, as well as higher education institutions representing around 60% of students in the UK and ANZ. We expect these customer verticals to remain the focus as Technology One continues growing its market share in these verticals and develops a broader suite of ERP products for them.

In other verticals, such as the federal government and health, Technology One has been comparatively less successful in penetrating the market, and we don’t expect this to meaningfully improve. Technology One’s products are used by around 25% of federal government organizations in Australia and New Zealand, and less than 5% of health and community services organizations. We attribute the difference to a lower level of product-market fit. Federal government customers, we believe, have a scale that makes them highly attractive targets for nonspecialized enterprise resource planning providers, which compete heavily. Health customers have more specialized requirements that specialized health ERP providers can better serve, in our view.

Bulls Say

  • Technology One’s product suite, like many ERP software suites, is highly entrenched and sticky.
  • Technology One’s customers are some of the most sound a company could wish for, boosting customer retention rates due to the absence of business failure risk.
  • Technology One has a substantial opportunity to upsell customers its continuously expanding product suite.

Bears Say

  • Technology One already has large market share in some of its verticals, especially the local government segment in Australia and New Zealand, limiting further market share growth.
  • Technology One already offers a fairly comprehensive ERP product suite, leaving little room for growth in the number of products. Expansion beyond ERP into customer experience remains unproven.
  • Continued advancements in AI are lowering the cost of entry for upstarts or global peers.

Subscribe to get Morningstar insights in your inbox