SS&C Technologies Holdings, Inc. (SSNC) Earnings Call Transcript & Summary

Great. Good afternoon, everyone. This is Mayank Tandon. I'm the fintech analyst at Needham. I would like to welcome SS&C to our conference. We have Patrick Pedonti, CFO; and Justine Stone, Head of IR. Patrick and Justine, thank you for joining us.

Thank you. Appreciate it.

Thank you.

Great. So Patrick, I'm going to jump into Q&A directly. And then I just want to mention to the audience, if you do have questions, please type your questions and I'll try to get them in before we wrap up. So Patrick, let me start with just, overall, I'm sure you've gotten this question all day about the impact of COVID. How has that impacted overall demand, pipeline, deal conversion, sales cycles? Just maybe walk us through from the beginning, to where we are today, how has that impact evolved.

Sure. It depends on the segment that we serve and how it's impacted. If you look at the alternatives business, which is about $1 billion of our revenue annually, that's been doing pretty well this year. We've been signing new business. Retention rates are good. There's been some fund launches. And I think, through the third quarter, year-to-date, the alternatives business grew 5.7%. So we've seen a little bit of impact. We probably maybe might have been growing a little bit faster, but the business is doing really well. A couple of our other recent acquisitions, Intralinks and Eze, they have been growing between 3% and 4%. So pretty good performance from Interlinks, considering they're in the M&A space, like 70% of their business is in the M&A space. And there were pretty weak M&A activity in the second quarter and improved a little bit in the third quarter. But that business has been doing well, and we've extended it into offering those services into alternative asset managers, banking and security, and that helped some of the growth this year, offsetting a little bit of the decline in M&A. Eze has done pretty well. They grew about 3%. Our new product introduction kind of helped out there, Eclipse, where we're introducing to our institutional and asset managers. Some of the businesses that have been impacted are some of the upfront license business, especially where the software license is installed at the client. So in those cases, the client, it takes the majority of the load of the implementation. And I think some of our clients have been reluctant to tackle implementation in today's environment, where they've got all their employees working remotely and they're focused maybe on other aspects of the business. The worst quarter was the second, improved a little bit in the third, and we're seeing some improvement this quarter in that business. The other one is the DST business. Same thing, those are large-scale deals, large-scale, complex implementation. And where we expected to sign business earlier in the year, those contracts got delayed until about the late third quarter. We announced some of those contracts we made. I think we signed about $60 million of annualized revenue retirement contracts in the DST business. The other segment that's been hurt is our health care business, which is about $400,000 -- $400 million a year. We saw real low health care and pharmacy claims in the second quarter as people weren't going to the doctor. We saw an improvement sequentially in the third quarter, and we think we're seeing a little bit more improvement in the fourth quarter. So the real impact is software businesses, in-house installations and some of the DST business, where some of the contracts were delayed.

That's helpful, Patrick. So it sounds like the underlying message here, is in terms of the areas that were weak, was really more about license versus subscription. But overall, you would say that the demand environment did not really change, it sounds like, for most of your core offerings or some of that subscription-based revenue. It was pretty resilient...

Yes. Yes. If you look at the subscription-based revenue, where we're hosting the software or we're doing full back-office outsourcing for the client, we didn't see much impact in that business.

So we saw the initial market volatility. It might be worth reminding investors what the sensitivity of the business is to overall market volatility. I realize there are other revenue drivers as well that dictate your business. But could you just maybe parse out what the areas are that are sensitive to the market volatility versus that revenue that is more maybe predictable, more recurring in nature?

Yes. Mostly the Fund Administration business. The Fund Administration business is priced assets under administration. And typically, they're billed on a monthly basis. So in monthly basis, you cut an NAV and you bill the client based on the assets in their portfolio. We saw a little bit of impact at the end of the first quarter when markets were down significantly, but then they recovered pretty quickly in the second quarter. So I don't think it impacted us very much. And even if you look at that business, in the first quarter, I think that alternatives business grew 8%, right? So it had a pretty good quarter. But I suspect the market, that growth might have been 9% because -- if the market hadn't been down. I mean they are hedge funds, and we tend to be in more complex hedge funds than long-term short hedge funds. So temporary volatility in the market doesn't impact us too much.

Right. And Patrick, I know you're not going to give guidance for '21, but of course, the question that's on everyone's mind is visibility for '21. So given where you are today, I know you'll be reporting in the next, say, month, 1.5 months or so, could you just speak more generically in terms of how visibility is today versus what it may have looked like, say, 3, 5 months ago?

