OneSoft Solutions: A De-risked Early Stage SaaS Play

OneSoft Solutions (OSS.V)

Current price: $0.12

Shares outstanding/fully diluted: ~46.9M/~66.9M

Basic insider ownership: 65.7%

Market cap $5.6M

Company history:

OneSoft Solutions, formerly known as Serenic Software, has undergone major transformations making for what I believe is a very compelling investment opportunity. Essentially, Serenic Software used to sell on-premise accounting software for large NFPs (not-for-profits) which did reasonably well peaking at ~$12M in sales and being profitable. In 2009, management recognized the opportunity in cloud-based software and decided to start developing a cloud-based version of their accounting software. Fast-forward to early 2014 and they made a very bold business decision to divest the old on-premise software to Sylogist Ltd (SYZ.V) which accounted for virtually 100% of revenue in order to completely focus on the new cloud opportunity. Therefore, the company transitioned from being a mature operation to a start-up. I believe the company is more de-risked than the average start-up for reasons I will get into, but first:

A look at cloud-based computing:

Technology changes at such a fast pace, hence it’s very difficult to predict what technologies will come to fruition and become the standard in the future. However, every so often, there are obvious ones like cloud computing. The evidence is in the fact that Microsoft, Amazon and Apple have made huge investments into their cloud infrastructure and provides numerous important advantages for clients and software providers alike. For more information, see: http://www.salesforce.com/uk/socialsuccess/cloud-computing/why-move-to-cloud-10-benefits-cloud-computing.jsp. Now that the predictability of cloud computing has been covered, I’ll get into what makes OneSoft particularly interesting.

The opportunity:

The ultimate goal of OneSoft Solutions is to become a provider of cloud-based software for an array of industries, starting first with accounting software for NFPs, and software applications for the oil and gas pipeline industry as per their latest acquisition of Bridge Solutions (section on this below). They started with those two industries because they are the paths of least resistance given their knowledge, experience and past success in those markets. Therefore, revenue growth and profitability should happen much quicker than a typical start-up – the first reason why I’m compelled to invest. Further adding to management’s credible business strategy is the way they structured the sale of the Serenic subsidiary (the legacy software business) to Sylogist which allows OneSoft to legally pursue their cloud accounting software without interference regarding non-compete issues. This is due to the fact that the Serenic software products that Sylogist acquired operate as single tenant applications while OneSoft’s applications are multi-tenant – the delimiting factor of the non-compete agreement. Additionally, OneSoft’s multi-tenant applications are likely the way of the future, and may set up the business up for increased future growth well beyond what Sylogist can probably do with their older technology platform, which is in its sunset phase.

The second reason I like the story is because of the high barriers to entry. Despite not being the first movers in their respective industry, they are still an early entrant and enjoy a major competitive advantage over the first movers. OneSoft is one of only a half dozen worldwide Microsoft managed partners, who have pioneered the movement away from legacy to Microsoft Cloud computing.  This relationship allows them to seamlessly integrate into Microsoft Office products and operating systems, which for accounting programs is a major feature. The seamless integration with Microsoft products is also a huge business advantage for any future software they will write or acquire. They’ve had this strong working relationship with Microsoft for over 10 years, which has intensified in importance to both parties with OneSoft’s solid commitment to the Cloud business model, so there’s no real risk of this relationship deteriorating. Furthermore, since the cloud-based software industry is in its infancy, most software providers have not yet made the jump to cloud software. Should competitors decide to make the switch to cloud, it will likely take them anywhere from 18 to 36 months, and will typically require several million dollars in investment to evolve their applications to Microsoft Cloud. OneSoft has already incurred over $4M in development costs, which started during the Serenic days. Competitors will struggle with the transition as they will need to forgo their legacy business, which means they can expect to operate without significant revenue for approximately 2 or 3 years. Forgoing revenue during initial stages of the cloud business model is often necessary due to the compromising culture clash and internal conflicts within a company, when one department is attempting to sell large upfront licenses (typically in the tens or hundreds of thousands of dollars) while the other is selling a $500 monthly all inclusive service. The management at OneSoft has experienced this first hand. These high barriers to entry will surely help to preserve their market share.

