Fortnox - An SMB's Best Friend
Fortnox (NGM: FNOX) is a SaaS- and cloud-based ERP software provider with specific focus on accounting and financial services. Despite its high valuation, I believe the company is fairly valued and offers a compelling investment case:
Fortnox is developing a sticky one-stop-shop ecosystem that constitutes the backbone for many SMBs. The company enjoys typical industry tailwinds and is a market leader in Sweden (~26% MS), which it will focus on to strengthen even further in the upcoming years.
Fortnox holds several growth opportunities with tremendous potential that can significantly expand the company's TAM and ARPC, enabling high non-linear deteriorating growth rates for this decade. However, the ability to execute by the management team remains a question mark for now.
Using base case assumptions and the set targets for 2025, I believe Fortnox is currently trading at a fair value range. I consider 350-380 SEK an attractive price area where I expect market outperforming returns with a 5-year 10%-14% IRR and strong potential for further upside. Nevertheless, the case is relatively high risk with substantial downside if fundamentals come in below expectations.
Fortnox's Business Model
Fortnox has managed to create a market leading, cloud native and SaaS-based platform for SMBs in Sweden to solve financial and administrative burdens. Similar to other platforms, clients can add modules (products) with new functionalities that help their companies grow. The accounting and invoicing modules are the most popular ones and can be implemented for a mere 99 SEK per month (~10$). Furthermore, Fortnox is in the process of developing several new services and offers an ecosystem with open APIs and integrations, allowing users to purchase additional features through an app store. The marketplace enables Fortnox to offer services without the need to develop it themselves. This in combination with their own modules transforms Fortnox into an one-stop-shop solution for SMBs.
To easily breakdown Fortnox's business model, one can divide the company's services into eight product areas, including 4 core, 3 growth and 1 support:
Core:
Accounting: the main value proposition and product area where the company started its journey. As the name implies, this product area helps companies with their bookkeeping and keeping track of accounts payable. It is furthermore connectable with banks and other authorities, enabling seamless insights and payment possibilities. Since the platform is cloud-based, customers can access the information from anywhere at anytime on their mobile phones or other devices. The main development to look out for in this area is real-time AI bookkeeping. This feature will be released to the entire customer base during 2021 and aims to remove all manual labor in the bookkeeping process. Additionally, the real-time information provides updated insights that can be transformed into valuable advice to customers about future trends and opportunities for their businesses.
Billing: product area that enables clients to send invoices and quotes to their customers, keep track of their inventories and project planning. The idea of this module is to make billing easier. Last year Fortnox sent out 500B SEK worth in invoices (~10% of Sweden's GDP) with 1 invoice being sent out every other second. The aim for this area is two-folded. Firstly, 1/3 of the invoices were sent to consumers outside of the platform, meaning there are still many potential customers left to onboard that have already been in touch with Fortnox. Secondly, Fortnox is focused on activating the already acquired users by enabling them to perform all activities through the Fortnox system including invoicing, consequently reducing the incentive to leave the platform.
People: product area focused on the people in the organization, including services such as payroll, benefits, insurance, time reporting, receipts and travel management. The payroll service is connected to all necessary authorities and is currently the fastest growing product area. Fortnox aims to process 1 million monthly payslips by 2025 and completely digitalize as well as automatize the payroll administration for both large and small businesses. The insurance segment is also a noteworthy product with large potential. While it's still in early development, Fortnox can function as a middleman offering pension services and different type of insurances (car, company, health etc.), which increases income, reduces churn and enhances the overall offering of the company.
Financing: product area in which Fortnox sees large opportunities and currently is investing in the most. The first part of this product area is concerned with the dealing of invoices including distribution, collection and factoring. Distribution and collection simply imply that Fortnox allows users to outsource the invoicing process by sending reminders to the user's customers and automatically process the collections. It furthermore offers users to temporarily finance the uncollected invoices against a set interest rate per month (2.5%). In addition to this, through the factoring process the company also offers users to sell their invoices to Fortnox. Fortnox utilizes real-time credit rating scoring to estimate credit risks and appropriate yields. The advantage here for Fortnox is when both parties are within the Fortnox ecosystem providing larger amount of data points, consequently enhancing the credit risk assessment process. Combining the real-time credit scoring with AI bookkeeping further enables Fortnox to offer financing solutions to customers facing potential needs, such as lack of capital. However, what is potentially most interesting in this product area is the payment service, which will gradually be deployed during 2021. This service is still in the very early stages but aims to provide customers with cash management accounts and company debit cards, allowing Fortnox as the issuer to claim a take-rate on each transaction (>1% of TPV). Moreover, the payment service supports locking customers into the ecosystem, discouraging users to leave the platform. The finance vertical currently represents 14% of Fortnox's revenues, but can be expected to increase throughout the upcoming years. Growth:
Insights: recently launched product area to utilize the customer's data to provide noteworthy insights and feedback on their business operations. Main offering is the ToDo product, which simply functions as a to-do list that also aims to incorporate integration partners. The goal is to also offer a platform with automated business operations to SMBs.
