Whatever happened to boring old Misys?

Misys was a perennially frustrating software company for a long time. Founded in the 70s, it acquired leadership positions in healthcare and banking IT – but by the 1990s it was running out of steam. It failed to get growth out of its verticals, and never seemed as interesting as other IT stocks during the technology boom.

 Too many acquisitions may have been its biggest problem. Misys never integrated the different bits of software that it acquired; its different packages drifted further and further out of contention. The amount of R&D required to bring them all up to date with browser based functionality, workflow and process management, and open platforms would have been prohibitive.

 Much of the product portfolio was beginning to look dated – and growth was unexciting for Misys' 'universal banking' systems, compared to sub-sectors such as derivatives, trading platforms, workflow, or banking CRM. The company had become unwieldy – too big to achieve significant growth – and the shares languished.

 By 2006 the situation had become intolerable. Many analysts were suggesting the company would be worth more as the sum of its parts than it was on the stock exchange [ref] Independent, 10 June 2006, http://www.independent.co.uk/news/business/news/misys-shares-surge-as-lomax-considers-1631bnplus-buyout-plan-481811.html [/ref] . Founder and CEO Kevin Lomax tried in 2006 to take the company private with an MBO – but failed, and left the company.

 Mike Lawrie, a former IBM manager who had failed to turn around CRM supplier Siebel Systems, took over in October 2006, with an unusual pay package – the options only pay out if he gets the share price to 400p, double what it was when he joined the company.

 The easy job was to get rid of diversions. The Sesame IFA network was sold to £FP in May 2007, and a number of non-core health products were also sold off.

 More imaginative was the transformation of the healthcare business. It had been too small to be effective in the US; in March 2008, it was merged with its major competitor, Allscripts. Misys now holds a 54% stake in the NASDAQ traded Allscripts-Misys Healthcare, the leader in the US health market. This has enabled the group to gain substantial cost savings, as well as improving its marketing ability [ref] Forbes magazine, 18 March 2008: http://www.forbes.com/feeds/afx/2008/03/18/afx4785612.html [/ref] .

 Misys also refocused its sales effort. Banks in the US and Europe are not growing fast, if at all, so the decision was taken to concentrate on selling into emerging markets. The company moved into India and China through joint ventures with local partners HCL and Digital China [ref] Bloomberg, 24 Jan 2008: http://www.marketwatch.com/story/earnings-rise-for-uk-software-group-misys-after-disposals-turnaround [/ref] – and as a result has been able to minimise the effect of the credit crunch on its banking markets.

 The development of the new BankFusion product has also revolutionised Misys' banking sector offering. BankFusion ticks all the boxes for modern software – SOA (service oriented architecture), J2EE, platform agnostic, web capable. Perhaps even more important has been the decision to open the legacy banking products, Midas and Equation, to BankFusion technology, providing an easy migration path for existing customers.

 That should help Misys fight off competitors such as Temenos which had been picking away at its customers – particularly its Equation customers, who were dissatisifed since attempts to update Equation internally had stalled. The company points out that new products accounted for nearly a third of order intake in banking and TCM (Treasury and Capital Markets) in FY2009 [ref] 2009 results presentation – http://www.misys.com/cds-portlets/digitalAssets/5/3206_2009-07-23-Misys-Results-2009-FINAL.pdf [/ref] .

 However the strategy is a risky one. BankFusion's reference customer, Standard Bank of South Africa, has been joined by a number of others, but it's still not a mainstream banking platform. If it fails to gain traction, it could bring the other Misys products down with it, since they now have no separate future [ref] IBS Publishing review, September 2008: http://www.ibspublishing.com/index.cfm?section=features&action=view&id=12150 [/ref] .

 Still, the treatment seems to be working. Results for the year to May 2009 showed a 41% increase in revenue and 45% increase in operating profit. At the same time, the company had reduced net debt by over a third [ref] Annual report 2009: http://www.misys.com/cds-portlets/digitalAssets/5/3479_MISYS_AR09_110809.pdf [/ref] . The operating margin, only 9% in 2006, increased to 17% in 2009, as cost efficiencies were gained and the company focused on high margin products and services.

 Misys has certainly started its turnaround well. But it's worth noting that most of the increases in revenue are due to dealmaking – organic growth was some way behind. And that raises the question; is Misys exciting, in the way a tech stock should be?

 Well, with banking seeing revenue increases of 2% - and targeted on 3-5% for the medium term – that's a definite 'no' for that side of the business. Healthcare could be more interesting – particularly if healthcare reforms in the US play out to Misys' advantage – but again, revenue targets are low, at 6-9% growth a year. The good news is that fewer than 20% of small and medium size doctors' practices in the US have an electronic healthcare system [ref] Presentation to analysts, October 2008 p25: http://www.misys.com/cds-portlets/digitalAssets/2/1280_Analyst_and_Investor_Presentation.pdf [/ref] , so Misys is pushing at an open door.

 Misys does have some downside protection. While it's still dependent on initial licence fee income for much of its revenue, recurring revenues now account for 47% of banking business and 48% of TCM sales [ref] Presentation to analyst, p5 [/ref] .The shares have responded well to the company's transformation, and now sit on a historic multiple of 20x. Given further growth in earnings as cost savings keep coming, that will probably reduce to 15-6x prospective – valuing the company as a growth stock. And like a typical technology growth stock, Misys isn't paying dividends.

 I'm not entirely sure Misys deserves a growth stock rating. It will have to tell a much better story on revenue growth to deserve it, I would think – and although it's smartened up its act on banking products, it still doesn't seem to be in the highest growth sectors of the financial software market. Besides, the company has now achieved its medium term operating margin target, so there's not going to be any further margin expansion – making growth in profits more difficult to bring through.

 By comparison with other software stocks it looks a bit too highly valued. Take a look at Fidessa Group Plc, which provides trading platforms and has a high rate of recurring income – it trades at 22x historic earnings, but it's growing like Topsy even in the middle of a recession. Management increased the interim dividend 33%, and even though the second half of the year won't see that level of increase sustained, it will still grow. And it pays a dividend (yes, I know – I like yield). To my mind, Fidessa is by far the better punt – a real growth stock, and one that's less dependent on initial licence fees.

 Or you might even want to take a look at Intelligent Environments, a financial software company that managed to grow revenues despite losing one of its biggest customers, RBS, due to the credit crunch (RBS pulled out of the consumer finance market and no longer needs the product). The company's progress in the first half of the year led management to propose a maiden dividend might be paid at the end of the year – though the team won't be drawn on just how much the dividend might be.

 It's a pity but I doubt the leopard is going to change its spots. Misys is far more efficient than it used to be, and its products and market positions are much better than they were. But it still seems like a great, galumphing Leviathan of a company – and not a racing cheetah.