Fortnox: A High Growth Small-Cap with High Profitability
Fortnox is, according to themselves, the leading provider of Internet-based applications for businesses, associations and accounting and auditing firms (a big part being their offering of accounting software). The business concept is to offer a wide range of Internet-based applications that are easy to learn and use, yet is powerful and feature-rich enough to meet most needs and wishes. Fortnox has been growing at a fast pace back since it was founded in the early 2000s.
Below a page from the 2015 Fortnox annual report with my own notes (I now see that I made a mistake when I wrote 2016 which is incorrect, should be 2015 and nothing else).
Cash Offer from Visma
On March 14, 2016, Visma made a cash offer to acquire Fortnox for a total purchase price of SEK 1,406 billion, or SEK 24 per share. To read the press release, click here.
In its quaterly report for Januari-March 2016 Fortnox disclosed a non-recurring item of approximately MSEK 1 for consultations, a so-called fairness opinion, in connection with the Visma bid mentioned above. The Fortnox Board of Directors have evaluated Visma’s bid by themselves, and from taking in a fairness opinion, decided to favour Visma’s bid.
Visma’s current bid puts a total value of MSEK 1,406 for the shares outstanding, or SEK 24 per share. On the same day as the bid was made public the share price rose from SEK 18.2 to SEK 23.9, an increase of +32%. With the value of equity at MSEK 1,406, almost no debt (only MSEK 0.5) and cash of MSEK 46 at year-end 2015 (compared to MSEK 52 per March 30, 2016) Fortnox has an enterprise value of about MSEK 1,360.
Re-Engineering Visma’s Cash Offer
Reverse engineering a certain valuation makes it possible to back out what growth is implied in it, as noted by James Montier:
So, if one can’t use DCF how should one think about valuation? Well, one solution that I have long favoured is the use of reverse engineered DCFs. Instead of trying to estimate the growth ten years into the future, this method takes the current share price and backs out what is currently implied. The resulting implied growth estimate can then be assessed either by an analyst or by comparing the estimate with an empirical distribution of the growth rates that have been achieved over time, such as the one shown below. This allows one to assess how likely or otherwise the implied growth rate actually is.
Let’s see what implied growth assumptions we get if we reverse engineer Visma’s cash offer per share of SEK 24, equal to a total purchase price of MSEK 1,406.
I have put together three different scenarios, all starting with earnings per share (EPS) of SEK 0.43 (calculated by assuming 25% growth in revenues in FY2016 and an operating margin of 20% with a 22% corporate tax rate). A discount rate of 10% is used in all the scenarios.
- Scenario 1. Forecast period of 5 years with a compounded annual growth rate (CAGR) of 25%.
- Scenario 2. Forecast period of 10 years with a compounded annual growth rate (CAGR) of 15%.
- Scenario 3. Forecast period of 3 years with a compounded annual growth rate (CAGR) of 35%.
Scenario nr. 1 requires, except for the assumed 25% CAGR during 2016-2020, a terminal growth rate beyond 2020 of 6.76% to end up with an intrinsic value per share of SEK 24, equal to the cash offer from Visma. The numbers and the calculation of the reverse engineered scenario nr. 1 valuation is shown in the table below.
Scenario nr. 2 requires, except for the assumed 15% CAGR during 2016-2025, a terminal growth rate beyond 2025 of 6.76% to end up with an intrinsic value per share of SEK 24, equal to the cash offer from Visma. The numbers and the calculation of the reverse engineered scenario nr. 2 valuation is shown in the table below.
Scenario nr. 3 requires, except for the assumed 35% CAGR during 2016-2018, a terminal growth rate beyond 2018 of 7.20% to end up with an intrinsic value per share of SEK 24, equal to the cash offer from Visma. The numbers and the calculation of the reverse engineered scenario nr. 2 valuation is shown in the table below.
Discount Rates and Terminal Growth Rates
By altering the discount rate used we can solve for what terminal growth rate needed to get an intrinsic value per share of SEK 24.
See table to the right where different growth rates are shown for each of the three scenarios depending on what discount rate is applied, ranging from 8.0% to 15.0%. Depending on the discount rate used the growth rate range between 4.1% to 13.1%. What should be considered a reasonable discount rate as well as growth rate is up to each individual investor to decide.
The Trade-Off and Where to Go From Here…
I have not, and I do not, own any shares in Fortnox. Clearly, I was too late to the party and didn’t find this gem before Visma made its bid public. Without doing a lot more digging into this case it looks like Visma’s cash offer per share is reasonable. Of course Fortnox could go on and grow even faster. As always, the future is uncertain, but selling and taking the cash received to look elsewhere for new investment cases may be the thing to do. By reverse engineering the SEK 24 per share cash offer from Visma we are at least able to see what kind assumptions give this value.
Before making any further decisions about what to do, one would have to take a look at what levels of revenues that each EPS is derived from and analyze them to come up with an answer to whether they could be deemed reasonable or not. A quick look at revenues from the three different scenarios is shown in the table below. Scenario nr. 2 gives MSEK 395.8 in revenues in 2020, CAGR of 25%. This growth looks to be in line with the underlying growth in the industry (see link to analysis, in Swedish though, that I found that is referring to Statistics Sweden).
Before making any decisions one would likely want to have a closer look at revenues, both for Fortnox but also for the whole industry, to decide what levels could be deemed reasonable.
See tables below for some historical Fortnox key ratios.
- Visma, press release, March 30, 2016: Fortnox cash offer, March 30, 2016
- Visma, press release, April 30, 2016: Fortnox acceptance period extended to May 20, 2016
- Visma Investor Relations
- Remium: Fortnox Analysis
- Analyst Group: Fortnox Bull or Bear Analysis
Disclosure: I have no position in the stock mentioned, and no plans to initiate any position within the next 24 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion, and should not be considered investment advice. Always do your own due diligence and contact a financial professional before executing any trades or investments.