Connect: further supports the needs of SMBs by offering ID, mailbox and storage services. Although these are minor services, they further strengthen the platform and enable customers to perform all business operations through one system.
Integration Services: probably the most exciting growth area where Fortnox offers its customers a marketplace with 3rd party software integrations that offer additional business tools, further extending the ecosystem. The marketplace enables Fortnox to become an one-stop-shop, consequently reducing customer churn and increasingly leverage their customer base. As of now Fortnox offers over 400 partner solutions and charges customers a monthly fee of 59 SEK to enable these integrations. This pricing model resembles a significant opportunity to Fortnox as it can transform towards an Apple/Google Play store model where pricing is based on take-rates (~30%), which in return increases income. Fortnox has stated this to be a future goal. Support:
Infrastructure: product area focused on customer support and subscription management. Area is more of a CRM product for Fortnox itself, as well as a center to help customers with their specific problems (help center).
Besides the product areas, Fortnox distributes its services through two main sales channels: direct customers & accounting firms. Direct customers simply add the services through the Fortnox's website or application, whereas accounting firms use Fortnox's software for their clients and because of that turn them into Fortnox customers as well. Both sales channels are extremely scalable as their costs of acquisition of new customers (CAC) are close to 0. The partnership with accounting firms is also mutually beneficial, as Fortnox can connect customers with accounting services and vice versa. The portion of sales being derived from each channel is estimated to be approximately 50/50.
Industry & Competition
As of the time of writing, Fortnox is only active within Sweden and has from the most recent quarter (Q1 2021) approximately 385.000 customers (26.2% 5-year CAGR). Fortnox stated that there are 1.5M addressable businesses in Sweden and therefore currently has based on these figures a 25.6% market share. Nevertheless, these numbers are up for debate as several different totals have been thrown around before by both Fortnox and investment firms, whereas cloud-based SaaS applications also do not have a 100% penetration rate. The main takeaway is that there's quite some room left for growth in the current market. Fortnox was initially developed for smaller business, hence the majority of the customer are companies with less than 10 employees. However, Fortnox's system is also applicable to larger organizations with companies such as Volvo and Apotea using the platform as well. The underlying market growth for new businesses has been around 2% over the last two decades in Sweden.
As mentioned before, partnerships with accounting firms are important to Fortnox. Fortnox currently has partnerships with 6000 accounting firms, including all of the Big 5 (KPMG, Deloitte, PwC, EY & Grant Thornton). In 2021, Sweden had approximately 23.500 accounting firms, hence Fortnox has a similar market share here as with their customer base (25.5%). Fortnox has the highest penetration rate in large and medium-sized firms and plenty of opportunities left for smaller accounting firms (16%).
During the most recent Capital Market Day (CMD) presentation, Fortnox presented several targets for 2025, including growing the customer base organically to over 700.000 customer (14% CAGR) and establish over 12.000 partnerships with accounting firms (~50% MS). The company also guided to improve its average revenue per customer (ARPC) per month from 171 SEK in Q1 2021 to >300 SEK in 2025, but more on that later.
Fortnox faces competition from multiple players in the industry (both legacy and cloud-native) with the main competitor being Visma SPCS, who as estimated by SEB has somewhere around 238.000 customers at the end of 2020. Fortnox also faces competition from Hogia, although their solution is mostly on-premise with only a minor part being cloud-based. Björn Lundén is also a more common alternative to Fortnox, but also appears rather insignificant in size compared to both Fortnox and Visma with an estimated 12K customers.
Besides these legacy/more established players, Fortnox also faces competition from smaller start-ups that attempt to take market share through their cloud-native solutions. Some examples here include Bokio (80K users at the end of 2019, but also active in GB), Speedledger (owned by Visma), Wimt, Dooer and PE Accounting. Finally, Fortnox is also starting to face competition from abroad with 24SevenOffice (Norway) and Talenom (Finland) entering the Swedish market. Talenom has made some small acquisitions from 2019 in Sweden, yet still remains very small in size today. 24SevenOffice mainly focuses on larger enterprises and is therefore not a direct competitor to Fortnox, nevertheless there does exist some overlap.
