Feature: Sylogist
History
Sylogist, originally a private company named FinTech Services, began in the mid-1990s, primarily offering SAP business application software solutions to mid-sized companies in Western Canada. The company went public in 1998, made several acquisitions, and changed its name to Sylogist in 2002.
After several management changes, more acquisitions and several capital raises, Sylogist began to scale its operations with a growing focus on acquiring technology companies that offered critical solutions to the public sector and not-for-profit organizations. In 2014, the executive compensation was changed so that a percentage of the free cash flow of the business would be paid to the CEO and the CFO. This was a significant and generous compensation scheme, giving the CEO and CFO 8% and 4% respectively for a total of 12% of the total free cash flow of the company, paid as a cash bonus annually.
This incentive led to decisions that sought to increase the short-term free cash flow of the business, while under-investing in technology, cutting costs and poorly serving clients. It also enriched the management team. The CEO was paid $29M from 2013-2020. The corporation paid him another $8M as a one-time buy-out payment to end this absurd agreement and have him leave the company.
When we first met the company in 2018 there were parts of the business that we liked but we could not get past the executive compensation plan. It was clearly not aligned with long-term shareholders. They were milking the company. This was an example where poor governance and misalignment created a hard stop to our research process.
The New Sylogist
By 2020 the board had a fresh slate of independent directors, and the new CEO Bill Wood was brought in to turn the ship around. Not only was there better governance, but there was also a better strategy.
Bill Wood brings over 25 years of technology leadership experience, starting his career as a founding member of U.S.-based Blackbaud (Sylogist’s much larger competitor). Bill had also served as CEO of two other technology companies, both of which were acquired; one by Constellation Software and the other by a private equity firm.
Bill set out to refresh the technology, re-engage with customers and make key acquisitions aiming to offer a more comprehensive suite of solutions. During Bill’s first two years he made three key acquisitions, repositioned several software offerings moving them into the cloud and re-engaged and re-contracted with all the customers.
Bill also had to change the culture by investing in sales, marketing and account management to position the company for future organic growth. Adding to the complexity of turning around the business was the long sales cycle in selling enterprise-level critical software solutions. Seeing the results of these changes would take time. However, given its tainted history and the market’s impatience with slow results, many shareholders decided to move on.
Sylogist’s share price sank from $14 in mid-2021 to around $5 by the end of 2022. It was around this time that we took another look at the company to see if there was an opportunity.
Sylogist Timeline
The benefit of selling enterprise-level critical software solutions is that customers stay for a long time – not just years, but decades. It’s what we liked about this business when we first looked at it in 2018, but this time the set-up was even better as Sylogist has re-built the relationships with their customers. Previously, Sylogist had a patchwork of businesses that they bought and subsequently raised prices, cut costs and milked them for greater cashflow. There was little effort to grow the business organically.
Bill Wood implemented a strategy focusing on the best cloud-based SaaS solutions tailored for each sector to organically expand the business. The company launched SylogistMission for the not-for-profit and NGO sector, SylogistEd for the education market and SylogistGov for the government sector. Each platform is built upon Microsoft’s cloud-based infrastructure.
The Growth Opportunity
SylogistMission provides industry-leading Constituent Relationship Management (CRM) and Enterprise Resource Management (ERP) solutions to the not-for-profit and non-governmental organizations (NGOs). Many of Sylogist’s customers were acquired through acquisitions and many are only using one of their two leading solutions (ERP or CRM) – meaning in time, there is room to sell to the existing base of customers.
A more significant opportunity lies in targeting new customers, especially as their main competitor, Blackbaud, disrupts its existing customer base with aggressive pricing strategies. These are not small price increases. In Blackbaud’s own investor presentation material, they highlight that historically they would increase prices 5-6% in the first year of a three-year contract, keeping the other years stable at that new rate. The new strategy is to increase prices 15-18% during the first year and another 6-7% in year two and 6-7% again in year 3. That is like a 30-35% price increase when they are already one of the most expensive solutions in the market.
Switching can be costly and time-consuming, yet Blackbaud is providing compelling reasons for potential clients to consider a switch. Sylogist is well positioned to grow in this environment for years to come and this was demonstrated by the 31% growth that this segment experienced in 2023.
The solutions for SylogistGov and SylogistEd are still new in their markets, and we expect to see sales traction later in 2024 and more meaningful results in 2025 and beyond. Both segments have a long multi-year runway for growth.
The other growth opportunity is Sylogist’s recent effort in working with channel and integration partners. These partners are ideally mid-sized technology services companies that have expertise with Microsoft applications. They would help clients with the burden of moving their data and setting up integrations for the Sylogist solutions. Sylogist is working closely with half a dozen partners now and hopes to have 10-12 partners trained and fully able to onboard clients by the end of the year.
The partners earn all the service fees to get clients set-up and Sylogist gets the on-going SaaS revenue. Remember that Sylogist didn’t have a functioning sales team until two years ago, let alone working with partners on sales and integrations. These relationships take time, but when they are working well, we see a future where new clients can be onboarded with little effort for Sylogist – systematically adding high margin SaaS revenue to the client base. Effective partners are a strong source of referrals and act as another sales engine for the business, adding sales and implementation capacity without adding to headcount. Both CEO Bill Wood and Chief Revenue Officer (CRO) Grant McLarnon have extensive experience working with partners and we expect them to be an important part of Sylogist’s sales function in the years to come.
