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The subscription economy goes beyond the consumer (B2C) into the business arena (B2B), and increasingly we are seeing products become services: Software as a Service (SaaS), Equipment as a Service, Infrastructure as a Service. The benefits to businesses from subscription rather than ownership are often similar to those for consumers: reduced obsolescence risk on technology; lower maintenance costs; predictability of costs; revenue rather than capital spend; and a saving of resources such as space, technical staff, and data centres.
On one estimate, the digital subscription economy was worth $650bn in 20201 and is expected to grow at 18% compound to 2025. It has spawned a series of new three letter acronyms for analysing the financial success of providers, such as ARR (Annual Recurring Revenues), TCV (Total Contract Value), NCC (Net Customer Churn), and CAC vs. LTV (Customer Acquisition Costs vs Lifetime Value).
Investing is not without risk
Investing in the subscription economy is not without its risks. On the consumer front, investors need to unpick the impact of Covid. Consumers took out multiple video on-demand services during the pandemic but Netflix warned in April this year that its subscriber numbers had fallen back by 200,000, the first decline since 2011. The impact of the upward pressure of fuel, food, and mortgage costs will likely generate more cancellations. In software, suppliers sometimes have to make a painful transition from perpetual or multi-year licence fees, often paid upfront, to a subscription model where revenues are more predictable but initially lower and spread out. For example, in April Aveva Group, which sells software to design, operate and maintain manufacturing plants, warned that an acceleration in Annual Recurring Revenue from moves to subscription and the cloud would negatively impact traditional point-in-time revenue recognition, leading to a near-term impact on reported revenues.
Companies that should benefit from the trend
I have invested in four companies that should benefit from the growth of the subscription economy in different ways. Alfa Financial Software is a leading global provider of software and services to the automotive and equipment leasing industries. Its software manages the entirety of the life of individual leases, from inception, through changes in interest rates and regulations, to termination or even default. Many of its 31 customers are in the process of rolling out its software globally and it is winning new customers with a “cloud first” approach to its offer. It seems that Electric Vehicles and Autonomous Vehicles are even more likely to be leased than their predecessors, not least because this technology is so new and technological risk, for example around battery life, is therefore higher. Alfa helpfully quotes its next 12 months TCV, but typically actual revenue has come out much higher.
Another software company that should benefit from the growth in the subscription economy is Aptitude Software. Aptitude actually provides software to manage subscriptions, and its largest customer is T-Mobile. In the company’s own words: “The subscription economy is continuing to expand into new sectors as the benefits of subscription income are increasingly valued more than traditional non-recurring revenues. Organisations require new systems to manage these subscriptions and require new capabilities to address the complexities of revenue recognition inherent with subscriptions2.” Aptitude has seen Annual Recurring Revenues grow from £29.8m in 2019, to £41.8m in 2021, including some from an acquisition part way through 2021.
The trend for more and more business critical software to be accessed “off-premise” brings with it a shift of network security needs from data centres to the cloud. More users, devices, applications, services and data are now located outside the enterprise than inside. This complexity should create more work for companies that test mobile networks, Wi-Fi and mobile devices and high speed ethernet performance, among which is leading global player Spirent Communications.
The growth of subscription TV mentioned earlier has generated increasing spend on content creation from the likes of Netflix, Amazon, Apple TV and Disney, as well as defensive spend from traditional broadcasters. This is driving demand for more TV production equipment such as camera systems, mobile power, prompters, lighting, and audio systems. Videndum (formerly known as Vitec) is a leading global provider in these product areas and hence a clear beneficiary of this trend. In addition, the development of the metaverse in industries such as computer games will likely stoke demand for its equipment and its real time streaming capabilities.
Manager VT Downing Unique Opportunities Fund
(based on a talk given to private investors at Mello in May 2022).
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1UBS Editorial Team, Investing in digital subscriptions, 11 March 2021
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