A high gross margin software company trading at a PE of 7
Possible multi-bagger potential
Introduction
Connexion Mobility (Ticker: CXZ) trades on the Australian Stock Exchange and sells software to General Motors and its franchised dealerships.
Market Cap: 17M USD
Entreprise value: 15.5M USD
5Y Revenue CAGR: 64%
3Y average ROIC: 30%
EV/EBIT = 6
Connexion is currently priced at a low PE (<8) since it started making profits in 2019. It has achieved a 5-year revenue growth rate of 86% and a 3-year Free Cash Flow growth rate of 17%.
Is Mr. Market unaware?
Let’s dig in.
Connexion Mobility is a SaaS company that sells its services to franchised car dealerships. It currently has 3 services:
OnTrac which has 1 customer: General Motors
Connexion Platform is an Original Equipment Manufacturer (OEM) agnostic service but also has General Motors as its only customer
A marketplace that will allow to provide 3rd party software vendors to dealerships
Their vision: To help OEMs and dealerships move people, parts, and vehicles starting with the courtesy transportation program (CTP).
When you go to a dealer to service your car, under the CTP, you will get a loaner or replacement car for the duration of the service.
What does the car dealer get out of this?
One single platform to manage all modes of ground transport
Telemetry, allowing them to recoup excess fuel & toll usage from customers
Quick reservations and integration into the Dealership Management Software (DMS)
Some major milestones over the last 3 years:
2021
Extension of partnership with General Motors for 5 years
Launch of connexion platform to be able to service other OEMs
Signing of 2 first partnership products (Tollaid and Quickride) that can be used in trials with car dealerships
2022:
Connexion was approved as a vendor by Ford and Lincoln for their car dealerships. This allows them to compete with other vendors within the Ford and Lincoln ecosystem.
2023:
Launch of the marketplace
Signing of 3rd partnership product (Privacy4cars)
2024:
Partnership with Uveye for automated loaner damage control
Over the years, new features in the software are released. Dealers can go through the marketplace and choose from a variety of 3rd party software vendors to nourish their own needs.
If successful, the company’s business model will have transformed from a SaaS software provider to a platform business.
With their first piece of software, they have built a strong integrated relationship with GM.
The future growth drivers for the business are:
Deepening the relationship with General Motors
Selling services to franchised dealerships through new features and the marketplace
Selling services to other OEM/dealerships
We’ll assess the quality of the company using our SPECIAL ranking system. Then we’ll look at what kind of future growth the market price is implying to judge how Mr. Market judges the company at this time.
How SPECIAL is Connexion Mobility?
The quality of the company will be determined by how SPECIAL the company is. We define it through 7 attributes. Each attribute has a 10-question checklist behind it.
S for Sales Strength (go towards the checklist)
P for Profitability (go towards the checklist)
E for Endurance
C for Competitiveness
I for Industry
A for Asset Agility
L for Leadership
Sales Strength
The OnTrac platform used by GM car dealerships to manage their loaner fleet generates revenue related to the number of cars loaned. Revenue varies with inventory levels of new vehicles.
The new Connexion platform provides several benefits:
There is a subscription fee independent of the number of vehicles
It allows used vehicles to be provided as loaners which reduces the dependence on new vehicle inventory
Revenue has increased significantly in 2023 due to General Motors' policy of mandating all its dealerships to use the Connexion platform.
Since then, revenue growth has been much slower.
Most of Connexion’s sales are recurring. About 8% is generated as a one-off service or specific development for General Motors.
Here’s a more detailed analysis of sales over the last quarters:
The weaknesses in sales strength are:
Signs of weakness low single-digit revenue growth over the last quarters
Variation in product/services: Limited at this time
Sales are only in the United States
Massive concentration risk: 99% of revenue comes from GM
Although Connexion has been added to the approved vendor list of Ford and Lincoln, as opposed to GM, there is no obligation of the dealership to use Connexion. This approval allows connexion to compete with other vendors.
➡️Sales Strength Verdict: 6/10
Profitability
Gross profits and operating profit margins are high and increasing.
Maybe go a little bit deeper into the expenses discussion and evolution of growth?
As opposed to other software companies, Connexion immediately expenses development costs. Most costs are accounted for in operating expenses.
Investments made are the hiring of new staff to further develop their platforms. The annual report does not include the number of staff, but LinkedIn provides a staff count of 38.
➡️Profitability Verdict: 8/10
Endurance
Our Endurance checklist looks at the strength of the balance sheet and how resilient the business is. Can it withstand regulatory changes or downtrends in the economy? How long can the company endure?
Connexion has a strong balance sheet. It has no debt.
Here’s an overview of their cash position and receivables versus their payables.
Their cash position follows the evolution in revenue. At the drafting of the annual report for 2023, their cash position was a lot lower than the past 3 years, but receivables was a lot higher. The overall level can be considered stable as compared to the last 3 years.
Connexion is liquid, with current assets being 6 times current liabilities.
As we’ll discuss in more detail in the asset allocation paragraph, part of the cash position is used to buy back shares.
