At our March Pro member event, Motley Fool Pro lead Advisor Matt Joass got a chance to sit down with Class (ASX:CL1) CEO Kevin Bungard.

Tune in to the video below to hear Kevin's answers to Pro members most burning questions, like:

• Why do so many customers choose Class over it's competitors?
• What is 'cloud' software, and why does it matter?
• How much can Class keep growing?

Full transcript:

To kick things off, I'd be keen to hear a little bit about your history with the company, and kind of how Class got started.

Sure, okay, I think like a lot of these sort of new ideas,it sort of started over a glass of red.

The founders of the business were, well one of the key founders was a fellow named Andrew Blau, who's on the board of AMP's SMSF business now.

At the time, he was running a business called Smart Super, and they had about 1,000 self-managed super funds that they were administering, and they were really struggling to get scale, and they wanted to go from 1,000 funds to 10,000 funds, so they were sort of basically spit-balling, what can we do?

How do we do this?

How do we scale the business?

How do we make self-managed super fund administration something that can scale and not be dependent on having highly-skilled accountants doing what was effectively mundane work? So that was really kind of the genesis of the idea.

They looked at what was involved and basically came up with the idea of saying, "Well, we need to actually automate a lot of the accounting so that we can focus on the strategy and focus on the exceptions around admin, but have all the accounting just be done."

And that's kind of one of those things where it's, I think, when they started off, their original budget was 12 months and a million dollars, and they could build it, and I think that was in 2005.

The product launched to the market in 2009.

Right, took a few years. And cost a lot more than a million dollars by then. I first got involved end of 2007. I came into sort of help with some requirements.

My background was big super, so APRA funds and consulting in that space, and I joined in 2008, and I came on board basically to kind of take them from what was effectively a research project to let's turn this into a business, how do we take this into market.

And we launched the product to market in February 2009.

And how have been those years since, between 2009 and the IPO? What was that journey like?

Well, I think starting a business in 2009, just off the back of the GFC, was a bit of a challenge.  We'd just asked all of our founding investors for a whole bunch of money, and then throughout that first few years, there were a few capital raises, and asking people to crystallise their losses in the middle of the GFC and sort of pony up more money to keep the business growing, was pretty tough, but thankfully, we had a really great shareholder base who were committed to what we were doing and stuck with us through those sort of early years of development.

And yeah, it was tough going, you know, it's always hard starting a business and building it up, and obviously, building it up to the point where we actually then made a profit and then IPO-ed, it was a bit of a journey. That was basically end of 2015 when we IPO-ed.

So a fair bit happened in between there, and yeah, a fair few stressful moments.

Absolutely. To dig in a little bit more, so a lot of people in the audience, a lot of Motley Fool Pro members that will later be watching at home, they have SMSFs themselves, so I'd be curious to explain a little more for them, what exactly does Class do? And what are the products that you offer?

So fundamentally, what we do is, at the outset, the idea was to automate particularly the accounting side of the self-managed super funds, and what that means is we really started from the view of we should be able to take whatever we can get, particularly if we can get data from source, if we can get data from a broker or from a RAP provider or from a cash provider, and if we can take that information and bring it together and work out what the accounting should be, and automate that all the way through.

One of the challenging things about super is that the superannuation laws and the tax laws around superannuation are quite complicated, and the super reform recently didn't help.

It's not getting easier.

But the thing about it is it's very predictable.

There's generally only one way to do things, and so that's great from a how do we automate something?

Because, well, there's only one way to do it anyway. And so, what used to happen is you'd have fairly highly paid accountants having to make sure they did things the right way.

We basically just took that and codified that and really, what we do for the accountants is, we allow them to automate a significant amount of that day-to-day processing work, which means they're able to provide out to the planners and to the end investors that they're working with, an up-to-date view of where their fund is at.

Traditionally, self-managed super funds have had to wait until May the following year, after the financial year's finished, to get a view of where their fund is at, other than what they might be checking themselves. So being able to provide that live, up-to-date view on what's going on means that the administrator can provide a much better service. They can be on top of what they're doing, they can be making sure they're adding value in terms of strategy and decision-making, and informing their client where they're at, or assisting the planner

It's interesting, we live in such a connected world, and yet so often, so many services we have are so primitive in that sense, and we can only get information very late.

Yeah, and unfortunately, accountants in particular aren't great embracers of technology. You know, because we're supplying the accountants as users of the software, we're aware of what they're using, and they were like the last people to move off Windows XP, you know.

Right.

Microsoft had to kill it with a hammer before the accountants would get off it.

Because the accountants are kind of, in a way, your clients, obviously there's end users, but those are the people you work with.

So how do you reach that [accountants] channel?

It is, a lot of accountants, and so, our clients are the accounting practices, our typical client is an accounting practice that's in a suburban area or a rural area, looking after a couple hundred self-managed super funds.

In fact, the median is 58, the average is 120 funds. So you're talking about small businesses spread around the country. For the most part, we have some larger clients as well, but of the over a thousand clients that we have, the vast majority of them are these small accounting practises, and so, they're generally pretty busy. They're head down, doing the work. So to get in contact with them can be a challenge, as I said, they're not necessarily, accountants are not, you know, early adopters by nature.

Right, more cautious.

They're very conservative, oh yeah. Their general attitudes are just keep doing what I was doing rather than look to do something different. So reaching out to them and finding them, we go to conferences because accountants are professionals, they have to get their CPD points, so that's the best place to sort of catch them is at a conference or a seminar or those sorts of things, so we do a lot of that.

We'll do a lot of direct mail out, email, out to the various lists that we can get. We advertise in the trade and industry magazines to again, try and get their attention. We make sure we engage in the various associations, both the accounting and specialist the SMSF associations that they might be engaged with as well.

