Reckon (RKN)

Not your typical software investment - it's cheap, profitable, and throwing off cash.

Hi folks! I hope you enjoy this one and thanks as always for your support!

Reckon is listed on the Australian Stock Exchange and has two distinct businesses. The first produces Accounting Software for smaller companies to help with invoicing, payroll, and tax compliance. The second makes Legal Software for larger law firms, managing printing, scanning, billing, and business intelligence.

As a price conscious investor, just the mention of Software as a Service (SaaS) brings me out in a cold sweat. It takes me back a few years - to a time when market participants seemed willing to underwrite heroic growth assumptions for cash-burning SaaS businesses based on little more than a Total Addressable Market (TAM).

To be clear, Reckon isn’t this type of racy new software idea. It has a multi-decade history of profitability and pays a regular dividend (equivalent to 60-70% of Net Profit). It’s also run by an aligned and shareholder friendly management team. A team that’s intent on unlocking value through a slow and opportunistic liquidation.

This started in 2017 with the spin-off of a Document Management business. Subsequently listed on the UK’s AIM market as GetBusy, at a value of ~A$30 million. Then in 2022, Reckon sold an accountancy management tool to The Access Group (a UK private company) for ~A$100 million. A respectable valuation, given sales were ~A$23 million in 2021 and Operating profit was ~A$5 million.

Instead of re-investing the proceeds, the management team choose to pay off debt and distribute excess cash to shareholders as a special dividend.

The CEO, Sam Allert, is heavily incentivised to continue this trend and divest the remaining two businesses. Under a recently implemented incentive scheme, he receives a payout only if shareholder distributions over the next six years (to the end of 2029) reach A$150 million (over twice Reckon’s current Enterprise Value). If payouts reach A$300 million, Sam Allert receives almost ~A$6 million, equivalent to 9 times his base salary!

These incentives were implemented by a board who together own a fifth of all shares outstanding - the biggest shareholders being Clive Rabie, the Chair, with ~9% and the original founder Greg Wilkinson with ~7%.

To keep this short, I’m going to focus on the Accounting Software business (called Business Group in Reckon’s accounts). It is the obvious source of remaining value, generating over three quarters of Reckon’s sales and the entirety of the company’s profit.

This business dates back to the 1980s, when Reckon began licensing and distributing Intuit’s Quickbooks product in Australia and New Zealand. The licensing deal finished in 2016 and Reckon negotiated another agreement whereby they retain the Quickbooks software and the users. But change the Quickbooks name to Reckon Accounts.

Under this new agreement, Intuit still retains a claim on the source code for Reckon Accounts, which effectively prevents the sale of this business. Reckon has therefore been developing and marketing its own product, called ReckonOne. This is designed specifically for the cloud whereas Reckon Accounts is based on older desktop software.

ReckonOne currently lacks the functionality of Reckon Accounts, which caters to larger and more complex businesses. Importantly, over the next 3-5 years Reckon’s management team expect to close this functionality gap and migrate all legacy Reckon Accounts customers onto the ReckonOne platform.

Looking at past results, sales growth has been in the low single digits, but the mix and quality has been improving. From 2016, subscription revenue grew from ~70% of total sales to nearly 100% today. Over the same period, Cloud users grew from ~39,000 to ~110,000, and cloud subscription revenue increased at an average rate of ~20% per year. Sales of the legacy desktop product (Reckon Accounts) has been stable, but cloud subscriptions (almost entirely ReckonOne) continue to rapidly grow.

This resilience looks even more impressive when you consider Reckon’s competitive environment. It has ~110,000 cloud users, but competes directly with the public company Xero, with over 1.5 million subscribers! Despite this minuscule market share, sales have been resilient, and operating profit margins consistently above 20%.

At A$0.56 per share, Reckon’s current Market Capitalisation (and Enterprise Value) is ~A$65 million. Let’s simply compare this to the Accounting Software division, which produced sales in 2022 of ~A$41 million, Operating Free Cash Flow of ~A$11, and Operating Profit of ~A$12 million. Given the long history of solid profitability and the capital light business model Reckon seems like an absolute bargain.

But Adrian, I’ve looked at Reckon’s consolidated Operating Profit in 2022 and it was ~A$5mm. You’ve completely ignored the Legal Software business, which lost ~A$4mm, and central costs ~A$3mm. Surely we must take these into account!?

I’m not so sure. I think there’s a good argument to ignore ongoing central costs because of the likely liquidation. For example, an acquirer of the Accounting Software division is unlikely to include central costs in their valuation.

As for the Legal Software business, there’s lots of changes happening and covering these in any detail would require an entirely new post. All I will say, is that Reckon’s management has a culture and a history of running profitable software businesses. They have control, the ability to reduce costs, and are heavily incentivised to sell, wind down, or turn around this division. All options that would reveal the excellent underlying economics of the Accounting Software business.

This will not happen overnight, and will probably take years. But as a long term investor, I’m content to wait. Confident that the true value of the Accounting Software business will be unlocked - an event I’d expect to result in a valuation (or distribution) that’s multiples of the current price.

Disclaimer. This article is for informational purposes only, and should not be seen as investment advice. Please do your own research before investing in any company mentioned.