Two types of software companies dominate the list of Canada’s most valuable technology stocks. There are those that generate most of their growth by expanding sales of new and existing products every quarter, such as Shopify Inc., Lightspeed POS Inc. and Kinaxis Inc.
And then there are the consolidators such as Constellation Software Inc., Open Text Corp. and Descartes Systems Group Inc., which gobble up slow-growing or declining businesses.
Enghouse Systems Ltd. is firmly in the second camp. The low-profile Markham, Ont., company specializes in paying low prices for troubled businesses that supply good quality software used in contact centres, telecommunication networks, transportation systems and for video conferencing. Enghouse quickly fixes the operations, enabling it to recoup the investment, typically within its target period of five to six years.
Stephen Sadler, who took over as chief executive from founder Claudette MacKay-Lassonde just before she died of cancer 20 years ago, is one of the most respected and disciplined capital allocators in Canadian technology.
No one will ever accuse him of building the next Google or Shopify, but under Mr. Sadler – whose 13.8-per-cent stake in Enghouse is worth more than $500-million – the profitable company has generated steady shareholder returns including 12 consecutive years of dividend increases, unlike many tech companies that don’t generate profits or pay dividends.
(Mining entrepreneur Pierre Lassonde, Ms. MacKay-Lassonde’s husband, is an Enghouse director and owns 11 per cent of the stock.)
Even with the dozen straight dividend hikes, Enghouse yields just 0.7 per cent – partly a function of a stock price that has doubled in the past year, hitting a record high of $77 on June 5 after reporting fiscal second-quarter results. (The stock closed at $69.75 on Monday.)
Revenue for the quarter ended April 30 was $140.9-million, up 58 per cent year-over-year and 13.2 per cent above consensus analyst estimates. Net earnings of 49 cents a share were up 64 per cent year-over-year, and 68 per cent above estimates.
It’s unusual for Enghouse to beat analyst expectations by such a wide margin, Stifel GMP analyst Deepak Kaushal said. All five analysts that follow the stock bumped up their price targets, with Royal Bank of Canada’s Paul Treiber, Stephanie Price of Canadian Imperial Bank of Commerce and Toronto-Dominion Bank’s Daniel Chan all moving to $75 a share.
The reason for the unexpectedly strong quarter was the 2019 acquisition of a video conferencing company called Vidyo Inc. In the era of COVID-19, it turned Enghouse’s newly acquired business into a growth machine – at least for now.
When Enghouse bought Hackensack, N.J.-based Vidyo last May, it looked like a typical deal: Enghouse paid about $40-million for a company generating $60-million in revenue. Vidyo had raised a lot of venture capital but stalled out. Revenues were declining by 10 per cent to 20 per cent annually and it was losing money. “They were very good technologists,” Enghouse president Vince Mifsud said. “From a business perspective they were not stellar, let’s just say.” Within two quarters under Enghouse’s ownership, Vidyo was generating an operating profit margin of 30 per cent.
Vidyo’s specialty was enabling health care organizations, mostly in the United States, to hold video appointments with patients over the internet, and for banks to meet virtually with customers. When the pandemic sent everyone into isolation, use of video conferencing software spiked: Zoom Video Communications Inc. reported revenue in its most recent quarter increased by 169 per cent year-over-year. Analysts aren’t exactly sure how much Vidyo business spiked in the quarter – Enghouse doesn’t break out the exact numbers and Mr. Sadler told analysts only that revenues “exceeded our expectations by a significant amount.”
“Did they luck in by buying a video conferencing company that specializes in telehealth for hospitals across the U.S. right before a health crisis? I mean, yeah, who can predict that?” Mr. Kaushal said. “I think it will continue to sustain momentum for their business.”
That’s open to debate. Jeff Mo, a portfolio manager with Mawer Investment Management, noted that $27.3-million of the revenue increase in the quarter from a year earlier was attributable to increased licence sales, primarily of Vidyo software, that might amount to a one-time boost. Meanwhile, RBC’s Paul Treiber estimated in a note that Enghouse generated organic, or internally generated, revenue growth of 12 per cent in the quarter, compared with 3 per cent in the first quarter and 1.5 per cent last year. He expects the rate to be 5 per cent in the second half.
If the company can improve organic growth, it could increase its valuation multiple; it currently has an enterprise value of about 21 times operating earnings, in line with other consolidators and above its five-year average of 15.9 times, Mr. Kaushal said.
But even with more potential organic growth Enghouse isn’t changing its path. Mr. Sadler, who doesn’t give financial guidance, was asked on an earnings call whether he thought Vidyo would continue to generate stronger sales after the lockdown. “No idea,” he said. “We don’t want people to focus on a quarter. We try and think longer-run.”
And that longer-run strategy continues to be defined by acquisitions. Mr. Mo noted the company has spent about $150-million on acquisitions in the past four quarters; it typically spends between $20-million to $40 million a year and has never topped $65-million worth of acquisitions in any other fiscal year prior to 2019.
Mr. Mo expects the greater scale of acquisitions to continue. “There’s definitely a trend for Enghouse becoming more recognized as a top tier Canadian software acquirer and integrator,” said Mr. Mo, whose firm, Mawer, is one of the top institutional holders of Enghouse stock.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.