More Market Uncertainty Is Coming. However, Don’t Paint with A Broad Brush. Align Yourself with Market Leaders.

We expect Enterprise Software companies to provide conservative outlooks for the 2020 calendar year. We do not expect Enterprise Software companies to completely yank their respective 2020 outlooks as have other Technology companies. We anticipate negative investor sentiment coming off of the Q1 earnings reports that is likely to overshoot the operating reality of most leading Enterprise Software companies. If your mandate requires you to stay invested, align yourself with market leading Enterprise Software companies.

• New bookings activity will dramatically slow for most Technology companies. New bookings activity has ground to a halt for many technology companies in the face of the COVID pandemic (see our recent TEK2day article for a list of industries and companies that are well-positioned to thrive in a post-COVID world). This is especially true of large deals which typically need to be nurtured in person for an extended period of time prior to signature date.
• A shift to customer retention. We wrote some weeks ago that companies will shift resources away from new sales activity and focus more resources on existing customers. In a down economy losing a paying customer is more painful than not signing a brand new customer relationship. CEOs and CFOs will focus on maximizing customer renewal rates.
• Halt to global travel hurts. Closing of borders and limited flight activity will surely have a material negative impact on sales activity. Global air traffic needs to return to normal in order for sales activity to return to normal. When this may occur is unknown and in our view an underappreciated variable.
• Work-from-home is a productivity killer. The logistics associated with migrating employees to “work-from-home” environments has hurt productivity.
  • TEK2day was surprised to learn that many employees across industries did not have an employer-issued laptop in their possession until March.
  • Working remotely is a new experience for many employees, especially within Financial Services.
  • We take infrastructure for granted in the U.S. Consider that in countries such as India electricity and broadband bandwidth is not as robust in at-home work environments as what one finds on state-of-the-art campuses operated by companies such as Infosys (ticker: INFY).
• The above bullet points paint a picture of uncertainty. Choppy seas are ahead as companies begin to report Q1 earnings later this month. We expect these earnings reports to generate uncertainty and another leg down in technology company valuations. If you have to remain invested, we can think of no better place than high-quality, market-leading Enterprise Software companies.
• “Resilient” is the word to best describe market-leading Enterprise Software companies. Blue chip customers, recurring revenue operating models, broad competitive moats and 30%-plus operating cash flow margins enable leading Enterprise Software companies to absorb the rare black swan event (we’ve been hit by two over the past 12 years), navigating choppy waters while extending competitive leadership positions.

Don’t Draw A One-for-One Correlation Between The Health of an Enterprise Software Company and Its End-Market. A Trip Down Memory Lane.

The CRE market was hit hard in 2008-2009 and investors feared this meant certain doom for CoStar Group (ticker: CSGP). Yes, bookings activity slowed. Yet revenue only declined by 1% during the 2008-2009 period before growing by 8% in 2010 and 12% in 2011.

• CSGP is far stronger today than it was in 2006-2007 heading into the financial downturn.
• Despite today’s CMBS market turmoil (we may read more about it in the days to come), we do not expect CoStar’s business to fall off of a cliff.
• New bookings activity will slow. Organic revenue growth will slow. Some CoStar customers may close their doors for business. CRE market headlines may further sour from here. Multi-family listings activity and advertising spend will slow. Yet the downside risk to CoStar’s business is likely to be materially over-estimated by investors as it was in 2008-2009 when the company got little credit for its recurring revenue base. At that time CSGP got zero credit for customers that increased their usage of CoStar products during the 2008 financial crisis. This was especially true of CoStar’s Analytics products that provided insight to various CRE global risk exposures and CRE owner global cash flows.

Advent Software (formerly ticker ADVS, now part of SS&C Technologies, ticker: SSNC), provides another example of negative investor sentiment overshooting economic reality during the 2008-2009 financial crisis. Many investors at the time were convinced that Advent’s revenues would decline by 10-20% or more (revenue actually grew during the 2007-2010 period).

• The firm’s customer base included Asset Managers of all types and sizes – most of which felt significant pain. Many smaller hedge funds closed for business, including some that were Advent customers.
• This softness appeared in Advent’s reported numbers. Yet Advent, like CoStar, continued to operate and drive the business.
• Advent’s products were (and “are”) used by Asset Management firms for portfolio accounting and related use cases. Asset Manager customers are not allowed to “turn off” this software which is essential for regulatory and client reporting pertaining to a fund’s investment activities.
• SS&C is in a similar position with investors as Advent was 12 years ago. The primary difference being that SS&C is a far larger, more durable company that generated 2019 revenue and operating cash flow of $4.6 Billion and $1.3 Billion respectively.

Align Yourself with Market Leaders

We expect the equity markets to soften from here as Q1 earnings reports come in. We are not prepared to call a bottom. However, if your fund mandates that you stay invested – align yourself with high quality, market leading companies.

• Examples include large software platform companies such as Adobe (ticker: ADBE), Amazon (ticker: AMZN) and Microsoft (ticker: MSFT).
• Leading FinTech and Information Services companies such as CoStar Group, FactSet (ticker FDS), Jack Henry (ticker: JKHY), IHS Markit (ticker: INFO), SS&C Technologies and Verisk (ticker: VRSK) also fit the bill (this is not meant to be a comprehensive list).

As we wrote last week in “The Return of Actively-Managed Funds“, this economic downturn is setting itself up to be a stockpickers market.

How might this year play out for Technology companies? Our podcast episode sheds some light.

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