Well, if you look at our business, we've got really high levels of recurring revenues, right? I mean it's probably nearing 90%, right? So -- but if you look at 2021, I mean, there's 3 key factors to it. We need to continue having high retention rates so that our core recurring revenue is stable, right? And over the last 18 months, I think we've been running around 96%, 97%, and that tends to be on the high end of the range. So retention has been really good. And so that's important in maintaining our recurring revenue. Then to get some growth, we need to sign new deals. We need existing clients to launch new funds, and we automatically get that revenue when they launch new funds. So I think it's going to depend on where the markets are, how investment managers are doing, how they're raising capital. But we're pretty confident that we've got good trends in our favor in our business. We've got segments that have grown well even in a difficult environment. And we think that this, this COVID environment is going to be good for demand for outsourcing in the future. I think we were able to move 22,000 people remote in the months of March and April with no impact on our customer service. I think that's going to pay dividends in the future. And I think people -- and I think investment managers that were running in-house operations, I suspect they had some difficulty moving people remotely and running their systems. And they might view it as a derisking of their operation by outsourcing. So we think that probably would be a good trend in 2021.

Right. Patrick, on that note, I mean, obviously, you'll have easy comps in '21 versus '20 just given the headwinds you've talked about on the license side. Is it fair to assume, if the conditions continue to improve, slowly but surely, you could get back to at least some level of positive organic growth in '21? Is that something we could maybe sort of take to heart given some of the improvements you've seen in 3Q and then potentially in 4Q based on the guidance?

Yes. We think so. I mean if you look at our software business, I think our software business is maybe around $800 million a year, right? Through 3 quarters, it was flat in '19 -- in '20. In '19, it grew 6% or 7%. So if we can get that back to some level of growth in 2021, and we have some confidence we can, and we get improved environments, people back to work and able to travel and things like that, we can get that back to growth. I think on DST, we're also making progress. DST kind of hurt us this year, that they're probably down or around 3%. It's about 40%, 45% of our business. We saw weakness in the health care because of claim demand. And we saw deals being delayed, signing new deals being delayed. So if we can continue holding our retention rates at DST, and we've won some new business, about $60 million in annual run rate, we need to double that by winning some new business. And if we can get DST either flat year-to-year or up a little bit, then I think we have a really good chance of having positive organic growth in 2021.

Right. That's helpful. And Patrick, maybe we can pivot over to competition. Have you seen any noticeable change within these different subsets that you talked about during the last, say, 9 months in the midst of the pandemic? Has there been any sort of shift in terms of competition, whether it's from some of the incumbents, some of the so-called legacy providers globally across your different portfolio of businesses, and also from the emerging fintechs that are now starting to maybe make some inroads but in certain subsets of your business?

Yes. We haven't seen the competition change at all this past year. In our Fund Administration business, we're competing against State Street, BNY, CITCO, SEIC. We haven't seen much of a change there. We've still got an advantage against those competitors, in that we own our own technology, and most of them are procuring technology and don't have internal technology. So I think we still have the best offering there. We haven't seen them make any inroads in the technology space. So I think in that space that things haven't changed much. In the software space, I think it's the same thing, too. It's typically -- we see some of the typical portfolio competitors there. And I haven't seen much of a change. I think we still have an advantage with Geneva and some of our other large-scale portfolio systems in that space over competitors.

Anyone trying to undercut on pricing? Has that been one of the areas where maybe you see more pressure from some of your competitors given, again, some of the softness on the license side?

We haven't seen any pricing pressure. I mean there's probably a little bit in perpetual licenses, but that's a small segment of our business. I don't know, we did like $4 million to $6 million of perpetual license in the quarter. Term licenses and subscriptions have been hanging in there. We've been implementing some price increases in some of our products, so we haven't seen the whole. And in Advent, in DST, I think we've focused on improving our customer service and our technology capability, and we're holding pricing there. So we haven't seen a change in that at all.

Got it. And then looking out longer-term, how should we think about the growth between winning new logos? And I know it's different across your different subsets again, but maybe more generically first and then maybe you could talk about some of the larger components of your portfolio. How should we think about growth between new logo wins and expansion within the installed base? I know Bill's talked about in the past, before COVID, that there was pricing leverage available to you over time. So just putting all of that together, how does that play into the overall growth theme longer-term?