The business is highly dependent on General Motors. It is not a defensive business, but even in a slowdown of new car sales, cars will need to be serviced, and loaners will still be made available. The strengthening of the business model with a recurring fee has made the business more durable.
The industry is competitive and future innovations might disrupt the business.
Management presents a long-term view, a vision, and a strategy to achieve this view:
➡️Endurance Verdict: 7/10
Competitiveness
Every business with a MOAT has a great ROIC. But every business with a high ROIC doesn’t necessarily have a MOAT.
Connexion manages to generate great returns with very little invested capital.
Their main competitive advantage is their integration with General Motors, which, if it continues, provides a barrier to entry for competitors into the GM ecosystem.
The difficulty over the last quarters to sell their service to other OEMs shows the competitiveness of the market.
It is difficult to judge pricing power at this time. Their latest partnership with Uvey will not be accompanied by an increased price to provide more value to dealerships and their customers.
A short-term pain for a long-term gain?
When going through our MOAT checklist, we arrive at the following:
There are increasing switching costs with GM, but not with other OEMs
There are no network effects
There are no patents
Connexion does not have specific distribution capabilities
Their main competitive advantage lies in the team, their software development skills, and future R&D which can lead to more products.
We conclude that Connexion at this time, does not have a durable competitive advantage (MOAT).
➡️Competitiveness Verdict: 3/10
Don’t be surprised by such a low score. Only established MOATy companies with clear dominant market leadership have higher scores.
Industry
Connexion sells software to cater to the connected car industry. More and more cars are interconnected which will allow live telemetry, over-the-air updates, and other future solutions.
Here’s a quick overview of the industry:
Where TSD Mobility Solutions is the clear market leader. TSD is a private company, so I was unable to uncover revenue estimates.
Here’s an overview of the market from the 2022 AGM:
Connexion caters to a niche. The mobility technology market is big, with lots of players and niches:
Where connexion competes inside the Fleet Management and Connectivity division.
The Fleet Management software market as a whole is expected to grow at an 18% CAGR between now and 2031. It is estimated at 21 Billion USD worldwide at this time, with about 1/3rd attributed to the United States.
There are no barriers to entry.
There is a secular trend with more and more cars becoming interconnected and OEMs looking to provide more value through this interconnection.
The business could be disrupted. If a new business comes around with a better product at a lower price, General Motors could decide to change depending on the size of the switching cost. Let’s not forget. General Motors made 10 Billion USD in net income in 2023. A dealership itself has a low profit margin of a couple of %. If for some reason, General Motors decides to change its software provider, it will not make a dent in GM’s financial statements. It could momentarily hurt the dealerships though.
However, as long as Connexion provides more and more value to GM and its dealerships, the switching cost will continue to rise and a true partnership will be established.
The fleet management software market may not change as fast as a consumer-facing software product, but it is still a fast-changing market.
➡️Industry Verdict: 6/10
Asset Agility
Connexion is asset-light. All investments are expended immediately. Therefore, CAPEX on the balance sheet is low.
Their R&D expenses for 2022 and 2023 were about 17% of revenue. SG&A sits at 39% and is lower than in the past.
Here’s an overview of the cost structure compared to gross profits:
Management is very clear and transparent regarding capital allocation. This is something rare in such a small company.
They buy back shares, at the minimum to offset the Shareholder Loan Program and the performance rights plan. They have stated to continue to do buybacks but the focus remains on the operational, on the business. If they feel some opportunities would be more interesting from an operational point of view, then the buybacks would cease.
Despite the buybacks, the total share count has increased. So the promise of offsetting the share issuance has not been met in 2023.
Here’s the detail from 2022 to 2023 from the annual report
The loan program allows employees to buy into the company. The 14 Million shares awarded through the performance rights program amount to 140,000 AUD. This needs to be compared to 6.6 Million USD in revenue or 1.1 million USD in Cash from Operations. Respectively this is 2% and 13%.
Is this elevated? Not when you compare it to Stock-Based Compensation in the IT sector:
There have been no acquisitions and management hasn’t stated anything related to this. They focus on developing and building their software products and trying to get a foothold with other OEMs.
Although you might think the cash conversion cycle to be negative for a SaaS company, this is not a consumer-facing SaaS business.
Here is the aging of trade receivables from the 2023 annual report:
The cash conversion cycle sits at about 49 days based on the annual report data and is stable.
We mentioned that the ROIC was pretty high in 2023 at a level of about 73%. However, the company does not reinvest everything it generates in cash. We calculate a reinvestment rate of just below 50%.
➡️Asset Agility Verdict: 8/10
Leadership
About 27% of the company is insider-owned.
Within the table below an overview of the major shareholders:
Aaryn Nania was the Chief Investment Officer at Lucerne Investment Partners. Lucerne had an important stake in Connexion Mobility in the past. When Guy Perkins resigned in 2020, Mr. Nania became Interim CEO and permanent CEO at the company.
Here are the details from the remuneration report as stated in the annual report:
The salaries of the CEO and CFO are average for this size of company.
As the wise Charlie Munger says: Show me the incentives, and I’ll show you the outcome.
As mentioned before, the CEO has a right to a performance share plan. Here are the incentives:
The first three conditions were met and the CEO was awarded 4.5 M shares.
