Checking-In with Agilysys (AGYS)

We met with CFO Tony Pritchett at Agilysys’ (AGYS) headquarters in Alpharetta, GA last week. The meeting was introductory in nature and focused on the company’s evolution, product portfolio, go to market initiatives and recent financial results. Our initial impression is that the bull case for buying shares is likely rooted in Agilysys becoming recognized as the next great vertical SaaS story, while the bear case may arise from potential risk in the numbers due to end-market weakness or a painful SaaS transition, neither of which are issues today. We also note that in order to satisfy investor redemptions, funds controlled by Chairman Michael A. Kaufman recently transferred approximately 2.9MM shares of AGYS to Bermuda One Fund, which plans to engage in the orderly liquidation of those shares. This could of course pose an overhang on shares near-term, but given AGYS’ limited liquidity historically, perhaps this may also represent an opportunity for interested investors to acquire a stake. We present the Agilysys story and encourage investors and other interested parties to provide us with any insight that may inform our views in the future.

Agilysys provides a broad suite of software and hardware solutions to the hospitality industry, including casino and gaming venues (55% of sales); hotel, resort and cruise operators (26% of sales); and foodservice management groups (18% of sales). Standalone restaurants, universities, stadiums and healthcare facilities also comprise the hospitality industry, but Agilysys generates only 1% of sales from this customer set. Rather, Agilysys chooses to focus mainly on enterprise-scale organizations with complex operations spanning multiple properties, concepts, activities and locations. The company’s products include InfoGenesis for point of sale (POS); LMS and Visual One for property management (PMS); Eatec and SWS for managing inventory and procurement; and DataMagine for document management. These legacy products comprise over 90% of TTM sales with the company’s new rGuest hospitality platform accounting for the remainder. In essence, Agilysys’ customers can rely on the company for everything from room and table reservations to managing the guest experience from arrival through departure to payments and everything in between.

Mr. Pritchett joined Agilysys in 2012, initially serving as controller of the company’s Retail Solutions Group and eventually being appointed Senior Director of Operations as well. At the time, the company had just divested its Technology Solutions Group with an eye towards focusing on higher margin growth opportunities in the hospitality and retail verticals. With a war chest of approximately $100MM, Agilysys embarked on an ambitious effort to develop a next-generation platform for the hospitality industry. In mid-2013, the Retail Solutions Group was sold to Clearlake Capital Group and Mr. Pritchett opted to remain with Agilysys. While investment in the next-generation rGuest platform continued in earnest in the ensuing years, the company was unable to launch an end-to-end solution prompting the Board to initiate a CEO succession plan during the latter part of 2016. Separately, then-CFO Janine Seebeck resigned to accept the same position elsewhere, leading to Mr. Pritchett’s appointment to Interim CFO. In January 2017, Ramesh Srinivasan was appointed President and CEO, and six months later, Mr. Pritchett was named CFO.

Under the new executive team, the company re-committed to supporting its legacy customers and products, which had been neglected to an extent given the prior focus on next-generation solutions. However, the company still remains intent on bringing new innovation to market on the rGuest platform and opened a development center in India last year that has already grown to 350 employees. Management’s current vision is to leverage the proven capabilities of its legacy solutions, while extending or adding to those via new applications built on the rGuest platform. For instance, rGuest Buy is a consumer-facing POS solution enabling customer self-service at kiosks deployed in restaurants, while rGuest Express Kiosk is an extension of Visual One and allows guests to check-in and check-out at kiosks, bypassing the front desk. We believe that over time, rGuest could in fact develop into a fully-fledged cloud native platform for the hospitality sector, but the transformation to a pure SaaS company will not be a near-term phenomenon.

Agilysys goes to market with a direct sales force comprised of approximately 35 quota-carrying reps. The sales team is organized by vertical and sells those solutions appropriate for their market segments. The company’s POS solutions are typically priced per terminal per month, while PMS solutions are generally based on a cost per room per month. Emerging products on the rGuest platform generally garner an additional upcharge of anywhere from 25%-50%. The company maintains a hybrid model comprised of both perpetual license sales and newer SaaS agreements.

From a financial standpoint, management’s strategy appears to be paying dividends already. Net revenue for FQ3 ‘19 increased 15.0% Y/Y to $36.0MM, while adjusted EBITDA reached $2.1MM, representing a 5.9% margin. Recurring support, maintenance and subscription services revenue increased 12.4% Y/Y to $19.3MM, reaching 53.7% of total revenues. Products revenue increased 25.5% Y/Y to $10.2MM. Per management, perpetual licenses typically represent anywhere from a quarter to a third of Products sales with the remainder being lower margin hardware revenue. Professional services accounted for the remaining $6.4MM of revenue, increasing 8.4% Y/Y. From an expense standpoint, product development stuck out most given a 38.4% Y/Y increase to $10.1MM, which was attributable to the company’s investments in its new Indian development center and the lack of capitalized R&D relative to the prior year period. Given the performance through the first nine months of the fiscal year, management reaffirmed prior FY ’19 expectations for approximately 10% growth from the $127.4MM posted in FY ’18 and $3.5MM-$4.5MM in adjusted operating earnings, defined as adjusted EBITDA less capital expenditures and capitalized R&D. Only one analyst covers the company at present, and his forecasts for the coming fiscal year include $159.1MM in sales and $10.7MM in adjusted EBITDA, implying shares trade at forward EV/Sales and EV/EBITDA multiples of approximately 3.0x and 44x, respectively.

At a high level, Agilysys appears to be an accelerating growth story under new management. Fueling this success is not only an emphasis on products, but also a favorable competitive landscape in which the 800-pound gorilla in hospitality technology, MICROS Systems, was acquired by Oracle in 2014. More recently, Shiji Group acquired SaaS hotel property management system vendor StayNTouch and Infor acquired POS software provider Vivonet, which may reduce competition from the upstart vendors and pave the way for a more benign pricing environment. Given this backdrop, investors may well salivate at the relatively low 3.0x EV/Sales multiple compared to vertically-oriented software plays like Blackbaud (BLKB), Real Page (RP), Tyler Technologies (TYL) and Veeva (VEEV). From a risk standpoint, the relatively high contribution of Products revenue presents the most concern given the potential for a miss should the company’s end-markets soften or an industry transition to SaaS occur more quickly than anticipated. Finally, we note that funds controlled by Chairman Michael A. Kaufman transferred approximately 2.9MM shares of AGYS that “represent the pro rata portion of Shares of certain redeemed and partially redeemed investors of MAK Fund and MAK-ro Fund” to Bermuda One Fund, which “was formed to engage in the orderly liquidation of these Shares.” A large seller could create an overhang on shares near-term, but given AGYS’ limited liquidity historically, this may also represent a buying opportunity for interested investors.