Fortnox is a clear market leader in Sweden but the important question remains: How does Fortnox differentiate itself and what is their edge? I believe Fortnox's main value proposition is their comprehensive ecosystem and product suite. Through integrating various modules besides accounting and invoicing (e.g. payments & insurance), Fortnox is creating a sticky one-stop-shop ecosystem that removes the incentives for users to leave the platform. The marketplace furthermore strengthens this advantage by enabling users to integrate that what Fortnox is unable to offer themselves (e.g. CRM). As a result, Fortnox positions itself as the backbone of SMBs. Furthermore, Fortnox has an amazing opportunity that its services are required for basically any kind of company. No matter whether you're a hairdresser, pharmacist or a restaurant, all these businesses require accounting, invoice, insurance and payment services. The only downside here is that Fortnox cannot tailor their ERP system to specific industries, putting it at a disadvantage compared to more niche players (see Admicom post).
Aside from its comprehensive ecosystem, Fortnox has clearly enjoyed a first-mover advantage in Sweden with its cloud- and SaaS-based services and is furthermore supported by all the integrations it has with local authorities (banks and tax agencies). In addition to that, Fortnox's partnerships with the major accounting firms puts it at a advantage compared to other players. All of the aforementioned competitive advantages increase the barriers to entry and aid Fortnox with maintaining their dominant market position in Sweden. Nevertheless, the main issue here is how Fortnox will compete outside of the Swedish borders where it doesn't have the first-mover advantage and no connections with local establishments. Integrations with foreign authorities and local partnerships have to be built from the ground but will also no longer be an unique advantage to Fortnox. Hence, that what can really differentiate Fortnox from others is their extensive ecosystem and is therefore a key differentiator in their competitive landscape.
Management & Ownership
Fortnox was founded by serial entrepreneur Jan Älmeby in 2001, who's also the original founder of Scandinavian PC Systems, which later got acquired by Visma (hence Visma SPCS). In 2010 he left as Fortnox CEO to focus on Fortnox International, which spun-off and nowadays goes by the name of Briox, another accounting software business focused on Finland and the Baltics. Älmeby also left his position here in 2013 to start a similar company called Computer Innovation, which eventually ended up in bankruptcy in 2019. Anyhow, Älmeby is no longer involved in the day-to-day operations of Fortnox, meaning the company is not founder-led.
Current CEO Tommy Eklund joined the company in 2020 after serving as CEO of IST Group, a leading ed-tech company in Scandinavia, for 5 years and several leadership roles at Saab prior to that. CFO Roger Hartelius has been at Fortnox since 2017 and has previous experience as CEO of IST International and CFO at Swedish digital newspaper and magazine subscription service company Readly AB. Olof Hallrup is the current chairman of the board of directors and is the only insider with a significant ownership position, whereas members of the management team hold very small stakes through shares and option incentives. Hallrup however owns through his company First Kraft AB 20,68% of the shares outstanding and was an active advocate against Visma's takeover attempt in 2016 (which did fall through). Fortnox furthermore enjoys institutional ownership by the likes of State Street,, Morgan Stanly, Swedbank and JP Morgan. Overall I'm not that impressed by the management team, but they do deserve time to prove themselves. I find it however good to see that the chairman owns such a significant stake, making sure that the interests of shareholders and those in charge are aligned.
Opportunities & Risks
Even though Fortnox has already captured a significant share of the market, I see several opportunities for the company to sustain high growth rates over the upcoming years, giving the company a lot of optionality:
Verticals: The vertical part for Fortnox is two-folded. Firstly, Fortnox still holds tremendous room for growth through expanding their current offerings and modules. I already pointed out before that payments (finance), integrations and insurance are growth areas with large TAMs that can aid the company to support top line growth, increase ARPC and reduce customer churn. Secondly, Fortnox can through their ecosystem expand to new verticals over time to fulfill all the needs for their customers, consequently strengthening their on-stop-shop solution (e.g. CRM).
Pricing Power: Fortnox's prices have remained unchanged for several years and a price hike does therefore not seem unreasonable, especially since this will be cost-free and therefore go straight to the bottom line. Nevertheless, CEO Eklund stated during the recent CMD that price increases are not in the business plan for now and therefore also not included in the 300 ARPC target for 2025. This can be seen as a positive sign due to it making it easier to onboard customers at lower prices and increase the ARPC even further in the future.