We would prefer a free cash flow per share objective but have seen worse.
The CEO and CFO also used the Share Loan program in 2022:
In addition, the CEO bought shares in the open market. The sum of all these provides him with a 6% ownership percentage in the company.
The AGM presentations provide information about the company’s vision and long-term strategy. It also provides some radical candor.
From the latest AGM presentation in 2023:
What went well?
What didn’t?
What can we do?
This is something I would like to see in every company presentation or hear in an earnings call. Alas, most management teams are focused on selling the perfect image.
Finally, I couldn’t find a lot of information on work culture. Glassdoor provides a 4.8/5 from 5 reviews. The annual report states that there hasn’t been a resignation in 2023.
➡️Leadership Verdict: 8/10
Valuation
We look at 3 things:
A reverse DCF analysis: What is the market implying?
An expected return model for different future PE multiples
The no-growth equity bond comparison
You can download the Excel templates from our Tools section.
Reverse DCF scenario analysis
What is the current market price implying? Let’s look at different scenarios.
In 2023, Connexion generated a free cash flow of 1.9 Million AUD. If we assume:
A 10-year DCF
A 15% discount rate (I increase the hurdle rate when dealing with microcaps)
A 2% perpetuity growth rate
Then for different starting Free Cash Flow levels and 10-year growth rates, the following reverse DCF provides these scenarios:
A 1.9 base FCF (2023 result) and 0% growth is the no-growth scenario. Even at 0 growth, we’re not quite at the intrinsic value yet
If the company grows its FCF at 10% over the next decade, then it is undervalued (Intrinsic Value/Enterprise Value = 46%)
The market is pricing in a no-growth scenario for the company, probably related to the fact that it only has 1 single customer or the fact that it is less known (although there is 9% institutional ownership)
In the last 3 years, it has increased its FCF at a 17% CAGR.
From this point of view, Connexion seems to be attractively priced in the market.
Earnings growth heat map
If we look at the current P/E multiple and apply our hurdle rate and an estimated buyback yield for the future, we get the following heat map for different earnings growth CAGRS and P/E multiples:
Growth over the last quarters has been slowing down, and future growth towards new services and new OEMS still needs to be proven.
To reach a 15% hurdle rate, without multiple expansions, earnings growth needed over the next decade is 13%.
EPS has grown at a 23% CAGR over the last 3 years and 10% over the last 5 years. The decision of GM to expand connexions offering to all their dealers contributed to this in a big way. 13% means doing a little bit better over the coming 10 years as opposed to the last 5 years.
However, if the company manages to grow at 10% over the next decade, the market should rerate the multiple if ROICs remain as high as they are now.
From this point of view, valuation still seems attractive but looks less undervalued as important growth will be needed knowing that GM can no longer expand the offering as all dealerships are now being services inside the ecosystem.
The operational focus and prowess of the company will determine the outcome.
The equity bond/No growth
Let’s look at the free cash flow yield compared to the US treasury.
If the company stays stable with no growth, you could look at a 9% return. The risk if of course from another category compared to the US treasury.
Conclusion
How SPECIAL is Connexion Mobility?
Let's compare Connexion and Semler Scientific to get a better understanding of the final scoring:
Semler Scientific
Connexion has a lower Sales Strength because it only has a single customer
Both companies are very profitable with high gross margins
Both companies have no debt and a strong balance sheet
Connexion is still early in its lifecycle. It still needs to build its competitive advantages
Semler and Connexion operate in competitive markets with low barriers to entry. But the markets are growing.
Although Connexion is a small company, it performs some buybacks to create shareholder value. The CEO is a former professional investor at a fund and is very aware of capital allocation
The contrast in communication and presentation between the companies is pretty stark. For Semler, there is no clear vision or strategy for where the company wants to go in the future. For Connexion, there is a roadmap with specific KPIs that are tracked to pave the way for the future.
The Quality value (the average of each SPECIAL score) for both companies is 63%.
But I prefer connexion mobility as opposed to Semler. Semler’s past performance is better, but it has a lot of problems to find its way into the future. Connexion does not have a great past tracked record when going back to the IPO. But it has found a niche, where it is diving into and there is a clear pathway toward the future.
Connexion has shown great performance in sales and profitability in the past and they have a solid Saas business model in the fleet management software industry.
They have a strong balance sheet good leadership and pretty good capital allocation.
Connexion has some vulnerabilities:
They only sell a single service to a single customer
They have been unsuccessful in selling their services to other OEMs
Their competitive advantages are unclear. GM might change its software provider if needed
The price in the market seems attractive based on our reverse DCF and earnings heat map.
I hope you enjoyed this first look into Connexion.
Disclosure: I hold a starter position in Connexion because of the single customer risk. Watch out for the low share turnover.
As always, may the markets be with you!
Kevin
I came upon this idea through an X-space where the talented investor Jakub Kreuzmann pitched this idea. You can check out his article below. Use google translate.
Great Deep Dive!
Too risky and only at 20 m market cap. Very easy to be killed by competition. But numbers look good, I have to admit. Maybe wait a couple of quarters and buy a company that will have become a bit stronger?