green butterfly
Crayon Group Holding (OTCPK:CRAYF) is a Scandinavian software and services company active in the Software Asset Management (SAM) market. This market is expected to grow at a CAGR of 18% from 2021 to 2028. In the SAM market, players control the software domains of customers to optimize their use of software licenses. Traditionally, this company has focused on Microsoft licenses with complicated pricing structures, but recently has also included cloud offerings that manage both the use of cloud resources and SaaS (Software as a Service) licenses from various vendors. As businesses’ digital transformations continue, the use of software will become more important and tools to monitor this use will become even more important. There are a limited number of players in this area, including Crayon and its wholly-owned subsidiary Anglepoint, SoftwareONE of Switzerland and Deloitte Consulting. Crayon targets smaller and medium-sized customers (although it’s getting higher and higher), while Anglepoint targets the very large customers. In its 2022 Magic Quadrant for Software Asset Management Managed Services, Gartner placed Anglepoint in the Leaders quadrant and Crayon in the Visionary quadrant.
Last quarter, margins were slightly below analyst expectations, propelling stocks and creating an opportunity for investors. A big factor in the miss is that Microsoft is trying to smooth out seasonality from quarter to quarter. Microsoft’s goal was to have a stronger Q3 (March) and a weaker Q4 (June). This led to a stronger Q1 for Crayon and a weaker Q2 and was not well telegraphed by the company and surprised analysts. Crayon has kept its annual forecast intact, so this is more of a seasonality change than a change in business fundamentals.
A smaller factor was a temporary slowdown in US sales. US growth came in at 25% thanks to the strong dollar (as Crayon reports in NOK, the strong dollar helps to translate sales from USD) and was 12% on a constant exchange rate basis. Anglepoint does have some foreign business, but until this year it wasn’t material, so all Anglepoint income was counted as US income. This year, Anglepoint foreign earnings are material, so it’s broken down into the appropriate regions, making the Anglepoint comp in the US not apples-to-apples. On a pure US versus US basis and at constant currencies, Crayon grew 18% in the quarter. This was a letdown from the 25-30% growth Crayon had seen in previous periods in the US, and there’s a reason for it. At the end of last year, Crayon made some management changes in US sales and the new leader took care of a number of salespeople and brought in some new ones. This caused a temporary downturn in the US business, but now the new sales force has been hired, and the pipeline is showing a likely return to its previous buoyant growth rates there.
Last year, Crayon made a significant acquisition ($285 million deal size) of a company called rhipe that focuses on the APAC region with a large presence in Australia. Rhipe had a similar business model to Crayon and was a good fit for Crayon, as Crayon didn’t have much of a grip on APAC before.
In terms of product direction, Crayon is focused on enhancing its cloud offering with a new FinOps platform, which will be generally available in Q4. This platform automates many of the features needed to track and budget for cloud spend, which is very important for customers. This FinOps offering has already been sold to a few select customers. Earlier this week, Crayon issued a press release announcing a win with a Germany-based global auto supplier (BMW? Mercedes?) for software asset management, FinOps and technology-related strategic advice over a three-year period. Data and AI are also a new product direction for the company. This group already has 80 employees working on a data and AI platform that can help customers with their data and AI needs. Security is also a new product initiative at the company where it will advise customers on the security of their cloud environments.
Even with a market cap of $1 billion, Crayon is not well known in the United States and has very few US investors. I think there’s an opportunity here, as Crayon’s slight disappointment in the latest earnings release has hammered his stock ever since, but the medium- and long-term proposition remains intact. The company has critical mass in the Nordic region and operates here with an EBITDA/gross profit ratio of 30% with organic sales growth in the mid-teens. The company is investing heavily in other regions and growing faster there, but with lower margins due to the forward investment. My proposition (which the company agrees with) is that over time the other regions can also hit the 30% margin and the company’s valuation will be extremely low at that point. For example, the company forecasts EBITDA margins in the 21-22% range this year, resulting in a 2022E EV/EBITDA valuation of 11.7x. Organic business growth in the 20% range has been the historical norm and I think this could continue in the future. At this rate, EBITDA margins will approach the asymptote of 30% of gross profit by 2025 and the EV/EBITDA valuation will be 4.8x. This is an unsustainable valuation and on a 20x multiplication, the stock price would be NOK 517 or 353% higher than it is now.
What are the risks of investing in Crayon? A recession could slow sales if technical spending slows, but I don’t think this is a very likely event. Businesses are focused on efficiency through digital transformation, and software spend is a key part of that. As such, this creates a tailwind for SAM players like Crayon. As the company appeals to smaller customers, there may be some churn risk if these customers go bankrupt in a long and deep recession. Finally, there is a stock overhang issue, as SoftwareONE, a competitor, has a 7.5% stake in Crayon’s stock. It was bought at the time of Crayon’s IPO, with the thought that there might be a business combination, but that seems more remote these days. As such, SoftwareONE sold 40% of its stake in March 2022 and the 90-day lock-up period has expired, allowing it to hit the market at any time. From conversations with SoftwareONE, I think it wants to maximize the value of its Crayon share and not sell at these low prices.
