Redeye retains its positive view of Formpipe following a Q3 report largely matching our expectations on the most important lines. While Deliveries came in somewhat short of our forecasts, resulting in a lower EBIT, the solid new sales towards banking customers and a more positive take on the ERP market were the quarter's highlights. We lower our Base Case and forecasts slightly.

The total ARR (S&M and SaaS) was SEK409m (339m), up from SEK406m in the last quarter. While the q/q growth looks weak, note that FX negatively affected SEK5.5m q/q. The total FX-adjusted ACV was SEK8.3, largely matching our forecast of SEK9m and an improvement compared to last year’s SEK6.2m.

The gross ACV was an impressive SEK16m (10), boosted by an agreement with The Swedish Transport Agency and four new banking customers, the highest intake within banking seen so far. On the other hand, the churn was also higher than usual at SEK-7m due to two larger contracts being terminated by banks in financial trouble. According to management, the record-high intake of the four new banking customers is a better indicator of the underlying development and interest for Lasernet within the banking industry.

Overall, we get the impression that management has a more positive outlook for Private ACV relative to the number seen in the quarter, which is not weak but probably below the potential growth level. In addition to the momentum in the banking sector, there are indications of some improvements in the ERP segment, primarily Microsoft Dynamics in Formpipe’s case. However, sales cycles remain longer – something we hear from basically every SaaS company. Also, based on the comments from the new CEO following a visit to the Dynamics Communities Community Summit last week, we note that Lasernet remains one of few Input/output solutions focusing on Dynamics. The offering is strong, and the challenge is instead to increase awareness among Dynamics users and prospects further.

While Public SE had small numbers regarding both S&M and SaaS ACV, Public DK had strong SaaS but soft S&M, which could indicate accelerating churn and new sales. However, according to management, the deviation is related to expansion sales, where customers are moving from S&M to SaaS. In our view, that is a much better signal than accelerating churn on S&M customers.

The ARR, both S&M and SaaS, and its growth rate (ACV) is the most important metric to follow in Formpipe. The ARR is a leading indicator of recurring revenue growth, the major driver of profit growth in Formpipe and essential to the investment case.

Total sales came in short of our forecast of SEK131m and amounted to SEK124m (117), corresponding to 5% growth y/y. As expected, the y/y growth was mainly driven by S&M and SaaS, following the strong ARR growth (ACV) during 2022 and early 2023. Recurring revenue, S&M and SaaS, grew by 23% y/y, which matched our expectations. The deviation was due to lower Deliveries in Public DK and, to some degree, because of lower Licenses (which was a mere SEK1.9m (3.4) in Q3) compared to our expectations.

Total Deliveries declined y/y by 31%. Deliveries in Private are coming down as Formpipe wants partners to take care of the delivery in the Private segment, and, thus, that is nothing we are worried about. The decline in Private was roughly as we anticipated.

For Sweden, Deliveries was up by 10% y/y, as we forecasted. Management is satisfied with the reorganization from relying on partners for sales and implementation to relying on in-house capacity and subcontracting. However, at the same time, it points out that we have not seen any major effect of the transition in the numbers so far.

We will discuss our view of the pros and cons with partners versus in-house and which strategy suits what markets in our SaaS Update Q3 2023 (expected to be published in late November). In short, we believe a local market with a rather small TAM, like the Swedish public sector, is best served with in-house resources, in line with Formpipe’s new strategy.

As mentioned, the miss relative to our forecasts was related to Public DK. While we expected a decline y/y due to some revenue in the Landburgsstyrelsen moving from Deliveries to S&M, the decrease was larger. However, our impression is that Public DK had a softer overall Q3 in terms of Deliveries, and thus, we do not cut our forecasts for DK Deliveries significantly.

Formpipe has four kinds of sales: Support & Maintenance (S&M), SaaS, Licenses and Deliveries. Support & Maintenance relates to service agreements for software sold as an on-premises license and SaaS add-on modules where the platform was initially sold as an on-premises license. The Support & Maintenance revenue is 100% recurring and largely resembles SaaS revenue with high gross margins. SaaS revenue is 100% recurring software revenue from software sold as a subscription with high gross margins. Licenses constitute on-premises licenses, and their share of total sales is low and declining. Deliveries is revenue from consulting or professional service with lower gross margins, where Formpipe integrates and sometimes customizes the software.

Overall, OPEX came in below our forecast of SEK111m and was SEK108m (110). There was no major deviation in the specific cost items. However, the number of employees decreased by eight q/q while we expected a net add of two, which, naturally, all else equal, lowers our OPEX forecasts.

According to management, the net reduction of eight employees q/q is mainly related to the Danish business following the lowered volumes from Landburgsstyrelsen. We expect Formpipe to have a slight net increase in the number of employees over the next few quarters, mainly related to the Swedish deliveries organization.

Sales expenses relate mainly to partner kickbacks and sub-consultants. In addition to the typical Other costs, like rent, software and travel, the line includes Formpipe’s Ukrainian-based offshore resources.

Adjusted EBIT was SEK13.1m, corresponding to an adjusted EBIT margin of 10.5% (adjusted for SEK1.5m in severance pay to exiting CEO). Our forecast was SEK15.1m and 11.6% and did not include any one-offs. While the margin improved both y/y and q/q, in line with management’s target of gradually improving towards 20% in 2025, we expected a slightly higher level. The lower EBIT than we expected resulted from the lower sales, due to less Deliveries in Public DK than we expected, while OPEX was roughly in line with our expectations.

EBITDA - CAPEX was SEK15.7m (-0.9), corresponding to an EBITDA - CAPEX margin of 12.7% (-0.7), somewhat below our forecast of SEK18.4m. Thus, also for this earnings metric, the trend towards higher margins and profitability is clear, although coming somewhat short of expectations in this quarter.

By the end of the quarter, Formpipe’s net debt was SEK35m, equal to 0.3x EBITDA 2023e.

As for any SaaS business capitalizing R&D, EBITDA and EBITDA margin are unsuitable metrics for Formpipe. This, as EBITDA discards a large portion of the company’s R&D costs totally. R&D is typically a high cost for most SaaS businesses. Instead, EBIT (where the capitalized R&D is amortized over time) or EBITDA – capitalized R&D/EBITDA – capex are better measures of the underlying profitability as it concerns the company’s full R&D spend.

We lowered our sales forecasts by 2-4% for 2023-2024, which, combined with a slight cut on OPEX, resulted in a 4% reduction of our EBIT forecasts for 2023-2024.

Notable changes:

We lowered our Base Case to SEK33 (35) following a Q3 report roughly aligned with our expectations. ACV remains healthy, and the expected margin expansion took another step forward in the quarter, although to a somewhat lower extent than we anticipated. On the other hand, the management’s ACV outlook in the Private segment was more optimistic than we expected. We believe strong growth in recurring revenue fueled by strong ACV in 2022 and continuing momentum in ACV during 2023, along with margin expansion, will provide solid profit growth over the next few years.

The slight decline in Base Case is mainly due to us increasing our risk-free rate in the WACC from 2.5% to 3%, following increased 10-year market rates. However, a slight decrease in EBIT forecasts also has a minor negative effect.

While Formpipe does not look very attractive on EV/EBIT multiples 2022-2023, as Formpipe focuses on While Formpipe does not look very attractive on EV/EBIT multiples 2023, as Formpipe focuses on growth, investors should focus on EV/Sales. We believe the combination of a rather low EV/sales, decent sales growth potential, and solid margin expansion potential make Formpipe interesting. The 2025 EV/EBIT of 10x hints at where the expected margin improvement and decent sales growth make with the EV/EBIT valuation. Also, considering that we believe Formpipe can reach an EBIT margin of almost 20% (19.4) in 2025, the 2023e EV/S of 2.6x is arguably attractive given the company reaches our forecasts or its 20% EBIT margin target.