Yes. I think if you look at our growth, winning new business, it -- generally, half of it comes from new logos, and half of it comes from expanding our product offering and existing clients or existing clients launching new funds. That's typically where our growth comes in and in addition to that, price increases. And our view is that we've got a good position competitively in a lot of our markets, in our alternatives market, in our software markets. We've got good positions, and we've got the ability to raise prices. Now those don't happen all at once because clients typically have 3- to 5-year contracts, right? So you can start instituting price increases when they renew their contracts. So maybe you can go after about a 30 a quarter or 30 for your business every year and implement price increases. And we think we're in a -- we've got the best technology in the industry. Our customer service is higher. Retention rates are high. Clients don't want to move off our platforms. So I think that gives us the ability to have reasonable price increases when contracts renew.

Right. That's helpful, Patrick. So again, to me, it sounds like once we are in a more normalized economic climate, we should see SS&C revert back to its, call it, normalized organic growth. Not to put words in your mouth, but it sounds like the low to mid-single-digit range, which has been the pattern historically, would be something we could, again, count on as we come out of this environment. Is that a fair assessment or not?

Well, yes. That's the goal we try to achieve every day. There is no doubt about it. And those are the targets we set internally for our businesses and our product lines as far as revenue growth in those product lines. And those are definitely our targets. And we think that as we get out of this environment, we're in good positions to get back to our historical growth.

Great. Let's pivot over to the favorite topic for investors when it comes to SS&C M&A. So there's been some news, and I would just love to get your thoughts on M&A opportunities more generically that you're seeing in the market. Have expectations come down to maybe more realistic levels? It doesn't appear to be, but I would love to get your opinion as you're looking for assets across the globe.

Yes. Asking prices got down at reasonable levels temporarily in the second quarter. And I think we did take advantage when we bought Innovest, I think, in May, mid-May, and we were able to get it at a reasonable price. So temporarily, there was this little dip in prices, but they're back up. They're back up. And we continue to actively look at M&A. We're probably looking at half a dozen companies at any time at some level, either some introductory level or maybe doing more due diligence. And we think it's part of our key strategy for growth in the future and also having more software capability to sell to clients. So we'll continue looking aggressively in that market. But as we do always, we'll be very sensitive to price in multiples. We want to make sure we get these at reasonable prices and that it returns values to our investors.

So should we look at potential M&A targets being around capabilities, product expansion, et cetera? Or is there also some potential for deals to expand your geographic footprint in some markets where you might not be as deeply penetrated as in parts of Europe and North America?

I don't think we necessarily target any area or any geographic area. Our M&A strategy mostly is to look at what's for sale, right, and determine whether we like the products, we like the industry they're in, we like the technology capability, the company historically got good performance and retention rates and that it's a fair value. So we don't necessarily target anything. I mean we stick with financial services, software companies, and our preference is systems around portfolio management. And so that's generally what we look at. And if it fits that criteria, and they've got good technology and we've got a reasonable price, then those are the type of acquisitions we're interested in. But we'll be patient because you can see, in 2018, we bought 3 companies, right? And over the last 9 months, we've probably only bought 1 or 2 small ones. So we'll -- they will come, and at that time, we'll pull the trigger.

Patrick, should we also expect health care to be a focus? I know there's been some softness given what areas you identified that caused the weakness in 2020. And I think initially, when you did the DST transaction, there was some talk about potentially divesting health care, but now I think it's part and parcel of your business. So is that an area where you might also target M&A to further expand your footprint within that area?

We'll look at it. We'll be careful in that area. I think we've got a good Senior VP running that business now. We've got some good technology capability. We've got some large customers. I think if that business goes back to -- I mean it's had a tough 2020 due to the environment and some terminations that were affected post -- pre-acquisition at DST, but we would be more careful there. I mean it's an unpredictable market, right? I mean it's -- there's a lot of regulation. There's a lot of large competitors. There's been a lot of consolidation there. But I think there's some niches that we could do a good job in.

Got it. I just want to remind the audience, if you do have questions, please type them in the box, which I think is on the right upper corner of your screen, and I'll be happy to bring them up. In the meantime, Patrick, I'll turn the focus onto margins. Again, you guys have done a tremendous job historically and again, in this environment of managing your cost structure. So help us understand how much more room there is for margin improvement if the conditions remain the way they are today, somewhat, call it, maybe not as normalized as one would like to see it for some of your businesses. In other words, what I'm getting at is do you think some of the cost savings implemented in 2020 were one-off in nature, where they will roll off as you go into '21? Or are they going to be now part of your cost structure going forward, even if conditions start to improve?

