dotDigital is Aim’s tech darling

As smartphones, tablets and laptops get ever better and cheaper, more people own more of such gadgets. A study last year found that the average home in the UK had around 10 internet-enabled devices: for a digital marketer, that means that there are 10 windows through which it can advertise. This opportunity sits at the heart of dotDigital’s (DOTD) business. The company's software enables its clients to reach customers across a whole range of digital touchpoints. 

Founded in a pub in Croydon in the late 1990’s (the company still holds onto the original tables and bar stools), it evolved from a web design agency into a marketing email specialist when it listed in 2008. Once known as ‘dotmailer’, its now more comprehensive marketing automation platform is used by more than 70,000 marketers internationally. Its ‘Engagement Cloud’ software service has developed beyond email into SMS text-messaging and social media. 

Foundations for growth

This digital approach to marketing means that the company has earned all the hallmarks of a high-quality software-as-a-service (‘SaaS’) business. A subscription-based model means that recurring revenues make up most of the company’s top line, giving it reliable earnings visibility. That proportion has been growing steadily, having breached its 90 per cent target in 2020 at 91 per cent, up from 85 per cent of the total in 2018. 

Meanwhile, the non-physical nature of its product means that it has flexible operating costs, with gross margins typically sitting at around 90 per cent and a free cash conversion rate on continuing operations of close to 100 per cent last year. Return on capital employed, which measures how effectively profit is generated from investments in the business, sits at a very healthy 22 per cent. 

Clearly, then, dotDigital has an attractive, cash-rich business model. This is built on its in-house data expertise and competitive technology. An extensive and growing suite of products has allowed it to squeeze more money out of its clients too: average revenue per customer has been on a steady upwards trajectory since it started to disclose the figure in 2017. 

This provides a solid foundation for further growth. A key way in which management achieves this is through strategic partnerships with content relationship management (CRM) systems and e-commerce platforms such as Shopify (US:SHOP) and Magento, a company which is owned by Adobe (US:ADBE). These alliances allow dotDigital to build international brand awareness, as well as generating revenue for both parties. In 2020 for example, the company added 206 Magento customers to its platform, making a total of 716.  Sales through connectors into strategic partners grew by a tenth in 2020 to £22.2m, which accounts for 47 per cent of total turnover.

While UK-listed technology companies often struggle to achieve international scale, dotDigital is not shying away from the challenge. For now, international revenues are steadily growing, hitting just shy of a third of the total in 2020, compared with 26 per cent in 2018. The company describes global expansion as a key tenet of its growth strategy, as it eyes potential partners in so-called ‘Big Commerce’. 

This goal looks well within reach. dotDigital’s model is well-suited to scale: the more data the company analyses, the smarter and more personalised its marketing products will become. The company's focus on adding of artificial intelligence (AI) software tools to its product suite will only strengthen its service. 

A turbulent end-market

The marketing industry is cyclical. As companies are squeezed by macroeconomic pressures, they often become less willing to splash out on discretionary spending such as advertising. So far, this has not affected dotDigital much. No customer accounts for more than 1 per cent of the group’s revenue, and while management noted in the early stages of the pandemic that there was a slowdown of new business wins, the impact was mostly contained to April. But churn reduced and trading has improved on a monthly basis until the end of the financial year. In fact, the company updated the market twice in 2020, pointing to higher than expected earnings.  

However, there remains the risk that a looming recession could force some of its clients to tighten their purse strings. Currently, trade receivables make up a conspicuous 27 per cent of revenues. Last year, overall receivables grew by 6 per cent as some customers in tradeshows and conferences deferred marketing expenditure. In a period of prolonged economic downturn and ongoing public health issues, this could result in impairment charges if a number of customers find themselves unable to cough up which is not without precedent in the software sector. 

On the flip side, depressed values in the media sector could work as an advantage for dotDigital. The potential to buy rival companies on the cheap could help its acquisition strategy, which is key to its international growth plan. With £25m worth of cash on hand, a slump in activity might offer a window in which the company can scoop up smaller rivals from "motivated" sellers. 

Equally, investors should bear in mind that dotDigital itself could end up being a takeover target, as consolidation in the tech-based marketing picks up and bigger fish go hunting on the alternative investment market (Aim). Take for example S4 Capital (SFOR), which has already bought two companies since the start of the year, or SAP SE (DE:SAP), which acquired omnichannel customer engagement business Emarsys in late 2020. WPP (WPP) has also set out a new growth plan that sets aside £200m-400m annually for acquisitions that specifically strengthen its digital services. 

The sunny, techy horizon

Digital products have  been growing as a proportion of overall marketing budgets for some time, but the pandemic has meant that marketers have been pushed to make more use of their digital channels in order to sustain relationships with their customers and continue generating high-quality leads. The pandemic did prompt an increase in uptake in the company’s omni-channel service, with more than a fifth of its customers now using more than one channel.  With global marketing automation spend forecast to grow at double digits and hit $25.1bn by 2023, this is unlikely to be behaviour that will reverse.

dotDigital has great foundations, as well as tenable ambitions for international expansion, adding more strategic partnerships and leading product innovation. For investors, the company offers both high growth and high returns. This is an attractive combination – and the market knows it. With a forward price to earnings multiple of 40, the shares do not come cheap. But at 160p, the stock is still trading below analysts’ average target price, according to data from FactSet. As a new tech dawn breaks on the marketing sector, the outlook is sunny for dotDigital.