May 10, 2021
[8 min Read]
Of the many forces of society, the advancement of technology is one that is truly unstoppable. From how we obtain information to how people communicate from a distance, technology has changed the way people live their lives. The service providers of our everyday lives are consistently looking for ways to automate & improve their offerings/operations. This created a market and demand for Amdocs Limited (Nasdaq: DOX), a technology and software product/service (such as consulting) provider that serves companies in communications, media, finance, entertainment, digital, etc.
Established in 1982 In Israel, Amdocs Limited is a multinational software company headquartered in Missouri, US. For 40 years, Amdocs has been offering advanced software products and related technology services to optimize their clients' operations. With 26,000 employees, Amdocs is currently in business with 350 service providers in more than 80 countries. Their clientele comprised of leaders in a wide range of industries: telecom giants AT&T & Bell, financial institutions like HSBC, and general crowd favorites such as Amazon, 7Eleven, and Microsoft.
Most of Amdocs' offerings are provided within “amdocsONE”, a comprehensive collection of products/services consisting of: Digital Experience & Monetization; Media & Digital Services; Enterprise & Connected Society; Open Cloud Networks & NGOSS; Services & Hybrid Operations; Technology & Practices-Driven Innovation. With its “cloud-native, modular and open offerings”, Amdocs helps clients smoothly and fully transition into tech-automated, digital operations.
In such a demanded market with high-ticket clients, Amdocs recorded $4.16B in revenue during FY2020 (ended September 30th, 2020), at a 33.9% Gross Margin, 19% EBITDA Margin, and 11.9% Net Profit Margin. DOX also has consistently growing Operating Cash Flow, recording $910.7M in the Last-Twelve-Months ending in December of 2020.
Yes, everything seems to be working out well for DOX, but that brings up the question: is there still room to grow, or has DOX plateaued, making it a safe bet, but not a high-return investment?
Capital Structure & Shareholders Breakdown
A quick look at Amdocs' capital structure: 22% Debt, 77.1% Common Equity, 0.9% Minority Interest. What is important to point out here is that DOX has recorded $0 in debt for 3 straight years from FY2017-19. This is a very uncommon occurrence for a company to be 0% leveraged. In contrast, most of its competitors are operating around the 15%-25% debt/total capital ratio, comparable companies like Akamai Technologies recording ~40% leverage in its capital structure.
When it comes the shareholders of DOX, most of its outstanding shares are owned by institutional holders. Traditional portfolio managers such as asset manager firms are the biggest investors, with FMR LLC. as the largest holder. The large scale and consistent (holds & buys) asset management investment shows street professionals see DOX as a profitable, stable investment.
Overall, I believe DOX shows potential at a hold/buy for long positions if you are looking to invest in an undervalued, but experienced & matured company. The following are three main theses behind a long investment in DOX:
As an established company, we are seeing highly predictable topline growth rate with consistent profit margins. Although these no longer large-scale increases we would see on a growing tech company, DOX's consistency and strong performance is definitely a supporting factor when it comes to investment. In more detail, DOX has a 2.9% top-line 5-year CAGR as of December 31st, 2020, with corresponding 3%, 3.6%, and 10.4% 5-year CAGR with EBITDA, EBIT, and Net Income, respectively. Although top-line growth was contracting a few years prior, it has rebounded between 2015-20, which could be contributed to the increasing number of companies transitioning into digital operations/cloud systems. Nevertheless, the higher (and increasing) bottom-line CAGRs means the company is still consistently increasing its profit margins (it is important to point out in that 5Y Net Income CAGR as of Dec.31st 2020 is significantly higher than previous years, which were around 2.2%-5.3%). DOX also has a strong cash flow, largely due to steady increases in operating cash flow. The OP cash flow is the best indicator here as unlevered free cash flow has seen some small-scale turbulence in recent years due to M&As such as the acquisition of Openet Telecom, Juganu Ltd., and Veego during CY2020. Overall, DOX is a strong investment from the financial perspective due to its margin growth and consistency.
Through “amdocsONE”, Amdocs is able to provide a full-suite of comprehensive products/services that covers every stage of digital transformation. From cutting 80% of time-to-market when utilizing Amdocs bundle offers, to continuous operational support and open tools/cloud platforms, clients receive a thorough service when working with Amdocs. Within the six main categories of offerings mention above (Digital Experience & Monetization; Media & Digital Services; Enterprise & Connected Society; Open Cloud Networks & NGOSS; Services & Hybrid Operations; Technology & Practices-Driven Innovation), there are numerous individual products that allows users to customize their usage of the Amdocs' platform and offerings. For example, CES20 is Amdocs' cloud-based customer experience suite. Within CES20, there are 4 products that helps automate and digitize the users' operations: DigitalONE, CatalogONE, RevenueONE, and Service & Network Automation. DigitalONE is a cloud-based system that allows users to work on their branding and customer experience. CatalogONE is an open-cloud platform catalog solution that allows users to launch new products easily with a detailed user interface. RevenueONE is a platform that allows users to scale or acquire new revenue stream while limiting the cost of acquisition. Last, Service & network Automation is a branch covered by amdocsNEO. AmdocsNEO is a service & network automation platform that offers a wide range of tracking and management capabilities. It is used to drive and control the fast automation process of the company. The CES20 is just an example of how Amdocs products are often interconnected and deeply comprehensive. They also offer certain platforms or products/services that are industry specific.