We've made a lot of progress on margins in 2020. I think we've -- when we bought DST, we thought we could get them to about 32%, 34% operating margins. Now they're in the high 30s. We think there's still ability to continue improving those margins, but it's going to be more in using more technology, moving some operations, maybe offshore to India, improving productivity, using more software. It's going to be kind of in those areas that we think we can improve DST margins. Or that's how we look at all our businesses, right? And our cost structure is -- 60% of our cost structure is personnel, right? So the way to reduce our -- improve our gross margins is to use more technology, improve productivity in that process, use less people in running our back-office operations. So we think there's still ability to expand our gross margins in those areas. We'll continue investing in sales and marketing and research and development, and we will cut costs there. We had some onetime benefits in 2020 due to COVID. Nobody got on planes anymore. There weren't any trade shows. So I think we saved about -- we saw travel, they were down significantly. We saw trade show expenses go down significantly. And those were offset by a little bit of cost increase in the IT infrastructure to support remote employees. But I think we saved about $15 million in Q2 and about another $15 million, $17 million in Q3 in those areas. And I don't think it changed as much in Q4 and probably not a heck of a lot in Q1. As far as those expenses coming back, I mean, I think trade shows will -- expenses will come back eventually. Those are an important part of our marketing campaigns. I don't think travel will ever get back to the level it was before. I think everybody is getting used to using video conferencing, and instead of jumping on a plane, I think we'll be using video conferencing. I mean there will be some travel to customers. That's part of the business. And then there's some other areas we can start saving money. I mean we -- I don't think anybody thought you could put 100% of your employees remotely, and you wouldn't lose a beat, right? But that's what happened. In March and April, we moved 22,000 employees to work-from-home, and our customer service didn't take a hit. I mean our service delivery was still as good as it always was. So we definitely view that, that some percentage of our employees that can continue to work from home in the future. And over multiple years because you can't get out of leases right away, but over multiple years, I think we can significantly reduce our floor space by 25% to 40% maybe, depending on how much capacity you can put in a space. So I think it was a potential for us to save in facility costs over the next 2 to 4 years.

Given that, what should investors expect in terms of margin expansion, ex M&A? What is sort of the organic potential for margin improvement, again assuming no M&A, which I know is unrealistic, but maybe just as a way to sort of think about it?

Yes. With no M&A, we set internal targets of improving margins by 50 to 75 bps a year, by productivity, technology, focusing on cost reductions where we can reduce costs. So we look to get about 50 to 75 bps of improvement every year.

And then Patrick, turning over to the balance sheet. Again, you guys have done a tremendous job of deleveraging post some of the large transactions from 2019. Are you comfortable where you're at today? What is the goal for the next, say, again, 12 to 18 months in terms of further deleveraging? And just more general thoughts around capital allocation, including -- you already talked about M&A, but how important is debt paydown as part of that strategy.

Well, as everyone knows, interest rates are pretty low right now. If you look at our term debt facility, we're paying a little bit under 2% for our term debt facility. So -- and I think the leverage was around 3.6 at the end of the third quarter. If interest rates are 2%, 3.6x leverage is not very high. But if we use all our free cash flow to pay down debt, we can probably move debt down about one full term, right? But we'll most likely -- I mean we've got an open -- stock buyback authorization will most likely use some cash to pay down -- to buy some stock in the open market. We'll continue to pay down debt because it will give us the ability to have more capacity if we do find a large acquisition. So I would suspect that, ex M&A, that we would use over 50% of our free cash flow to continue paying down debt.

Right. Okay. Well, I think we covered a lot of ground. Patrick, anything else that we didn't touch on that you want to highlight for investors before we sign off?

I think investors focus on organic growth all the time. And I think this year has shown that our business is very resilient, right, and in an environment where the stock market plunged and the world was working remotely from home. And we have very complex systems that are complex to implement. Our view is our business did pretty well. And I think we're positioned really well for growth in the future.

Perfect. Totally agree. Patrick and Justine, thank you so much for taking the time and doing the conference. Really appreciate your insights here.

Thanks for inviting us.

All right. Thank you, Mayank.

Thank you. Bye-bye.

Okay. Take care. Bye-bye.