Sylogist has also expressed a desire to do more acquisitions that could add customer density. In this scenario Sylogist could buy a software company with an existing customer base that fits Sylogist’s ideal customer profile but is currently using an inferior technology solution. Sylogist could then migrate those customers to its more modern cloud-based SaaS solution, likely at a higher rate given the stronger value proposition.
Although we do not anticipate an imminent acquisition, Sylogist is well-prepared financially to pursue such opportunities should they arise. The right acquisition could be highly synergistic and add a lot of value to the business. We see this as upside optionality to our base case organic growth outlook.
Investment Case
Our investment thesis is underpinned by the following tenets:
We expect 12-15% compound annual growth rate (CAGR) in organic revenue driven by SaaS solutions sales, partner channel sales leverage and contractual price increases.
We expect adjusted EBITDA margins to increase from 26.3% today to 32-35% in the next 4-5 years, with incremental improvements each year from greater SaaS sales and greater partner contribution.
We believe the company is undervalued due to limited investor awareness, especially regarding its transformation under new leadership. The company’s smaller size and its tainted history contribute to it being overlooked and misunderstood.
We also think the business quality is very under-appreciated. Sylogist’s end markets are mostly public sector buyers – they are less impacted by economic downturns. Sylogist’s business model should be resilient in a recession as they sell mission-critical software and have very high retention rates, often having customers for multiple decades. Contractual price increases assure steady growth in the base business, and the sales cycles are less dependent on the general economic environment.
Another element of the business quality that we feel is under-appreciated is the heightened risk of cyber security. Sylogist’s main cloud-based SaaS solutions are built on Microsoft infrastructure, and benefit from the billions of dollars that Microsoft has invested to have best-in-class data security. Many organizations in the public sector are often targets for hackers because they harbour vast amounts of private information often on antiquated technology. We believe we are in the midst of a long secular trend of a “security upgrade” cycle that should benefit Sylogist as they focus on mid-sized public sector organizations that can’t solve this problem alone.
Optionality
We see optionality with acquisitions that could increase the revenue growth CAGR to over 20%, potentially doubling sales and tripling adjusted EBITDA within the next five years.
We also see optionality in a take-over offer for the company if its full value is not recognized in the market. If Sylogist can deliver on organic growth, we believe that other investors – like private equity – would make a bid for the company to take it private. We are seeing that today with Sylogist’s competitor Blackbaud being subject to another take private offer from Clearlake Capital.
Compelling Valuation
We made our first investment in Sylogist in early May 2023 at just over $6/share – which at the time, it was trading at around 8.3x 2023 EV/EBITDA and a 7.4% 2023 free cash flow yield. Our multi-stage discounted cashflow (DCF) analysis valued the company at $11/share under our base-case assumptions.
The opportunity was attractive on all measures in our view and it didn’t rely on the optionality of faster growth or acquisitions to make the story compelling. Fast forward one year and Sylogist’s stock ended the quarter at $8.68 – up 38%. We continue to see a compelling valuation today. Our updated DCF analysis values the company at $12/share – still another 38% upside without factoring in any of the optionality for out-sized growth, acquisitions or take-over offers.
Today, the shares trade at approximately 9x 2025 EV/EBITDA and 6.4% 2025 free cash flow yield – still very attractive in our mind given the quality of this business and our view of its growth potential. We believe the likelihood of future acquisitions is increasing, given Sylogist’s flexible balance sheet and management’s recent affirmations of how well acquisitions align with their strategic plan. Based on our assumptions, a significant acquisition – purchasing $15M in revenue for $40M with and ideal customer base – could increase our intrinsic valuation to $16/share.
Summary
The Sylogist story is both a turnaround story and a multi-year growth story rolled into one. We benefit from having met the previous management team and having looked at the Sylogist business model over six years ago. We can see the change – in better governance, management quality and business strategy. The company has repositioned itself by making the right investments for growth for the first time in its 25 years as a public company. Sometimes change is hard to see – at least at first. And turnarounds can take a long time to turn around. We are already seeing the results of the repositioning for growth, giving us more confidence that our patience will be rewarded.
What hasn’t changed? The customers. The Sylogist solutions are running critical applications and client retention is very high. The base of this business is very steady and with Sylogist’s recent efforts to re-engage with their customers they have achieved an impressive Net Promoter Score (NPS) of 51 – meaning that they have a very high number of customers that would actively promote and recommend them to other potential customers. These public sector customers don’t really compete with each other – in fact they share best practices and often seek advice from industry peers. We believe that Sylogist has taken their most significant asset (their loyal customer base) and made it much more valuable to them as a referral engine and a shadow sales force.
We expect the path to value creation to be steady and perhaps somewhat uneventful – which is perfectly fine by us. Part of the advantage of our investment process is looking a little further out on the investment horizon to recognize that the opportunity over time is very asymmetric. This requires an investor to know the company well enough to have a longer-term fundamental view and the patience to hold on.
One of the key benefits of this approach is the power of long-term compounding. Compounding is often referred to as the ‘eighth wonder of the world’, because of how powerful it can be when a company effectively reinvests its capital continually over time. In the context of our investment strategy, this means that the steady and ‘boring’ returns we aim for can significantly increase in value over the long term. This is why we place such a strong emphasis on having a long-term view and the patience to stick with our investments. We want the magic of compounding to act as a wind at our back in our pursuit of long-term performance.