As the mantra goes, buy outstanding businesses at discounted prices and you’re almost certain to do well. Problem is, quality is treasured by the market and doesn’t stay secret for long. As a result, when it comes to investing in unusually good businesses, one will generally have to navigate price risk. Recently this has been the case with billing software provider Hansen Technologies (ASX: HSN).
HSN has performed exceptionally well over the last five years with the stock more than quadrupling to a $4.60 peak in October last year. However, since then it’s share price has declined by around 25% and now trades $3.50. You need to be careful even when approaching quality businesses. In our view, it’s more interesting with a ‘2’ at the front of the share price; i.e. at or below $3.
We’ll look at valuation shortly, but first, what makes HSN such a good business? In a nutshell, it’s because there’s long-term demand for its products and it has a very strong ‘lock’ on its customer base, owing to high switching costs. This lock translates to revenue growth and pricing power, which in-turn, produces high margins.
You wouldn’t think it, but billing software is a highly complex and dynamic field in ICT. HSN has a 200-strong global client base across the energy and water utilities, telcos and pay TV sectors. These entities serve hundreds of thousands (even millions) of end users. As their services are increasingly commoditised, they try to differentiate based on customer experience and product offerings to better cater to individual preferences and usage patterns.
Think of the range of bundling options offered by telcos or of energy plan pricing options. Also, think of how easy it is to switch when a competing provider comes up with an offer that better matches your individual needs, or if your own provider’s customer service lets you down.
As well as increasingly fickle customers, HSN’s clients must also adapt to regulatory and technological change. For example, the advent of government-mandated smart metering as well as the integration of micro-scale energy generation (eg solar panels) are recent challenges in the energy sector. Telcos are constantly adjusting to increasing demand for data, and pay-tv operators are dealing with digital disruption from streaming video on demand.
This environment has given rise to complex billing software that can handle large billing volumes in an accurate and timely fashion, as well as enable new configurations for pricing and bundling to support customer growth and improved customer experience. Billing software is therefore “mission critical” in the daily operation of utilities, telcos and pay-TV operators. Switching costs for billing software, on the other hand, are very high. Integrations generally take several months, and switching carries significant decision risk as providers can’t afford disruption to their services.
HSN was formed in 1986 by Kenneth Hansen after it was contracted by Telstra to develop a telecommunications billing system. From the mid 90’s the company focused on developing and acquiring proprietary billing systems software. The business listed in 2000 with its flagship HUB product, which aggregated internally developed software and previously acquired billing systems catering to the energy sector.
A continuing global key trend over the last 30 years is the deregulation of the telecommunications and utilities sectors. This involves breaking up vertically integrated monopolies into component functions to enable competitive pricing and service provision. As a result, there has been a significant increase in the number of operators which, in conjunction with elevated corporate activity, has translated to strong demand for billing software upgrades and integrations.
Australia and New Zealand were relatively early initiators of energy market deregulation, which party explains why each has birthed globally competitive billing software providers in HSN (Australia) and Gentrack (NZ). This is shown in the chart below with competitive energy markets in Australia, New Zealand and Europe (dark blue) and partially competitive markets in North America and parts of Asia.

Figure 1: Energy billing software competitor matrix (LHS), Global energy market liberalisation (RHS)
Source: Quindi Research, Gentrack
More recently, HSN has diversified into water utilities and pay TV billing software to capitalise on water deregulation in the UK and US, and strong growth of Pay-TV in developing markets. This was mainly via seven acquisitions totalling $91m over the last seven years. The influence on HSN’s exposure across market segments may be seen in the figure below.

Figure 2: HSN billing market exposures in FY11 and FY16
Source: HSN
To date, HSN has proven to be an impressive acquirer of niche billing software providers. For starters, each has been acquired at multiple of earnings of 7 times or below. In contrast, HSN’s stock trades on the public market at about 21 times. The result is that each acquisition has been highly EPS accretive.
As the next charts show, as well as driving very strong revenue growth, HSN has been able to increase margins following integration of acquired software. Particularly of note was the acquisition of energy market data management provider Utilisoft, which HSN purchased for $2m in 2013. Utilisoft generated $2.8 profit a year later, which means the payback period for the entire investment was less than a year. An alternate way of looking at it is that, capitalised at HSN’s PE of 21 times, Utilisoft is arguably worth $59m on the public market. We believe that any operator who can execute that type of transaction in the public market should be applauded.

Figure 3: HSN revenue and EBITDA trends
Source: Clime
Other things to like about HSN include its very strong cash conversion, with operating cash flow exceeding earnings in each of the last five years, a perennially strong balance sheet currently in a $15m net cash position, and alignment of management and shareholder interests owing to CEO Andrew Hansen’s 20.61% ownership in the company.
Given the strength in the underlying business, our investment decision making is mainly a matter of price. The stock’s PE of 21 times implies strong growth, and although revenues have increased strongly in the last three years, this has been largely driven by acquisitions. The downside of an industry characterised by sticky clients is that HSN’s client acquisition tends to be slow.
Organic growth from price increases, project revenues, and end user growth is more realistically in the single digits. HSN’s management admit as much and has suggested 4% to 8% growth is achievable absent of acquisitions. Presently, about two thirds of revenues are recurring, while the remaining project revenues can produce swings in organic growth. The next chart illustrates the contribution of organic and acquisitive growth in recent years.

Figure 4: HSN organic and acquisitive revenue growth contribution
Source: Clime
In sum, to achieve good leverage to potentially lucrative acquisitions, we believe it’s best to seek an entry price that only assumes modest organic growth of mid-single digits. Our valuation based on a 6% growth rate is $2.73 in FY17 and $3.01 in FY18. Based on HSN currently trading at $3.57, this indicates the broader market have considerably more acquisitions priced-in.

Figure 5: HSN future valuation
Source: Clime/StocksInValue