Description

CSAM is the leading provider of specialised software for healthcare in the Nordics. We believe the quality of the business is very high because of the predictability of the revenue stream, the high operating margins and a very strong outlook for growth. We refer to Astor’s write-up from March 2021 for more background on the company. The share price has declined approx. 50% since his write-up as a result of the general negative market sentiment and the company reporting disappointing earnings. Acquisitions of break-even or loss-making companies and growth investments have depressed operating margins. We explain below why we believe that 30% operating margins are within reach. If our analysis proves correct this investment should generate an attractive return with strong downside protection.

Business

CSAM is the leading provider of specialised software for healthcare in the Nordics. Its highly specialised software solutions are instrumental in the clinical care processes of healthcare providers and in enabling first responders to guarantee and enhance emergency services. Products include niche solutions in public safety, connected healthcare, women and children’s health, laboratory information management systems (LIMS), medical imaging, medication management and health analytics.

95% of CSAM clients are public hospitals in the Nordics. In terms of customer concentration, the largest contract (SOS Sweden) represents 12% of sales and the second largest represents 5-6%. Clients are given the choice between SaaS and a license/maintenance contract.

Most of the workflow processes for hospitals are highly specialised and take between 5 and 15 years to change. Software connected to the critical workflow therefore generates predictable recurring revenues over a long period. This is reflected in a churn rate of less than 2% and recurring revenue representing 70% of total sales.

Competitive pressures are low for both the existing products and the add-on’s CSAM develops. Changing the processes CSAM is involved in is all about process and planning (tender, roll-out, testing etc.) and their software is considered a crucial but small component. Competition is only an issue when they try to acquire another company as well as for tenders.

Scalability and size matter owing to the importance of CSAM’s software. For example, all emergency calls in Norway and Sweden are handled by CSAM software. It’s about life and death. Over time, the company created additional components and therefore customers became more and more dependent on them. Size matters in that respect. Clients are generally happier dealing with a larger company because they feel the process is more commercial, industrial, safer, and predictable.

Growth

The company estimates the market for their specialised software at NOK 3bn in the Nordics and the European market at 10x that size. With run-rate sales of NOK 400m and 13% market share in the Nordics, CSAM is the largest player in a fragmented market with many small companies and niches. This gives CSAM the potential to grow revenue at 40% p.a. through organic growth and M&A in the Nordics & Europe (as they have done in the past).

CSAM grows organically at 5-10% p.a. through new users, add-on components and annual price increases of 2-3%. Growth is supported by the increased adoption of technology in healthcare and this trend is likely to continue in the future. The large tender win in Denmark and increased order backlog give good visibility to mid-term organic growth.

Management has successfully completed about a dozen M&A deals, providing some confidence that they can continue executing their roll-up strategy. CSAM acquires software companies with recurring revenue, intellectual property, robust code and personnel to maintain that recurring revenue. The acquired companies are typically very small (sales of $2m), highly specialised, focused on one country and lack the scale to be profitable. For CSAM, these targets are very interesting for what they can do with the cost structure and growth through connecting with their own software solutions. CSAM adds quality management, a 24/7 single point of contact, common methodology, common test centres etc. to improve the cost structure required to support the highly recurring revenue stream. Additionally, small companies are generally not very good at maximizing the revenue per client. During the 24-month integration process, CSAM focuses on increasing prices, growing recurring revenue per client and selling additional products or services. 

Historically, acquisitions have been done at EV/Sales of 1-2x, with a Buy-Integrate-Build strategy to boost margins to 30% after 2 years.

Management has an ambitious sales target of NOK 1bn by 2025, as they continue to execute on their acquisition strategy and organic growth initiatives

Operating margins

Management shared with us that a 30% EBITDA margin with a cost structure supporting their growth plans (50% margins if they stopped growth investments) is realistic. Historically, the reported margins have been significantly lower, as the acquisitions of break-even (or loss-making) businesses depressed margins until CSAM completed the integration. Recently, the company decided to increase its growth investments, mainly by adding personnel and this depressed margins even further.

CSAM has gross profit margins of 90%. CSAM does not pay for distribution and day-to-day customer support, that is done by the hospitals themselves. Hospitals have their own IT departments delivering and installing the software and supporting the software users. CSAM delivers its software to a team of IT professionals who take care of the rest.  Therefore, CSAM’s costs are low.

In a business with high switching costs, growth results from developing new modules and M&A. More than 80% of organic growth comes from upselling to existing customers. The company’s strategy is to develop new functionalities and modules in close cooperation with its customers. This results in a highly efficient organization in terms of sales and R&D. 

In Q4 2021 the company reported a significant increase in operating expenses, mainly because of new hires. Management clarified this decision by the increasing backlog, amongst others from a large tender win in Denmark. They believe the impact on profit margins will be temporary.

CSAM achieved an adjusted EBITDA margin of 29% in 2020 (a period without acquisitions during Covid). In combination with very high gross margins and structurally low costs for sales, R&D and customer support this gives us confidence that normalized margins of 30% are achievable.

Valuation

The company trades at 26x our estimate of current underlying net income without further acquisitions and assuming an EBITDA margin of 30%. Based on the management plan of 1bn revenue by 2025, the multiple drops to 10x net income. In the unlikely scenario where the company would make no more acquisitions, we are paying 14x our estimate of 2025 net income. This strikes us as a low multiple for a business with very predictable cash flows growing organically at high single-digits. Management believes that EBITDA margins of 40-50% can be achieved if the cost structure is adjusted for a mature business. Based on this assumption we estimate mature net income at NOK 220m on NOK 1bn revenue in 2025, which translates to a P/E of 5x.

Management

CSAM is managed by Sverre Flatby (CEO) and Einar Bonnevie (CFO), who together own 21% of the company. Sverre and Einar have been with the company since 2006 and 2008 respectively, and have a good track record both as operators and acquirers.  

Conclusion

Poor equity market sentiment and company-specific issues have caused the share price to drop by 50%. Businesses with the characteristics we described above are rarely available at a depressed valuation. The predictability of the revenue stream is truly exceptional and protects our downside. The company has a long runway for growth, both organically and from M&A. The high gross margins of 90%, efficient sales, R&D and customer support and the fact that CSAM achieved 29% adjusted EBITDA margins in a period without acquisitions during Covid, gives us confidence that 30% margins are within reach. If our analysis proves correct you can buy a business of exceptional quality at 5x 2025 mature earnings or 10x 2025 earnings with significant growth potential.

Risks

- Poor acquisitions or operational problems in combination with a levered balance sheet

- Low valuation of CSAM shares constrains the growth rate. At current share prices, funding is restricted to free cash flow and debt. However, the management 2025 plan should be achievable without raising additional equity.

- Normalised operating margins are (significantly) lower than our assumption.

Catalyst

- Continued execution of organic growth and M&A

- Operating margin improvement as a result of operating leverage on the current cost structure