If you’re looking to invest in a company with pricing power as inflation surges, Toronto-based Dye & Durham Ltd. DND-T would appear to be a strong candidate: It has been boosting prices for its legal software, in some cases, at a triple-digit pace.
So why is the stock now struggling, ending a hot streak?
The company is relatively new to the stock market, after completing an initial public offering in 2020 at $7.50 a share.
It traded as high as $52.63 in February, 2021 – up about 600 per cent from its IPO – as investors embraced the company’s vision of consolidating legal software used primarily by banks and legal firms in Canada and abroad.
The long-term ambition: Generate $1-billion in adjusted EBITDA (or earnings before interest, taxes, depreciation and amortization) – up from $116.3-million in fiscal 2021.
Last month, the company announced its biggest deal to date: a $3.2-billion offer for Link Administration Holdings Ltd., a financial data and analytics firm with operations in Australia and Britain, which will significantly expand Dye & Durham’s global reach.
The bigger Dye & Durham gets, the more cash it can generate through operations and cost-savings, and the more debt it can raise to fund more acquisitions. It calls this approach to growth “a repeatable playbook.”
Besides getting significantly larger, the company is also ratcheting up the prices on some of its software.
This week, it announced that prices could nearly double for some Ontario-based clients using its real estate transaction software, as the company encourages service bundling. In November, the company hiked software used for real estate transactions in British Columbia by as much as 563 per cent.
Normally, pricing power is a magnet for investors because it implies fatter margins and competitive advantages that keep clients – especially when inflation is rising at a pace not seen in decades.
But Dye & Durham’s share price has slumped 26 per cent since the start of the year, leaving it at a 14-month low.
Some of the recent weakness no doubt is tied to jitters in the broader stock market this month over interest rate increases that could start in the United States and Canada as soon as March. These coming rate hikes have weighed on tech stock valuations.
But Dye & Durham is also facing challenges associated with its business model.
For one, price increases have reportedly angered some clients, even as they pass the higher costs onto their customers.
Angry clients aren’t necessarily a problem for some companies. After all, not everyone loves Canadian banks and telecoms either.
But in the case of Dye & Durham, the anger is prompting complaints to the Competition Bureau of Canada and may be inspiring new and existing competitors – including LawyerDoneDeal in Canada – in what has, typically, been a business with low customer turnover.
Dye & Durham’s acquisitions must also gain approval from regulators, who are showing some reluctance to sign off on deals given concerns about monopolistic behaviour, posing a potential threat to the company’s expansion strategy. The U.K. regulator, for example, has not yet approved Dye & Durham’s $156-million deal for TM Group Ltd., which closed last July, amid concerns about rising costs for home buyers and sellers.
The other risk relates to rising leverage, as the company strikes bigger acquisition deals with more debt.
According to Stephanie Price, an analyst at CIBC World Markets, the $3.2-billion offer for Link will mean that Dye & Durham’s debt could be five times the company’s expected EBITDA (earnings before interest, taxes and depreciation) over the next 12 months. That’s up from three times expected EBITDA before the deal.
That’s not necessarily a problem. The deal brings well-heeled corporate and pension fund clients that have been with Link for at least 10 years, on average, which means that the risks associated with integrating the Australian-based company should be relatively low.
Still, investors may be wary given that other aggressive Canadian acquirers have heralded big deals in the past, and then stumbled.
Most notably, Valeant Pharmaceutical Industries Inc., now Bausch Health Cos. Inc., soared through 2015 on a series of pricey pharmaceutical acquisitions before cratering under a pile of debt. By mid-2016, the shares were down about 90 per cent from their peak.
Last year, Dye & Durham’s share price rallied on the company’s growth potential. Now, investors may be more focused on the risks.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.