Class Limited (CL1)
Class provides a cloud subscription software service for the administration of SMSF in Australia. The model is very similar to that developed by cloud accounting software like Xero and MYOB.
The major competitor is BGL which has a cloud based solution called Simple Fund 360.
Class is the dominant player in the cloud area with around 68% market share. Overall Class has around 22% market share of SMSF’s with the total addressable market estimated at 593,000.
The organic growth in the industry last half 2017 was 1.3% and you would estimate that the overall growth would be capped at GDP growth rates. So for Class to grow then it has to expand market share which it has been doing as the following graph shows.
Demographics of SMSF
The lifespan of an SMSF is a long term. The average life expectancy for an Australian is 80+ years.
According to the ABS the median age of Australians at the end of June 2015 was 37 years*. So the average lifespan of a SMSF could be close to 35-40 years.
So we know the industry is going to be around for a long time and will need to be serviced as regulation is ever changing.
Class is the leading Cloud Provider
The following graph shows the growth in SMSF accounts on their system.
As at the end of Q3 2017 there were a total of 132,873 accounts. This is amazing growth of a base of around 80,000 at the end of FY2015.
Class has built a dominate position on the cloud with a 68% market share. The runway to growth is still long as there remains a large percentage of the market still running desktop or offline administration software.
The other attractive part of the business is the stickiness of the clients. Once a client is acquired typically the churn rate is low as shown in the following chart.
How to value Class?
In its first half 2017 report dated 9th February, the Average revenue per client (ARPU) for the SMSF product was $218 and the cost to acquire a client (CAC) was $112. From these values combined with the churn rate we can derive a future value for the current clients.
The churn rate is hard to estimate. The company states that the retention rate is close to 99.8% as show in the previous chart meaning once they have a client they have got them for good.
An annual churn rate of 0.2% would mean that they have the client for 500 years! (1/0.2%). This is practically impossible so I have assumed a churn rate of 5% equivalent to a 20 year lifetime for each client.
The business is scalable and low capital intensive so I have assumed that the business could increase margins to 50% from 45% as the business grows.
So what would be the capitalised asset of the business?
After 20 years of having the client generating $218 in revenue per year less the cost to acquire this client and after paying operating costs the Lifetime value of the client is $2,124. Note that I have not discounted this future value of 20 years to the present.
If we had this client for 20 years we would need to discount the $2,124 by an appropriate discount rate. Discount rates are arbitrary so I will leave it up to the reader to determine their own rate.
The following table shows scenarios of the Lifetime value to Class for different market shares. The market share number is based on the current estimated addressable market of 593,000 SMSF and does not include any factor for market growth.
As you can see if Class increased its SMSF accounts to 148,250 (25% market share) then the future lifetime cash-flow from these clients would be $314,883,000 (148,250 x $2,124).Compare that to the current Enterprise Value of around $340m with share price of $3.
If Class can accumulate market share of 50% then the lifetime value is around $640m.
Remember that Class is building market leadership. The stickiness of the client combined with the minimal cost of the service in relation to the assets managed (sounds very similar to accounting services like XRO or MYOB) then there will be pricing power in the business. This will have a compounding benefit to the Lifetime value of the client that is not captured in these calculations.
Class is also building a second segment, Class Portfolio which is a cloud based product that administers the management of other Trust and reporting structures.
The metrics of this business and very complimentary to the SMSF structure and Class is expanding its expenditure in the sales and software part of this business.
Currently Class has 2,863 paying portfolios. The ARPU is $147 per year and it is unclear what the cost to acquire the client is.
We can calculate the expected value of this business under some scenarios as we did with SMSF. If we assume the CAC is 6 months (as with SMSF) and the margin is 50% with similar churn then the Lifetime value of each client is $1,433.
The company believes that the market for Portfolio is around 1.8x that of SMSF.
To leverage of the existing SMSF relationship the following table shows the value of the business at different take-up rates for the existing SMSF clients.
Class is building a subscription model that is currently the market leader in the Cloud space.
It is building a profitable high margin scalable business that has a high customer retention rate.
With this business model they are building a trusted brand that has customer value. With this trust the business will be able to have pricing power similar to online Saas accounting software.
However I believe this future growth is priced in. At a current share price of $3 the market capitalisation of the firm is $350m. On my metrics the market is pricing in close to a 40% market share of all SMSF within a 10 year time frame. Currently the business has a 22% market share.