I'm very grateful for your write up. It has greatly accelerated my understanding of the company.
One question I have is how you have arrived at a 30% market share estimate for CMG in the core simulation software market? Since the investor slide you referred to indicates a reservoir simulation TAM of $767m CAD in 2022, wouldn't the company's turnover that year imply a market share that's actually closer to 10% than 30%? ($66m / $767m). Or are you assuming that the company's existing market share will expand towards 30% by 2030 based upon the growth drivers you described (increased need for unconventional and EOR, high growth CCS, etc)?
That was my estimate by 2030 for market share. It's a bit tricky to get an estimate of TAM and market share so I had to make some judgement calls. We do know that there are basically 3 major players with CMG and Schlumberger being the two biggest, so I didn't think CMG having 30% market share in 2030 was unreasonable for getting a high level revenue opportunity figure.
Question, wouldn't it be frowned upon by CSU to have their people helping constellation copycats? Wouldn't CMG be considered direct competition? Or is this common practice?
I understand the logic in the question, but CSU is more of a generalist in that they acquire businesses in many different verticals, whereas CMG would have a smaller TAM right now based on their one vertical. There is also a slight difference in hurdle rates (CMG's are lower) and CMG is also looking to benefit from synergies by building out a platform for their customers. A lot of CSU's board members participate on other company boards so all-in-all I think they end up learning from other companies and it doesn't impact CSU because their pool of acquisition targets is so large.
Hi Moritz - Thanks for the kind words on the write-up. You're correct in saying that technically 2% of insiders own the stock. Although, EdgePoint isn't an insider per se, I'd slightly disagree that it doesn't count. EdgePoint takes a very long-term view to their holding and the shares they own are locked up from my understanding for 6-7 years. Although insider ownership is a great filter, I personally focus less on the insider ownership % and more on the incentives. The performance incentive they have put in place is very unique and I think that's key to aligning shareholders with management.
Hi Sunny - Thanks for the kind words on the write-up. The poor revenue growth during this time period was a combination of cyclicality (back when the business was less diversified), poor capital allocation by prior management and of course you had COVID in the mix there as well. Overall, I think this is a completely different business now, and looking backwards I don't think will be a great forecast of what's ahead. I think a combination of the new CEO, strategy and incentive structure will lead to low DD organic growth with the rest coming from acquisitions
Two completely different companies and two different strategies. One is a mature serial acquirer of VMS businesses and other is just starting out with their 4.0 strategy. We'll see how things look in a few years
So assuming 8m WC investments per year in your valuation is just for sake of simplicity, and not something you have deemed structural for the company, or maybe is just to be expected in the early years of this new strategy as it takes time to ramp up new acquisitions? While they are different, software companies usually have negative WC as they get payment upfront before revenue can be recognized right?
Software companies do usually have negative WC. The formula in my valuation should have a negative sign in front of it. I've adjusted this and just used negative $1mil each year for changes in WC for simplicity. Thanks for pointing out my mistake.
I split the TAM into two, which was isolating just the simulation software TAM (which CMG estimated itself) and I also tried to estimate possibilities for the CCS market. The TAM presented is total TAM, and not what software specifically will be for CCS. My estimate was based on if CMG could take 0.5% - 1% of that TAM as software specific revenue, which is where I derived by revenue estimate for that market. It's a tricky TAM to estimate and it could increase as CMG acquires more companies, but as investors we have to make our best guesses
1- should we not think about low capex royalty firms with mineral rights instead of CMG which provides software to oil operators, if CCS is a major tailwind?
2- you mentioned moving from 'R&D' to a 'go-to-market' strategy in another post as per new CEO guidance, is it a good move? R&D is a pure DNA of these software firms or they will lose in the race. Am I missing something?
3- Stock-based compensation ended in 2022, but still I see SBC value increasing in statements to 6M+. Are there any other hidden calculations in it?
i am just a student at university and a newly born baby in the investing field, your guidance would be appreciated.
In terms of your other questions, 'R&D' was specifically related to CMG being not focused on returns on capital or growing the business. It was more focused on hiring PhDs and engineers. Now they are more focused on the business and how they go to market.
Stock based comp expense will still be there in the short-term, but will eventually be gone
1) Short-term, you're right, acquisitions would lower GAAP EPS. Over time, they will bring margins up. I have them going from roughly 34% (lower than current, due to new strategy) up to 45% in my terminal year.
2) Potato, potahto :)
3) I used the average of perpetual growth & EV/EBITDA. DCF's are a great tool to use, but they aren't perfect. Everyone's results will be a bit different depending on inputs.
4) They are undervalued in my opinion from multiple metrics compared to other software names (rightfully so based on history). However, I think your comment might be referring to the P/E ratio, which will be an irrelevant metric for this name and others in software for a long time. I'd focus more on revenue growth and FCF per share growth
I'm very grateful for your write up. It has greatly accelerated my understanding of the company.
One question I have is how you have arrived at a 30% market share estimate for CMG in the core simulation software market? Since the investor slide you referred to indicates a reservoir simulation TAM of $767m CAD in 2022, wouldn't the company's turnover that year imply a market share that's actually closer to 10% than 30%? ($66m / $767m). Or are you assuming that the company's existing market share will expand towards 30% by 2030 based upon the growth drivers you described (increased need for unconventional and EOR, high growth CCS, etc)?
