Is Craneware the next UK software takeover target?

As the pound continues to devalue, under-appreciated UK software companies are being snapped up on the cheap by foreign buyers. Edinburgh-headquartered healthcare software company Craneware (CRW) could be the next to go. Although there are no rumours it is under consideration, both current trends and Craneware’s recent devaluation below its peer group, makes it a likely target.

So far in 2022, Craneware’s share price has fallen 35 per cent. At the same time, FactSet data shows the consensus earnings forecast for the current financial year has risen 22 per cent to 81p per share. This valuation drop coupled with improving analyst sentiment means the stock now trades on an affordable-looking FY2023 PE ratio of 19.5 – around a 20 per cent discount to peers.

Neither is it hard to see what a potential acquirer might like in the business.

Craneware, which makes all its sales in the enormous US healthcare market, pitches its software as a tool to connect hospital financial departments with clinicians. From an operational perspective, giving hospital managers a clear view of what doctors are spending money on makes a great deal of sense, if the goal is to provide cost-effective treatment for patients. Having the systems that help hospitals stay compliant in America’s highly complex multi-payor health system is also a must.

This is where Craneware and its Trisus platform comes in. The software has multiple products, including Trisus pricing, Trisus Supply and Trisus Pricing Analyzer, and has just released the Trisus Chargemaster app, a cloud solution that enables hospitals to centralise all their billing data.

Unlike the UK’s health service, the US system is competitive. There are thousands of hospitals across the country, competing for patients and trying to generate as much profit as possible. That means getting pricing right is essential. Charge too much and patients and insurers may look elsewhere for treatments. Charge too little and you risk generating a loss. The legacy of Covid-19, which resulted in negative operating margin at a third of US hospitals during 2021, will have served as a painful reminder of these risks to hospital administrators.

M&A provides up-selling opportunity

In July last year, Craneware acquired Florida-based pharmacy software business Sentry. This means that the Craneware group now services approximately 40 per cent of all US hospitals and more than 10,000 clinics and pharmacies.

Sentry’s main use is to track pharmacies’ inventory to enable them to be 340B compliant. The 340B drug program is part of the Medicaid and Medicare program that provides cheaper healthcare to vulnerable people. The program allows pharmacies to acquire and sell drugs at a discount but to do so they need to accurately track where the drugs are being purchased from and who they are being given to. For hospital staff, paper-based audits of this process would have been a nightmare.

The Sentry deal was worth $400mn (£345mn) and at first glance this doesn’t look too expensive. Sentry generated $92mn of revenue in 2020, pricing the company at just over four times trailing sales at a time when many US-based software-as-a-service (Saas) businesses were trading at more than double that level. However, forward revenue multiples have fallen over 50 per cent on average since May 2021, suggesting Craneware did purchase near the top of the market.  

Craneware argues the increased scale means cross-selling opportunities. Sentry has a customer base of around 10,000 pharmacies and clinics. It also serves 600 US hospitals of which only 35 per cent overlap with existing Craneware customers. That means 390 hospitals that can be sold the Trisus platform.

Broker Peel Hunt said some of the early cross-selling to Sentry customers produced a 200 per cent uplift in annual recurring revenue (ARR) growth. Craneware currently makes around $85,000 per hospital but Peel Hunt said this could go “well into six figures” as the strategy beds in. This is a little vague – but if Peel Hunt means $120,000 then that implies around 40 per cent ARR growth even if Craneware adds no new hospitals.  

Despite the obvious promise of the Sentry deal, recent growth has been more modest. In fact, strip out Sentry and organic revenues declined 7 per cent in the six months to December 2021, as revenues in the group’s servicing arm – which involves on-site assistance with the software – contributing to the bulk of the decline. These revenues are not recurring and are only recognised as they are delivered, so were disrupted by Covid-19. Management expects this fall to be temporary.

'Sticky' software resilient in a recession 

To analysts who cover the software sector, service revenues that can wax and wane are less of a concern than stable ARR. In the half year to December, this increased 3 per cent to $170mn. Analysts at Peel Hunt said they “aren’t bothered by the drop in services” and are forecasting 10.6 per cent revenue growth in the 12 months to June 2023. Management seems confident of hitting these targets.

Double-digit growth for a UK software company during what is likely to be a recessionary year would be an impressive feat regardless of its sectoral focus. But the main thing that stands Craneware apart is its exposure to the US, where the energy crisis and looming recession are unlikely to be nearly so drastic compared with the UK and Europe.

This is likely to be good for dollar earners like Craneware. More importantly, even if the US economy contracts, it is unlikely to put a big dent in healthcare spending. Compare this to Sage (SGE) – the UK’s largest SaaS company – which sells mostly to UK SMEs that are about to get battered by rising costs and the picture is a lot rosier for Craneware. By contrast, Sage’s much more expensive trading multiple of 24 forward earnings looks hard to justify.

Healthcare is essential and is some of the last spending people would cut. Staff shortages will also encourage hospitals to spend more on technology that improves productivity. After the hit to margins during the pandemic, hospitals will be looking at ways to increase profitability. Craneware’s software not only frees up time for staff but also helps hospitals see where money is leaking into costly needless treatments.

We know such services are highly valued, because Craneware’s customer retention rates are above 90 per cent across the group. That shows the stickiness of the product and makes sense. Once a hospital has transferred all its billing onto a system, removing itself from it would prove costly. Churn from its current customers will be low and with CPI inflators built into its US contracts, protecting its mid-20 per cent operating margins should be straightforward.

UK markets still don’t appreciate the value of sticky software – especially when it is being sold into the huge US market. Until they do, these companies will keep getting picked off by foreign companies and private equity firms. Craneware investors could be next in line for a payday. And if not, at least the US hospitals will keep paying their subscription fees.