Technology One (ASX: TNE) has shown high-teens revenue growth in recent years, compared with midsingle digits in the years preceding it. We have revisited our analysis of the company’s various growth levers to determine if this growth can be maintained.

Why it matters: We find that underlying secular growth, which consists principally of growth within existing customers, has remained more persistent than we previously thought. We estimate this contributed around two-thirds of revenue growth over the past five years.

  • Although part of this has been driven by the pull-forward of software demand following the onset of the covid pandemic, as well as recent government spending growth, we are upgrading our revenue assumptions based on higher expected secular growth in existing customers.
  • We still believe recent growth was artificially supported by historically high inflation and population growth, which feeds through many of Technology One’s contracts. We continue to forecast this cyclical contribution to return to long-term growth rates.

The bottom line: We increase our fair value estimate for wide-moat Technology One by 17% to $21 per share. Shares still screen as materially overvalued, trading at nearly twice our fair value estimate. Our estimate implies a forward price/earnings ratio of 56.

  • We believe the market is overextrapolating recent top-line growth. Our forecasts assume revenue per customer to nearly triple over the next decade. To get to the current share price, we need to assume a more than quadrupling and for EBIT margins to expand to 50%, compared with 40% in our forecasts.
  • Management has touted growth levers to find its next leg of growth, but none of these strike us as likely to provide such a lever.

Key stats: We now forecast a 10-year revenue CAGR of 11% for our explicit forecast period, compared with 10% previously. With little additional costs required to service the faster growth, we now expect 10-year earnings growth of 14% versus 11% previously

Technology One’s secular growth remains the primary growth driver

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. 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 nearly 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 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 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.
  • Geographic expansion into the UK provides opportunity but also presents a more competitive market.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.