AI-First Strategy Fuels Cloud Growth Amid Economic Uncertainties And Margin Pressures

Key Takeaways

• The shift towards AI-first strategy and cloud-hosted services is set to enrich the revenue mix with higher-margin, cloud-based revenues.
  
• Enhancements in AI for supply chain planning and corporate governance improvements are poised to drive market share expansion and attract a broader investor base.
  
• Economic conditions and cautious spending may slow growth and lower client spending on products and services, impacting American Software's revenues and profit margins.

Catalysts

Develops, markets, and supports a range of computer business application software products in the United States and internationally.

• The continuation of high retention rates in the mid-90s indicates a strong and loyal customer base, which could lead to stable and predictable revenue streams, positively affecting future revenue stability and growth potential.
  
• The transition of self-managed clients to cloud-hosted versions due to the company's AI-first strategy suggests an uptick in cloud migrations, which can drive recurring revenue and improve the company’s revenue mix towards higher-margin, cloud-based services.
  
• Enhancements in supply chain planning with generative AI capabilities and the new decision command center are expected to improve the quality and efficiency of supply chain decisions for clients, potentially increasing demand for the company’s software and services, impacting revenue growth and market share expansion.
  
• The expansion of the late-stage pipeline, driven by delays and new interest, coupled with indications of readiness from clients and prospects to move forward with projects, presents a positive outlook for booking conversions and revenue realization in future periods, possibly leading to revenue growth acceleration.
  
• Approval from shareholders to eliminate the dual class structure, aligning with the company’s transformation towards a pure-play AI-first supply chain software entity, could enhance corporate governance perception and attract a broader investor base, potentially leading to a re-rating of the stock and positively impacting its value.

Assumptions

• Analysts are assuming American Software's revenue will grow by 4.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 8.9% today to 7.2% in 3 years time.
• Analysts expect earnings to reach $8.3 million (and earnings per share of $0.25) by about October 2027, down from $9.1 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 74.6x on those 2027 earnings, up from 40.4x today. This future PE is greater than the current PE for the US Software industry at 38.4x.
• Analysts expect the number of shares outstanding to decline by 1.47% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.63%, as per the Simply Wall St company report.

Risks

• The company faces uncertainty in the general economic conditions and a cautious spending environment, which could lead to slower growth or reduction in spending by clients on American Software's products and services, impacting revenues and profit margins.
  
• Delay in cloud migrations due to economic conditions and budgeting cycles might slow down the expected uptick in cloud revenue, affecting the company's overall revenue growth and potentially delaying the realization of improved gross margins associated with cloud services.
  
• There is a risk associated with the reliance on high retention rates for revenue stability; any unforeseen downturn in client satisfaction or competitive pressures could lower these rates, negatively affecting recurring revenue streams.
  
• The competitive environment, including new entries and evolving products from existing competitors, could impact American Software's market share and pressure on pricing, thereby affecting revenues and profitability.
  
• Investment and focus on AI and supply chain optimizations are contingent on the successful transition of clients to cloud-based services; any delay or resistance could hinder the anticipated growth from these areas, affecting future earnings and innovation capabilities.

Valuation

• The analysts have a consensus price target of $16.0 for American Software based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $17.0, and the most bearish reporting a price target of just $14.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $116.2 million, earnings will come to $8.3 million, and it would be trading on a PE ratio of 74.6x, assuming you use a discount rate of 6.6%.
• Given the current share price of $10.95, the analyst's price target of $16.0 is 31.6% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.