Third, insider ownership is significant and spread across multiple insiders.  Management has historically done right by shareholders – rather than retain all of the funds for the sale of the Serenic companies, management elected to dividend out most of the cash, which returned investment to shareholders who supported the legacy business model. Those who decided to support the next phase of the business have retained their shares and can ride the Cloud start-up opportunity. Since the inception of the company, there have only been 3 private placements:  a $0.5M raise when Serenic was acquired in 2004; a $1.6M raise to fund revenue growth in 2007; and the latest $1M funding that closed on March 27, 2015, to top up funding to pursue the Cloud business. No further private placements are planned, as the company expects to have sufficient funding with cash on hand and exercise of the warrants to continue until it is able to operate on a cash positive basis.  As at May 31, 2015 the company reported $1.7M in cash. If the outstanding warrants are funded (which are already in the money based on the current share price), this will generate another $2M, and OneSoft is still owed $529,000 in working capital adjustments from Sylogist (see section on lawsuit below). In the microcap world, companies generally continually perform equity raises, which results in significant dilution for shareholders; however, I don’t anticipate any further material reduction to shareholder value in OneSoft’s case.

The insider share ownership as recently reported on SEDI may be somewhat confusing to understand due to some disclosures which have been filed.  On July 2, 2015, the private disposition of 2.5M shares by the CEO was in fact not a sale of shares, but rather the collapsing of a pooling agreement in which he indirectly controlled those shares. SEDI filings confirm that the senior executives currently own 48.2% of the company, with another 12.9% owned by directors – i.e., the management and insiders as reported on SEDI own at least 61.1% This definitely bodes well for strong commitment by management and insiders, and clearly aligns their objectives with shareholders’ interests. What is also impressive is that insider ownership is spread amongst 7 insiders who file on SEDI, and that key management people and directors who were formerly with the Serenic companies elected to continue with the OneSoft Cloud projects. It is uncommon to see such a large number of insiders have such a large stake in a company such as OneSoft, which underscores their belief of OneSoft’s future opportunity.

(Note: I am happy to share a spreadsheet I created that provides a specific breakdown of insider ownership. Please email me if interested.)

The economics of the new business based on SaaS revenues are very interesting and opportunistic, as anyone who understands the model already knows. Instead of charging a large one-time upfront fee and selling support service packages, a SaaS company can now charge a recurring monthly fee, which makes future revenue streams more predictable and sustainable over the long term. The typical license under OneSoft’s old business model typically generated between $50,000 and $150,000 and usually required services amounting to about half of license fees, but involved significantly longer sales cycles and more elaborate sales and service infrastructures than the SaaS model requires. Although the SaaS business model generates less cash up front, equivalent revenues to what are received on the legacy model are typically generated by the third year, however, generally with shorter sales cycles and lower infrastructure costs, and higher customer retention in the longer term, thereby increasing the customer LTV (life time value) overall. Unlike the legacy single-tenant (Serenic) technology model, multi-tenant software applications and services can be provided to many more customers without the requirement to proportionally increase personnel and other service resources, thus profitability increases exponentially with volume. Additionally, OneSoft’s strategy is to reduce customer acquisition costs by seeking joint venture (JV) agreements with other resellers who already have large customer bases who require OneSoft’s products. Management has already demonstrated their ability to execute on JV strategies, as per their recent arrangement with TechSoup Global, which is one of the world’s largest technology providers for NFPs. The organization has 600,000 members, 70,000 of which were reported to be ideally suited to utilize OneSoft’s solutions. Management also expects to enter into other similar arrangements in the future.

