Digital enterprise – the future is here

As businesses across all sectors grapple with digital disruption and race to embed technology across all facets of their business, a number of technology providers stand to benefit. In this article, Grant Samuel Funds Management examines digital enterprise and looks to its investment partner Munro Partners, which has adopted ‘digital enterprise’ as an Area of Interest (AoI) for its Munro Global Growth Fund.

Disruption is not new. Consider the impact on buggy manufacturers when the first cars rolled off the production line, or the gas lamp businesses when Edison created the light bulb. History is littered with examples of businesses that had their day in the sun, only to be superseded by new ideas and advancements.

More recently, technology has been the driving force behind disruption. In financial services, online trading has impacted traditional stockbrokers, has paved the way for the explosion in exchange traded funds and made it possible to buy unlisted managed funds online via mFund.

Disruption heralds change…

The Innosite 2018 Corporate Longevity Forecast highlights that few companies are immune to disruption. The company’s longevity forecast of S&P500 companies anticipates that the average tenure on the S&P500 list will grow shorter over the next decade; its research found the 33-year average tenure in 1964 had narrowed to 24 years by 2016 and is forecast to shrink to 12 years by 2027. In other words, about half of S&P 500 companies will be replaced over the next ten years.

Importantly, no industry is immune from disruption. Even those industries with well-established players can be turned upside down – think of Kodak and its failure to recognise the rise of digital photography, now widely used in MBAs, business and marketing degrees as a case study in the failure to identify and act on changing trends. Interestingly, the term ‘Kodak moment’ which once meant capturing an image for posterity, is now used to describe those businesses that fail to identify potential disruptors and act accordingly.

…and investment opportunities

In 2015, Boston Consulting Group expected the internet economy of G20 nations to reach US$4.2 trillion by 2016, representing 5.3% of total GDP, up from 4.1% in 2010. This figure reinforces not only the importance of technology, but the myriad of investment opportunities that arise. A Harvard Business Review study found that approximately 75% of non-digital companies believe their industry will be disrupted by technology in the future – so while many companies are undergoing digital transformation, there remain many yet to do so.

Investment opportunities emanate from those businesses doing the disrupting, and others from those providing the technical ‘know-how’ and tools for it to happen. Munro Partners has identified those businesses involved in digital enterprise as an Area of Interest (AoI) for its investment team and this thematic has become the largest exposure in the Munro Global Growth Fund’s portfolio.

Digital transformation has become a buzzword across markets and in corporate boardrooms and has become a key area of spending. As illustrated in figure one, Munro Partners has found there to be several sub-trends that make up ‘digital enterprise’:

• Software as a service (SaaS)
• Infrastructure as a service
• Automation
• Cyber security
• IT services/consulting

 

 

Software as a service (SaaS)

The IT market is a large addressable market worth approximately US$2.1 trillion. Given the need for businesses to transform to remain competitive, IT spending is likely to grow in 2018 and beyond, fed by tax cuts which will free up money to fund large strategic investments in technology.

Within IT budgets, as illustrated in figure two, software is increasingly taking share. With the shift to the cloud, there’s less need to spend on hardware like servers and networking equipment, which in turn frees up capital.

Within software, the shift to the cloud brings network benefits and a reduced need for a myriad of software providers. Once there were 1000s of software vendors, but in SaaS, there’s a handful of vendors that have gained and held the attention of senior management – companies such as Microsoft, Adobe, Salesforce and ServiceNow.

 

 

Case study – ServiceNow

Listed in the US, ServiceNow is the global leader in automating help desk services. Its value proposition is simple – “Get to value fast, simplify the IT experience, and make smarter decisions.”

With a market cap of US$29 billion, ServiceNow has significant economic leverage; the company is forecasting an 18%+ compound annual growth rate over the next four years. John Donahue, the CEO and former CEO of eBay, likens the opportunity with ServiceNow to that of e-commerce 10 years ago…in other words, enormous.

The business is highly regarded by its customers, demonstrated by a renewal rate of 97%. These customers include large household names, such as Adidas, Ernst & Young and Fairfax Media, and is closing in on 50% penetration of the Global 2000 companies as customers.

