A niche software small cap to put on your radar

Any residual enthusiasm was extinguished when Alfa put out a shock profit warning in June 2018 following delays to some important customer contracts. The shares currently trade on about a third of their post-IPO peak. But this isn’t a story about a frothy tech listing that failed to live up to investor expectations. In the past few years, Alfa has upgraded its customer offering and quietly established itself as a leader in a niche market. Now, with buyout interest building, it is time to reexamine its credentials.

Specialist advantage

In hindsight, Alfa seems an unlikely candidate for a billion-pound float. Its speciality is asset finance software, meaning its customers are lenders that help companies buy or lease various types of costly equipment. According to Peel Hunt analyst Gautam Pillai, around 60 per cent of the group’s clients are banks, while 25 per cent are original equipment manufacturers, such as carmakers. The remainder are independent financial services vendors that specialise in providing asset finance to the growing number of businesses that want it. 

Put simply, leasing machinery can be more attractive than buying it because the cost is spread over a period of time, meaning large capital outlays won’t weigh on the balance sheet. From the lender’s point of view, however, these sorts of transactions tend to be more complex than a one-off loan. This is why it helps to have software that can track everything from customer creditworthiness to regulatory compliance and the depreciation of assets. 

Alfa’s product offering features front-, middle- and back-office capabilities – which is jargon that describes its function within a client’s business. Front-office applications interact directly with customers and help manage relationships, while the middle office describes everything that happens between the creation of a quote and finalising a finance schedule for an asset. Back-office programmes manage critical internal operations, such as billing and accounting. If it sounds like this technology is designed to be embedded into the fabric of an organisation, that’s because it is.

“The software is a boon and a bane for Alfa in that it takes anywhere from six to 18 months to put in place, and once it’s in you can’t take it out because it’s at the core of your day-to-day operations,” Pillai said. “Once Alfa’s product is installed, the lifetime value it will extract from the customer is significant. Similarly, it means that it’s very difficult for Alfa to displace another vendor.”

The complex and business-critical nature of asset finance software means lenders are increasingly turning to specialist providers like Alfa. In the past, customers may have relied on more general enterprise resource planning (ERP) software – made by major players such as Oracle (US:ORCL) and SAP (DE:SAP) – to meet their needs. They might also have used in-house developers to build a custom solution, but this can be costly and difficult to maintain. 

“Often when we are implementing for a customer, we're converting off one of the ERP providers or a general banking software provider,” said Alfa’s chief operating officer, Matthew White, on a March earnings call. “A more generalist finance platform was able to deal with the early growth of the product. But when it comes to specialising in asset finance, that’s a lot harder for something more general to handle.” 

Cloud cover

According to Peel Hunt’s Pillai, the total addressable market for asset finance software is somewhere around $4bn. The fact Alfa is currently netting around £100mn in annual revenue suggests there’s room to grow – and to take some of the $1.2bn share of the market controlled by the ERP providers. The real competition, then, is from other specialist software groups, and the company must continue to prove that its solutions are superior to the ones produced by its competitors. To this end, it ramped up investment in its product to £35mn in 2023 – up from £29mn the year before.

Staff numbers also grew by 8 per cent in the period to 475. Despite all the investment, however, operating margins remained enviably roomy at 30 per cent, in line with the past three years. Cash generation has also been excellent, with operating free cash flow conversion sitting at 115 per cent. 

Since its IPO, the company has also been on a journey to transition its product from an on-premise perpetual licence model to a subscription-based cloud service. Under the old regime, customers would pay a large, up-front fee for the software and a small maintenance fee for minor updates or bug fixes. Major updates and overhauls would necessitate the purchase of an entirely new licence. Under the new model, the software is hosted on cloud infrastructure (i.e. online) and customers pay a subscription fee to access it. 

The software is updated regularly and automatically, meaning there’s little cybersecurity risk to clients still using out-of-date versions. Meanwhile, the company benefits from having more consistent and predictable revenue streams. While total sales were up 9 per cent year-on-year in FY2023, subscription revenues were up 16 per cent. Management also said 90 per cent of its late-stage pipeline prospects (i.e. potential customers) were interested in a subscription-based pricing model.

In the fourth quarter of last year, the group began rolling out Alfa Systems 6, its sixth major software release since it was founded in 1990. The “functional upgrade” will give customers access to 10 additional modules and is being released via the group’s four-week update cycle. According to Panmure Gordon analyst Harvey Robinson, there are significant positive changes in the functionality and user experience of Systems 6.

“We believe this will be an important catalyst for market share gains and will also grow their addressable market,” he said.

In the past 12 months, two private equity houses have expressed buyout interest in the company, although neither has made a firm offer. The second approach, by Boston-based Thomas H Lee Partners, was actually terminated by Alfa without the consent of the potential buyer.

“Andrew Page, the co-founder and chairman, clearly has a view about this company should be run, and what its potential is,” Pillai said. “Clearly he did not see Alfa reaching that potential via Thomas Lee Partners compared to public equity markets in the UK.” 

Prospective investors should be aware that Page holds some 60 per cent of the company’s issued shares, meaning the free float is relatively small. FactSet broker consensus also puts the group’s forward price-to-earnings multiple at a relatively pricey 23.5 times for FY2024.

However, we’d argue this is a reasonable price to pay for a business with strong cash margins, an attractive niche, a growing customer base and clear takeover interest.