Thank you.
That was my estimate by 2030 for market share. It's a bit tricky to get an estimate of TAM and market share so I had to make some judgement calls. We do know that there are basically 3 major players with CMG and Schlumberger being the two biggest, so I didn't think CMG having 30% market share in 2030 was unreasonable for getting a high level revenue opportunity figure.
Thank you for sharing this, greatly appreciate.
Question, wouldn't it be frowned upon by CSU to have their people helping constellation copycats? Wouldn't CMG be considered direct competition? Or is this common practice?
I understand the logic in the question, but CSU is more of a generalist in that they acquire businesses in many different verticals, whereas CMG would have a smaller TAM right now based on their one vertical. There is also a slight difference in hurdle rates (CMG's are lower) and CMG is also looking to benefit from synergies by building out a platform for their customers. A lot of CSU's board members participate on other company boards so all-in-all I think they end up learning from other companies and it doesn't impact CSU because their pool of acquisition targets is so large.
Great writeup! How do you see insider ownership? As far as I can tell it's just about 2%. The ownership by Edgepoint doesn't really count.
Hi Moritz - Thanks for the kind words on the write-up. You're correct in saying that technically 2% of insiders own the stock. Although, EdgePoint isn't an insider per se, I'd slightly disagree that it doesn't count. EdgePoint takes a very long-term view to their holding and the shares they own are locked up from my understanding for 6-7 years. Although insider ownership is a great filter, I personally focus less on the insider ownership % and more on the incentives. The performance incentive they have put in place is very unique and I think that's key to aligning shareholders with management.
Thanks for the write up. What is the reason that revenue stayed flat from 2017 to 2023?
Hi Sunny - Thanks for the kind words on the write-up. The poor revenue growth during this time period was a combination of cyclicality (back when the business was less diversified), poor capital allocation by prior management and of course you had COVID in the mix there as well. Overall, I think this is a completely different business now, and looking backwards I don't think will be a great forecast of what's ahead. I think a combination of the new CEO, strategy and incentive structure will lead to low DD organic growth with the rest coming from acquisitions
Great writeup. I was wondering if you know what differences between CMG's strategy and CSI's which leads to positive NWC for CMG and negative for CSI?
Two completely different companies and two different strategies. One is a mature serial acquirer of VMS businesses and other is just starting out with their 4.0 strategy. We'll see how things look in a few years
So assuming 8m WC investments per year in your valuation is just for sake of simplicity, and not something you have deemed structural for the company, or maybe is just to be expected in the early years of this new strategy as it takes time to ramp up new acquisitions? While they are different, software companies usually have negative WC as they get payment upfront before revenue can be recognized right?
Software companies do usually have negative WC. The formula in my valuation should have a negative sign in front of it. I've adjusted this and just used negative $1mil each year for changes in WC for simplicity. Thanks for pointing out my mistake.
Thanks for the write up. How can CMG have so little % of your estimated TAM if it’s a duopolistix structure and a market leader? Confusing…
I split the TAM into two, which was isolating just the simulation software TAM (which CMG estimated itself) and I also tried to estimate possibilities for the CCS market. The TAM presented is total TAM, and not what software specifically will be for CCS. My estimate was based on if CMG could take 0.5% - 1% of that TAM as software specific revenue, which is where I derived by revenue estimate for that market. It's a tricky TAM to estimate and it could increase as CMG acquires more companies, but as investors we have to make our best guesses
1- should we not think about low capex royalty firms with mineral rights instead of CMG which provides software to oil operators, if CCS is a major tailwind?
2- you mentioned moving from 'R&D' to a 'go-to-market' strategy in another post as per new CEO guidance, is it a good move? R&D is a pure DNA of these software firms or they will lose in the race. Am I missing something?
3- Stock-based compensation ended in 2022, but still I see SBC value increasing in statements to 6M+. Are there any other hidden calculations in it?
i am just a student at university and a newly born baby in the investing field, your guidance would be appreciated.
See the link below for a great example of a CCS project CMG was involved in:
https://www.offshore-energy.biz/canadian-integrated-ccs-solution-enhancing-north-sea-carbon-storage-project/
In terms of your other questions, 'R&D' was specifically related to CMG being not focused on returns on capital or growing the business. It was more focused on hiring PhDs and engineers. Now they are more focused on the business and how they go to market.
Stock based comp expense will still be there in the short-term, but will eventually be gone
Hi,
Continue to hold strong conviction in this idea?
With the sharp drop it looks much more attractive.
It´s a strong buy?
1) Short-term, you're right, acquisitions would lower GAAP EPS. Over time, they will bring margins up. I have them going from roughly 34% (lower than current, due to new strategy) up to 45% in my terminal year.
2) Potato, potahto :)
3) I used the average of perpetual growth & EV/EBITDA. DCF's are a great tool to use, but they aren't perfect. Everyone's results will be a bit different depending on inputs.
4) They are undervalued in my opinion from multiple metrics compared to other software names (rightfully so based on history). However, I think your comment might be referring to the P/E ratio, which will be an irrelevant metric for this name and others in software for a long time. I'd focus more on revenue growth and FCF per share growth