International Expansion: Fortnox is only active in Sweden for now and has no near-term ambition to expand abroad until the Swedish market is completely dominated. However, the opportunity for international expansion can be huge as can be seen from the picture below. Expanding to other Nordic countries would double the market size for Fortnox. Additionally, expanding towards Central Europe increases the TAM even more. Nevertheless, international expansion is not easy as it requires a lot of local tailoring and competition against already well-established players. Fortnox has already pointed out that if it were to expand abroad soon, it would most likely do it through an acquisition, which is the next point.
M&A: Fortnox has stated M&A will be part of their growth and the company can utilize it in two main ways. Firstly, M&A can be used to strengthen existing or enter new verticals. Fortnox can leverage its customer base here to derive more value from new software capabilities. Generally, smaller tech start-ups lack the customer base Fortnox has, whereas Fortnox does not have the time to develop everything themselves, therefore making it a perfect fit. Recently Fortnox performed its first acquisition through buying Offerta Group AB for 300M SEK, a marketplace to receive tenders from service businesses. This was followed by three smaller acquisitions and one can most likely expect more in the future that enhance Fortnox's service offerings. Secondly, as mentioned above, Fortnox considers M&A a viable option when it comes to international expansion. Here it is mentioned that the reason for acquisition is more about the type of company rather than the region, although the Nordics seems to be the most plausible.
Despite all these opportunities, Fortnox also faces some serious risks that need to be considered. Apart from the common risk factors such as competition and potential lack of innovation, the major risk I see in the business is management execution. Even though current management shows no signs of being incompetent, I find the lack of solid track-records and skin the game concerning. Fortnox awaits a tremendous amount of challenges in the upcoming years with capturing more market share, increasing module adoption, M&A and possibly international expansion. These are no easy tasks and preferably I would've liked to see either experienced executives with exceptional past performance or founder-led driven entrepreneurs. Since Fortnox has neither from my point of view, I identify this as one of the biggest negatives regarding the investment case.
Financials
Fortnox has experienced a remarkable journey over the recent years with both strong top line growth and significant margin expansion. While revenues have compounded at a 40% CAGR from 2015 to 2020, operating margins have increased from 19% to 37% leading to an astonishing 61% CAGR over the same period. The graph below provides a clear visualization of this impressive development.
Top line growth is supported by strong new customer intakes which experienced a 26% CAGR from 2015-2020 growing from 115.000 to 367.000 customers in 2020 and 385.000 in Q1 2021. At the same time, ARPC increased from 113 in 2016 to 169 in 2020 and 171 in Q1 2021. The growth in operating income clearly demonstrates the scalability of the business model and the operational leverage Fortnox can achieve through it. The main expenses Fortnox has are Personnel, Purchased Services (COGS), Other External Costs and D&A. The figure below demonstrates that operating leverage is mainly derived through Personnel and Other External Costs, whereas Purchased services have remained relatively stable and D&A has slightly increased over time.
Fortnox has grown its cash position considerably over the recent years and currently has around 470M SEK in cash on the balance sheet (~2% of market cap.). Since Fortnox has approximately 175M in interest-bearing liabilities, the company has a negative net debt position and a robust balance sheet. The cash position and a Net Debt/EBITDA of approximately -0.9x. gives Fortnox a strong position for more acquisitions in the future. Fortnox furthermore works, like many other SaaS peers, with negative working capital enabling strong cash flow generation. Over the last 5 years, around 76% of EBIT converted to FCF on average. Fortnox has also experienced strong returns on invested capital with a 55% 5-year average (see figure below), clearly above their cost of capital and hence resulted into solid value creation. In addition to that, Fortnox has a 4-year ROIIC average of 87% (!) and a 3-year average of 79%, once again demonstrating the capital efficiency and operating leverage of the business. Both ROIC and ROIIC have been calculated following this paper.
Valuation
At the time of writing, Fortnox is trading at 413 SEK per share, which amounts to a market cap of around 25B SEK (~$3B). Fortnox has experienced remarkable returns with the stock increasing close to +1700% in price over the last 5 years, becoming a compounding favorite amongst Swedish investors. The stock is currently valued at 34x. EV/Sales and close to 90x. EV/EBIT, making the stock far from cheap. Moreover, the stock is trading at a premium compared to its historical average (see graph), although it can be partly supported by the improvement in margins and consistency in top line growth. Despite the high multiples, I believe Fortnox is trading close to fair value today given its growth trajectory.
