Why we sold Sage

Charlie Huggins (CFA) - Fund Manager

28 February 2019

We’ve held Sage in both the HL Select funds since launch. In the last few weeks we’ve been reducing our holding and have now fully exited our position in both funds.

The company ticks most of the boxes we look for – including high profit margins, strong cash generation, modest debts and a high proportion of recurring revenues. This is what initially attracted us but over the last 12 months our conviction in the investment case has steadily weakened.

Why we sold

We believe Sage’s products are losing relevance because of evolving technological trends.

Sage provides accountancy software that helps small and medium-sized firms manage their finances. The company's traditional strength has been in software solutions which are installed locally, on a company's own computers and servers.

The industry is rapidly shifting towards a cloud-based model, where software is hosted on the seller's servers and accessed through an online browser. Cloud-based accountancy software is easy to install, easy to update and provides other benefits to small businesses, relative to on-premise solutions like those Sage has historically delivered so well.

Sage was late to invest in cloud-based solutions and is playing catch up. Its strategy has revolved around transitioning existing customers to ‘hybrid’ cloud software - a halfway house between an on-premise and fully cloud-enabled solution. This strategy has been quite successful; not least because it allows Sage to sell its software on subscription while charging higher prices.

However, Sage has struggled to sign up new customers. After-all, if you’re starting a new business why would you go with a hybrid-cloud offering when for a similar or lower price, you can get a fully-cloud enabled solution? Sage’s full cloud solutions have struggled to gain meaningful traction. We believe this is because some of the group’s competitors have superior cloud-based offerings.

In the short to medium term, we suspect Sage will do ok by transitioning its existing customer base to hybrid cloud solutions. However, in the long run, if Sage is to continue growing, we believe it’ll need to do a much better job of signing up new customers. Given the group’s relatively weak position in cloud versus the competition, we think it faces an uphill battle.

The recent performance of the business, while being far from disastrous, does not inspire confidence. Sage has suffered a series of operational missteps over the last few years leading to revenue and margins falling short of expectations. Ultimately this cost Stephen Kelly, the previous CEO, his job.

His successor, Steve Hare (previously group finance director), has announced a new strategy designed to increase the competitiveness of the group’s cloud-based offering. This strategy sounds sensible. However, the extra investment will lead to lower margins and we have doubts as to whether it will make much difference (it’s not like the competition are standing still).

The shares have been pretty volatile during our period of ownership, but have enjoyed a recovery since their January trading update. This allowed us to exit at around £6.50-6.60, with the valuation approaching ten-year highs. The net result then, including the dividends we received, was a gain of about 7% in each fund.

What have we done with the proceeds?

We have not yet found an alternative home for the money so have built a position in a FTSE 100 ETF (Exchange Traded Fund). We hold this ETF tracker as a source of dry powder, rather than build up large cash positions in the fund. Stock markets have risen over the long term, so we believe holding cash in this fund is more likely to end up acting as a drag on performance. Once we have identified a company we want to buy, we will sell down the ETF and allocate the proceeds accordingly.