ServiceNow has upgraded its earnings growth as a result of continued growth in annualised contract value.  Last quarter, ServiceNow experienced 10% growth versus 4% expected growth. A re-rating is likely to occur when free cash flow kicks in and the market changes focus from an enterprise-value to revenue multiple to an enterprise-value to free cash flow multiple.

The key near-term catalyst for re-rating is a user conference and capital markets day scheduled for May 2018, where it’s believed the company may upgrade their currently long term financial targets of US$4 billion revenue by 2020, versus current revenues of US$2 billion.

Digital transformation

Unsurprisingly, companies are now spending heavily on digital transformation, not just for growth, but for their very survival. This creates a tailwind for providers of cloud computing, data analytics and Artificial Intelligence (AI), a trend discussed in the article Artificial Intelligence is a Mega Trend, but who are the beneficiaries? [Carmen – please link to: https://adviservoice.com.au/2017/08/cpd-artificial-intelligence-mega-trend-beneficiaries/], published in August 2017.

When Munro Partners’ team speaks to corporates around the world, they see businesses faced with a growing threat from digital disrupters. As a result, cloud spending, which has grown considerably in recent years, is likely to accelerate aggressively in 2018; mainly because from the cost side, it’s very beneficial to corporates. It also allows companies to position themselves to capitalise on artificial intelligence applications going forward.

Munro Partners sees companies like Accenture and Microsoft benefitting from this conversation.

Automation

An increasing number of companies are engaging in a fulfilment arms race, with a primary focus on the shift to e-commerce. People want convenience, and they want their items delivered to their home within 24 hours. Amazon can do this, and Munro Partners believes other retailers around the world follow suit.

As a result, Munro Partners expects heavy investment into automation in 2018 and beyond. Machine vision is the key code that most retailers need to realise this fulfilment, and its where Munro Partners believes there will be significant investment.

Transformative M&A

M&A firms will be significant beneficiaries of the US tax changes enacted late 2017; the new tax code allows large US corporates to repatriate huge amounts of offshore foreign earnings, estimated to be approximately US$1.4 trillion. The ability to repatriate offshore cash is becoming easier for US corporates and again expect other countries to facilitate a similar process.

Where could this money go? Munro Partners believes Disney’s purchase of Fox late last year provided a good insight and believes M&A will increase. With disruption accelerating and companies getting very little benefit for buybacks, particularly if they are in the wrong position, corporates will try and change the narrative, something Disney did quite successfully with Fox.

Over the longer-term, Munro Partners believes that earnings growth is most important. According to Munro Partners’ CIO Nick Griffin: “Valuations will mean-revert – they’ll always move around. In the long run, earnings growth will ultimately drive the great winners of the future.”

Faced with the growing threat from digital disruptors (Amazon et. al), companies need to spend to continuously grow, but they also need to spend capital and invest to remain relevant in a rapidly changing landscape. The competitive environment is being disrupted by well-financed non-dividend paying entrants and traditional dividend-paying businesses are limited in their ability to fight back. Those businesses able to innovate to avoid disruption, the disruptors and the companies providing the tools for disruption are the likely corporate beneficiaries of this trend.

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Grant Samuel Fund Services Limited ABN 48 129 256 104 AFSL 321517 (Grant Samuel Fund Services) is the responsible entity of the Munro Global Growth Fund ARSN 612 854 547 (Fund) and is the issuer of this information. The Fund is registered as a managed investment scheme under the Corporations Act 2001 (Cth). Grant Samuel Fund Services has appointed Munro Partners (ABN 58 295 538 057, AFSL 480509) (‘Munro Partners’) as the investment manager of the Fund. Class A Units in the Fund are available for issue by Grant Samuel Fund Services, as responsible entity of the Fund. This information has been prepared without taking account of the objectives, financial situation or needs of individuals. Before making an investment decision in relation to the Fund, investors should consider the appropriateness of this information, having regard to their own objectives, financial situation and needs and read and consider the product disclosure statement (PDS) for the Fund dated 1 March 2018. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Munro Partners, Grant Samuel Funds Management, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.