AI And Cloud Migration Will Drive Major Long Term Upside Potential

Catalysts

About Tyler Technologies

Tyler Technologies provides mission critical cloud software, payments and data solutions that power digital transformation for public sector agencies.

What are the underlying business or industry changes driving this perspective?

• Accelerating migration of a large on premises installed base to Tyler’s cloud platforms, supported by version consolidation and a 1.7 to 1.8 times revenue uplift on flips, is set to compound high visibility recurring revenue growth and expand operating margins.
• Expanding demand from governments to modernize aging systems and meet efficiency mandates, including reallocating labor budgets toward digital workflows, is increasing adoption of Tyler’s SaaS and transaction based offerings and supporting double digit annualized recurring revenue growth.
• Early proof points from purpose built AI solutions, such as document automation and priority based budgeting that deliver 10 to 30 percent productivity gains and two to three times process ROI, position Tyler to layer new high margin AI revenue streams on top of its existing SaaS base and enhance net margins.
• Growing adoption of transaction based services in areas like payments, resident engagement and inmate financial services, supplemented by contracts such as California State Parks and Colorado corrections, is driving higher volume, fee based revenue that supports durable transaction revenue growth and stronger free cash flow conversion.
• A proven tuck in M&A playbook in public safety, courts, corrections and emergency response, combined with over $1 billion of cash and additional debt capacity, enables accretive acquisitions that can outgrow the core business when pushed through Tyler’s distribution, lifting overall revenue growth and long term earnings power.

Assumptions

This narrative explores a more optimistic perspective on Tyler Technologies compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming Tyler Technologies's revenue will grow by 10.2% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 13.7% today to 18.1% in 3 years time.
• The bullish analysts expect earnings to reach $555.4 million (and earnings per share of $12.52) by about December 2028, up from $315.3 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $408.2 million.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 79.4x on those 2028 earnings, up from 62.8x today. This future PE is greater than the current PE for the US Software industry at 32.0x.
• The bullish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.55%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The wind down of the Texas payments contract, combined with normal lumpiness in large transaction-based wins, could slow overall subscription and transaction revenue growth below the anticipated low double digit trajectory, reducing total recurring revenue and earnings growth.
• A prolonged period of elevated research and development spending on cloud migration and AI initiatives, without commensurate pricing power or upsell success, may compress operating leverage, limiting further non GAAP operating margin expansion and dampening net margins.
• If public sector budget cycles tighten again after the post ARPA pause, or if federal and state funding priorities shift away from digital transformation, demand for new SaaS deals, flips and add-on modules could weaken, pressuring bookings momentum, annualized recurring revenue and long term earnings growth.
• Execution risk in accelerating flips and version consolidation, particularly among larger on premises customers in courts, justice and ERP, could delay the expected 1.7 to 1.8 times revenue uplift and associated efficiency gains, slowing SaaS revenue growth and limiting free cash flow margin expansion.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Tyler Technologies is $800.0, which represents up to two standard deviations above the consensus price target of $648.17. This valuation is based on what can be assumed as the expectations of Tyler Technologies's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $800.0, and the most bearish reporting a price target of just $510.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be $3.1 billion, earnings will come to $555.4 million, and it would be trading on a PE ratio of 79.4x, assuming you use a discount rate of 8.6%.
  
• Given the current share price of $460.2, the analyst price target of $800.0 is 42.5% higher.
  
• 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.