The Bridge Solutions acquisition:

On July 30, 2015, the company finalized an agreement to acquire the assets of Bridge Solutions Inc., a private software company specializing in the oil and gas pipeline sector. Tim Edward, the founder of Bridge Solutions, has pioneered a spatial data infrastructure (“SDI”) framework, which serves as the backbone of the Bridge software applications. The SDI framework has been under development since 2001, operating as a legacy on-premise licensed software application.  Management’s vision is to port the Bridge applications to the Microsoft Cloud technology model, which they believe will be unique in the industry. The first application to be converted to Cloud will be the Public Awareness (PA) application, which provides pipeline operators with the information they need to meet safety and regulatory requirements, which are becoming more and more onerous, particularly in the USA. Failure to comply with these requirements is now very costly for pipeline operators, who can otherwise be subjected to large fines for non-compliance. The SDI framework provides a spatial database, upon which multiple layers of data can be attached and referenced, to manage pipeline integrity, safety and public awareness factors. Although pipeline failures occur infrequently they are very high consequence events. In the event a pipeline failure occurs, the Bridge SDI provides immediate access and referencing of multiple layers of data, including, detailed information that pertain to the pipeline assets (e.g., appropriate shut-off valves), current meteorological data which is likely to affect the area, and a raft of other information regarding the residents who need to be notified, the appropriate emergency responders who must be contacted, and the action plans to be carried out in the event of a failure within the affected consequence area.  The Bridge applications are able to correlate and reference information such that action plans can be implemented in a matter of minutes, rather than hours or days, which represents the current usual response time in the pipeline industry today.

The Bridge project will now be operated under OneSoft’s new subsidiary, OneBridge Solutions Inc. By moving the current technology to Microsoft Cloud, Management’s view is that the applications will operate significantly faster and more efficiently, accommodate larger data sets, and be made available for use by any Internet capable device (including smartphones) – a vast improvement over the legacy on-premise computer systems that serve the pipeline industry today.

Dwayne Kushniruk (CEO of OneSoft) and Brandon Taylor (President of OneSoft’s US subsidiary, Cloudco Solutions Limited) had an equity stake in Bridge Solutions. As a result of their intimate understanding of the Bridge technology, Microsoft Cloud technology and the synergies in amalgamating the Bridge operation into the OneSoft organization, Bridge was able to be acquired as a share-only transaction, and probably at a discounted value. Interestingly, Mr. Edward and Mr. Kushniruk collaborated on a similar start-up software company that served the pipeline industry in the late 1990s that was acquired within 18 months of start-up.  This bodes well for the potential opportunity of OneBridge within the OneSoft organization.

The Sylogist Lawsuit:

OneSoft filed a claim against Sylogist Inc. on February 13, 2015, to recuperate the $529,000 in working capital adjustments that management believes is owed pursuant to the terms of sale of the Serenic companies. Sylogist subsequently filed a defence, refusing to pay the amount claimed, and also filed a counterclaim for $1.75M against OneSoft and three individuals, claiming that OneSoft and the individuals conspired to withhold full details regarding the Serenic businesses, which Sylogist claims lost some customers and revenue subsequent to the sale transaction. OneSoft and the individuals filed a statement of defence to the counterclaim, which states management’s belief that the loss of customers and revenue resulted from Sylogist’s mismanagement of the Serenic businesses subsequent to the sale date, as a result of Sylogist’s decision to disregard OneSoft’s recommendations regarding the personnel who were required and should have been retained to operate the Serenic business following the acquisition. OneSoft carries D&O insurance which is funding part of its legal costs, and which will ultimately pay an award to Sylogist in the (unlikely) event that their claim is successful.

To provide full disclosure to its shareholders, OneSoft has posted copies of all legal proceedings that pertain to this lawsuit on its SEDAR site, which confirm management’s belief that Sylogist’s defense and counterclaim have no basis or merit.

Conclusion:

Despite being in the start-up phase, OneSoft Solutions meets all the requirements I look for when owning a stock: recurring revenues, high barriers to entry, significant insider ownership, competent management team, substantial growth opportunities and low capex requirements. For that reason, I think the stock has one of the best risk/reward profiles out there and I wouldn’t be surprised to see shareholders make over a 10X return over a few years.

Disclosure:

I hold a material investment in OSS.V