The wide coverage of the Amdocs offerings means they can gain market penetration across numerous industries. At the same time, the stage-specific offerings allow Amdocs to stay in demand and relevant as clients transition and grow. This plays a huge part into client retainment.
Last, the continuous innovation initiatives at Amdocs supports an investment as it shows the company is consistently trying to grow and improve itself. As a tech company, it is extremely dangerous to slack-off on innovation, which is often seen with tech firms that reaches a consistent profit margin. Being in the tech industry means you live and die by the creativity and uniqueness of the offerings. Amdocs is consistently investing ~20% of their gross profit into R&D. This shows the company's dedication to innovation, which ensures that it will remain in demand in the future.
The last thesis is quite a short and simple one: the low leverage of the company means reduced risks and limits debt-related expenses such as interest/principal payments, which in turn increases their profitability. As mentioned above, there has be several years where the company literally at $0 in debt. During FY2020, the company took on ~$1B worth of debt, which could mean they are preparing for large scale development as from a financial standpoint, they are not in a situation where taking the extra cash is worth the liability. With that being said, the new debt is only 22% of the company's overall capital structure, and they will have no problem paying off the related fees as they have a strong track-record of positive cash flow.
Macro Market Trends
The overall demand for digital/automation transformation/operations creates numerous trends that can positively impact the future of DOX. With the COVID-19 pandemic, company were pushed by the circumstances to digitize their operations, which will expand the market as well as create higher demand for the future. Here are some top trends that will impact DOX's performance:
As we can see in figure 3.1, has been consistent growth in the past decade in the SaaS market. This is driven by multiple factors including the automation of internal control, enterprise centre processing system, as well as the boom of 5G and cloud-based services. Looking into the future, for the period of 2019-23, the worldwide SaaS market is expected to reach a $60.36B valuation, recording a 9% CAGR over that period.
As seen in Figure 3.2, the pandemic has already significantly accelerated the digitization rate due to the lockdowns and remote working environments. This is not a one-time catalyst, but rather a preview of what was going to happen in the future regardless; the pandemic situation has simply brought the future quicker. Going cloud or digitizing is not a temporary decision, this means the market has permanently expanded, and will continue to grow as demand increases.
Continuous developments in 5G technology will impact the SaaS industry in two ways: 1. It will increase the accessibility of cloud-platforms and related services, thus increasing demand. 2. It will improve the quality and range of capabilities for the products/services of software companies. In the modern society, it seems like life is limited if you have bad Wi-Fi connection. That is emphasized in the world of SaaS. Broader bandwidth and connection qualities will incentivize potential customers to digitalise and help service providers create higher quality products.
Financials and Valuations
When it comes to the fair valuation of Amdocs Limited (DOX), I used both comparable companies and intrinsic valuations, then weighted the price outcomes for the final target price. Instead, I evaluated the company using a basic comparable analysis. The companies included in the comparable universe are Akamai Technologies Inc. (AKAM), Ciena Corporation (CIEN), Citrix Systems (CTXS), Cognizant Technology Solutions Corp. (CTSH), and Perspecta Inc. (PRSP). The DCF valuation is relative crude with simple margin and top-line forecasts, but the results seem very reasonable and in-line with street estimates.
To finish off this analysis on DOX, there are a few key risks to keep in mind:
Although moving operations towards cloud or digital platforms will increase efficiency and limit costs, it does come with security risks. By nature of public, integrated, and/or connected cloud platforms or enterprise central systems, a large quantity of information can be easily accessed in one spot. Although that makes operations easier, it also increases the impact of hacks or other cyber security concerns. In these interconnected platforms, large amounts of information are at risks once the “first door” is opened. Hackers no longer need to crack multiple systems to acquire different information such as customer information and financials. If Amdocs gets hacked, it will likely be very detrimental to the company as large quantity of information will be exposed.
For Amdocs and the entire SaaS industry, poor internet infrastructure will limit growth potential and market penetration. If 5G usage and general internet coverage does not match the rate of innovation of Amdocs, revenue growth will stall, which might impact the pricing of the stock. It will also limit the room for innovation and enhancement, which allows more time for competitors to grow within the current infrastructure and increase the competition.
In the End: Buy, Hold, or Sell?
Overall, I think Amdocs Limited (DOX) is currently undervalued. In general, the street has a buy or hold/buy valuation on the current price, which I do agree with. Therefore, my final thoughts on DOX are: