Business Breakdowns
· Ben Needham
[00:00:00] S1: First of all, foremost, they'll reinvest in their business organically and where they think their return on capital stacks up. You can see that, as I said in the R&D spend over time and an interesting stat there on the R&D spend is their R&D spend is actually equivalent to the total revenues of the number three player within distribution, Travelport. And their R&D spend is equivalent to 50% of the revenues of their second nearest competitor, which is Sabre. They're reinvesting a lot of capital to fortify and differentiate themselves versus the nearest competition and that's a really important point to make. They will also do inorganic spend and I think their track record has been very good here. So they bought a business called Navitaire in 2016 that was a passenger service system in the air IT vertical but overweight low cost carriers. Amadeus, because of its history with Air France and with Lufthansa, et cetera, was overweight the full scale carriers and the hybrid carriers and it had a gap in its portfolio, which was the low cost carriers. Navitaire is a leading business there. It's actually got Ryanair as a major customer and they also bought a business called TravelClick in the hotel IT space and that was to give them more penetration with the independent hotels, so doing exactly what they do with the likes of Accor, Marriott, Ascott Limited now or soon to be and InterContinental Hotel Group in the independent channel. There's larger deals that are done we think make a lot of strategic sense and the return on capital has been good. Their capital structure is very good and their leverage is less than one times today. They de-gear very quickly because they are very cash generative with high margins and a very good cash conversion. They do have a sensible dividend policy, so payout today about 30% to 40% of their free cash flow in a dividend, which steadily grows over time, pandemics aside. They're increasingly doing share buybacks. The multiple we think that they trade on is actually pretty low given the growth opportunity. They started to do share buybacks with their excess cash, which we think is a very sensible form of cap allocation.
· Matt Reustle
[00:00:00] S0: On the valuation point. I'm curious to hear how you'd frame it. Much of my research about the business beforehand, it's pretty clear they're in this funny spot where they're grouped in with a lot of the airlines or transportation stocks despite being more IT software-ish in nature. How do you approach valuation? How do you think the market approaches valuation in terms of there being a difference there? Any commentary around that would be interesting to hear.
· Ben Needham
[00:00:00] S1: I absolutely agree with you on that observation. The stock's kind of in no man's land in that it's covered by airline analysts who are used to horrible cap intensity and cyclicality, and so I think it gets tarred with the wrong brush there. But then for tech analysts it's almost not cool enough, not AI enough even though they're doing quite a lot themselves with AI. But I think because of the pandemic as well, the market is absolutely schizophrenic about the cyclicality, but the pandemic is the wrong anchor because in typical travel downturns, the volume headwinds in global traffic are not that bad. They're minus two, minus 3% is what you saw in the great financial crisis, and that's a very bad recession for kind of those broad reasons that constrains the multiple Amadeus trades on. When we think about valuation, the qualitative side of things is really important and we think Amadeus has an abundance of untapped pricing power, which it can unleash over time. It is extremely well invested as well and their R&D spend is approaching new highs and you could argue that they're about to embark in a harvesting phase where they've got their product propositions ready, they're getting commercial gains with those new product propositions, there's increasing evidence of that and as those gains come through, the R&D spend can start to go down over time. They embark on this financial model attractive phase of their history. So we like it from that lens. The cash generation profile group's very good. Pandemics aside, the free cash flow per share trends have been in the high single digits. We think it can be better than that on a forward basis with buybacks, particularly at the share price at this high teens multiple, which trades on today and also because of these new propositions that are coming through and we think Nevio's a really interesting angle in the investment case. Free cash yield today is in the 5% to 6% area, 5.5.%. You've got a business which has that type of free cash yield, which is supported, but can grow its free cash flow per share. We think in the low double digits on a risk adjusted basis. The expected return is quite juicy. We'd be very disappointed if it was less than low double digits.
· Matt Reustle
[00:00:00] S0: Certainly, I have experienced as a former sell side transportation analyst how any business that gets bucketed in there, management teams are not happy if they're not a traditional transportation business and they're covered by those analysts, it seems to be guilty by association. On the risk front, you've detailed competition pretty well in terms of the incumbents. Do they face risks from new technology disintermediating them or some new evolution that would change their positioning? Has that over time popped up in different ways?
· Ben Needham
[00:00:00] S1: This is a technology business, so the innovator's dilemma is front of mind I think when you're looking at these types of companies, but I do think the really great thing about them is they are willing to reinvest. So when you look at industry changes that have taken place, like the evolution to the new distribution capability, which is basically the airlines try to take control of their own offers as opposed to going through the global distribution systems where the likes of Amadeus did the offers themselves for those airlines. Amadeus has actually invested in its own proposition. They now have over 70 airlines hooked up to their NDC proposition and because of their scale position within the channel, they're able to offer agents both the traditional form of providing inventory via the EDIFACT GDS type model, but also sell NDC into that channel as well. They're not actually losing share within NDC, they're holding their own and within air IT, there is a potential evolution to new order management systems or offer and order management systems, but they have a Nevio proposition which they've invested in the last decade, so they're ready for that transition. And when airlines are making these transitions, it's so mission critical and there's gonna have to be smart bridging technology whilst these migrations take place from old passenger service systems to the new. So Amadeus can manage that at a low price for their airline customers. Technology risk is very large, but I do think they manage it well. That is a reason that they reinvest so heavily in research and development spend over time, and it's also why the gap's increasing between themselves and their peers. The market position is so much greater now than their nearest two competitors. That's just becoming very hard for them to keep up. If these technology evolutions do take place, it's a really big risk potentially for their peers, but potentially not so much for them.
· Matt Reustle, Ben Needham
[00:00:00] S0: Are there other risks that stand out to you? What would you highlight as a risk to the thesis or to the business that stands out the most? [00:00:00] S1: It would have to be something which was very left field, which was a technology evolution that was very hard to foresee. That was always something that's hard to guard against that, but I think that's one of the risks. A big traffic downturn is a risk. If there was a war and traffic volumes crashed, obviously being a transaction processing business, being a derivative of traffic volumes, that's going to result in revenue headwinds. But then I could also spin that into a positive because if that happens, arguably they'll take even more market share because they're so well capitalized and you'll get bankruptcy with their competitors. You would actually take market share even quicker potentially in that scenario. So the investment case for a long-term investor can hedge to a degree with that risk. [00:00:00] S0: This has been fascinating. We finish these conversations out with some of the lessons that you can take away. What's been your experience in having broader lessons that you can pull away from Amadeus and potentially apply elsewhere?