For my assumptions to derive the fair value of Fortnox today I assume the company to meet its 2025 targets of >700.000 customers and an ARPC of 300. While I believe the ARPC can exceed 300 through increased module adoption and pricing power, I set the ARPC to 300 for the base case. I estimate a linear trend in ARPC improvement (12% CAGR), whereas I expect gradual decreases in net new customer intakes at a 14% CAGR, leading to a ~47% market share in Sweden. Fortnox's total revenues have always been higher than their final amount of customers multiplied by ARPC, since ARPC is a rolling 12-month figure that excludes non-recurring revenues. The number of customers multiplied by ARPC have been relatively stable around 88%-90% of revenue, hence for my future estimates I follow the past patterns of around 12% non-recurring revenues and derive a 28% revenue CAGR between 2020-2025. I furthermore only assume organic growth and no international expansion plans. In addition to this, I expect further operating leverage over time consequently increasing EBIT margins from 37% in 2020 to 50% in 2025. As can be seen in the assumptions below, this increase is mainly derived from decreases in personnel and other external costs. The increase also implies that Fortnox continues their achieved incremental EBIT margin of 57% in 2020 over the next 5 years on average. Lastly, for simplicity sake I assume that 79% of EBIT gets converted into FCF, which is equal to the last 4-year average.
Using these assumptions I derive the following figures:
Now for the final step in the valuation I assume a 10% discount rate (my minimal requirement for annual returns) and a 25x EV/EBIT exit multiple. While I've seen 30x. EV/EBIT exit multiples for similar names, I like to remain conservative as I'm not factoring in successful international expansion in the terminal value. Utilizing all of the aforementioned assumptions, I arrive at a fair value of approximately 350 SEK per share, which it was closely trading at on May 17th.
However, in a bull case scenario revenues and margins could obviously be higher, which is not unthinkable as Fortnox has a strong history of beating their guidance. Furthermore, new and existing modules, such as payment services, together with international expansion can seriously expand Fortnox's TAM and enable the company to sustain high growth rates even beyond 2025, resulting into a much higher exit multiple. In that scenario I could easily see the stock double in the next 5 years (>15% IRR). Nevertheless, if Fortnox fails to execute their growth strategy the stock would suffer a strong decline as current valuation is already factoring in a lot of growth. Management is therefore crucial in this case, which is a point I remain uncertain of for now. From my base case scenario I expect modest/slightly above market returns with optionality for a significant upside. I therefore see 350-410 SEK range as a decent area to accumulate shares, although I personally won't consider starting position until the stock drops below 380 again given the opportunity costs of my other holdings.
Comparing Fortnox with industry and other software peers demonstrates the premium the company is trading at. I personally believe this premium is fair given the business model, opportunities and execution Fortnox has shown in the past (e.g. high ROIC). Fortnox has been / is a high-quality Swedish compounder and is in my opinion one of those companies where you have to pay up for quality. Nevertheless, valuation always matters and to achieve a good risk-reward I would personally wait a bit until either the fundamentals have caught up or the stock has declined to a more attractive price level.
Conclusion
Fortnox is in my opinion one of the highest quality public SaaS companies in Europe that enjoys obvious industry tailwinds with businesses transitioning their operations to the cloud. Fortnox is developing a sticky one-stop-shop ecosystem that forms the backbone of many SMBs, regardless of their industry or focus. This alongside Fortnox's partnerships with the majority of accounting firms provides the company with a robust competitive advantage. Furthermore, Fortnox has many growth opportunities through enhancing existing modules (finance, insurance, marketplace), introducing new verticals, increasing prices, M&A and international expansion. Notwithstanding these promising prospects, the current management team has not convinced me yet of their execution abilities, which I see as a great concern moving forward. Fortnox has a remarkable track-record with significant top line growth, margin expansion and return on invested capital. In addition to this, the company has a solid balance sheet with negative net debt and a war chest for M&A activity. Assuming Fortnox reaches their targets for 2025, I believe the company is trading at fair value despite its high valuation. Using organic base case assumptions, I think the company can provide a 10%-14% 5-year IRR at 350 SEK and therefore normally market outperforming returns. Moreover, I see strong optionality (TAM expansion), enabling further longevity in growth rates, consequently leading to substantially higher returns. Still, if execution fails I expect significant downside making this a relatively high risk-reward investment case. I'm personally quite intrigued by Fortnox and might initiate a position if the price drops to the 350-380 SEK area.
Disclaimer: I’ve no position in Fortnox at the time of writing this blog post. The information contained in this report shall not be understood or construed as financial advice. I am not a financial advisor, nor am I holding myself out to be, and the information contained in this report is not a substitute for financial advice from a professional. I shall not be held liable or responsible for any errors or omissions from this report or for any damage you may suffer as a result of failing to seek competent financial advice from a professional.