That's really about just trying to be where they are and try and get their attention, start the conversation with them and explain how it's going to be great for their business if they engage with the software.

And is that something you're seeing shift over time? As Class obviously becomes more established? Is there more that are reaching out to you, or at least more receptive?

Absolutely, yeah. Early on, the real challenge was, accountants didn't know us from a bar of soap. They hadn't heard about us. They would kind of go, "Oooh, I don't know about this."

Back to conservatism as a barrier.

Absolutely, and so, they would go, "Well who else is using it?" And we'd go, "Well, nobody yet 'cause we've only just started." There's that real kind of, how do you get started thing. So we were lucky to find a few early adopters who could come on board and actually start using the software, and then what we found is that it snowballs over time because what happens is, the best way to convince an accountant that something works is to have another accountant tell them that they're using it, and it works.

And so, it's great, when we're at conferences now, we'll be, well, the guys will be talking to a prospect about, you know, "This is what Class does," then we'll have an existing user come up and they'll just start the conversation. If they happen to know them, they're in the same area or something like that, and next thing, the salesgirl will step out of the way and let the client go, and they'll demo the software for them. And we're like, this is great.

So accountants, yeah, they really, they're very collegiate, because they can't have lots of industry contact anyway, they always know a whole host of other accountants. So yeah, once you get known, once you get other accountants that you can provide a reference from, it helps tremendously.

I think the other thing is that obviously technology's changed over the time. When we started, when we launched the product in 2009, cloud wasn't a thing. It was still "software is a service" at that time, was the terminology people were using, and you'd have to explain to people, what does that mean.

What do you mean I can't run the software in my practise? I'm not going to load it up on the computer in the corner of my office. You're going to run it for me? It was great for us that Xero and other companies sort of started promoting the cloud model, and our sales guys, you know, they thought it was great. If they bumped into an accountant and they were already using Xero, it was like, great.

So you already know the cloud pitch. Now I just need to tell you, "Well, we're like Xero, but for self-managed super funds." And that really sort of helped, so I think, a lot more accountants now understand the cloud. They're comfortable with the concept. As is general industry is comfortable with the cloud.

The whole structure is quite different right. Desktop tends to be these one-off sales of software. Cloud is recurring. So what are the advantages for a customer, for a user, what's does cloud offer that desktop can't?

The key thing is about, there's one version of the software, and what we're going is we're

continually improving that. So I think as an industry, software development used to be this thing where you would squirrel away for a year or longer, and then you would release something. Then you'd start squirrelling away again, and then, once you'd finished something, you'd go, "Right, now we think it's ready to go to market. "And now we're going to try and get it out there, "and we're going to try and get people to upgrade." And nobody wants to upgrade. And I think that whole cycle of big changes, what cloud does is change that, because they know it's continuous development over time, and we'll make small changes.

So we make small changes every month. So every month, we'll do a release with small increments, and what that means is, that as users, you're always on the latest version. You're not having to upgrade service, you don't have to worry about whether the service is still running in the corner and whether it's been backed up, and all that kind of stuff. But you're always on the latest version, and the changes come through in small increments, rather than you get this

big change all in one go that suddenly, okay, now I gotta reinvent the way that I work. You can adopt pieces over time.

That example of Windows XP is a good example of that old model, right? You build something and that might stick around for decades because no one really likes the new stuff. So what does Class Super offer, versus competitors, and what do you think is the advantages of the product? Why should clients choose Class?

I think it depends on where you're coming from. I think it's, as a system of trustees, you should be saying to the accountants, I want access for my mobile phone app, and have a look and see where my fund is at, and see where the contributions came in, or see whether that pension went through, it's all been dealt with appropriately. So I think there's a benefit there to the end investor in terms of being able to see where their fund is at.

For the accountant it's really about the efficiency of what they can do. So the fact that they can provide this great service to the client is obviously a benefit, but it's also a lot more efficient for the accountant, so, instead of them having to pick up this work at the end of the year. In a lot of cases, when we talk to accountants about self-managed super funds and what they are to their business,so our typical client, 25% of their revenue is coming from self-managed super funds, but it's often marginal business, so they're doing it because they're also doing the small business accounts and the individual accounts for those the trustees that they're doing the super fund for. But the cost of running that is actually, the administration, they end up having to do write-offs on the cost of the administration because it's so inefficient.

And so what essentially it's about is saying, "Well, we've automated all of the, "up to about 80% of the accounting." Which means, they're just having to deal with the sort of exceptions here and there, and it streamlines that and makes it a profitable part of their business, so, that's really the key to it.

In terms of what we do that I guess the competition doesn't do, the big one is that we started from the view that we wanted to automate the accounting, so we have this automated general ledger. We never ask the accountant to pick a general ledger account. So in a traditional accounting solution, at some point, if you've got a dividend comes in, and some brokerage on it, you're going to have to split the amounts up, and then you have to say,"Oh, that's going to go into account 456,and that one's got to go into 789," and so forth.

So you need to know which account numbers you need to put things into traditionally, and journals, and make sure all of the various journals kind of match up into the different accounts. We automate all of that. And we do that for every transaction. What our competition do is they've seen that, seen that that's efficient, and they've done that for some of the transactions, but not for all of the transactions, and what that means is that things like data feeds, if you can't do all the accounting in an automated fashion, there's no point having the data coming and spraying in like a fire hose, and then there's nothing to catch it. And so any time a transaction requires you to pick an account code, you can't automate it, because you got to stop, put it in a suspense account, and wait til someone comes along and tells you what it's supposed to be.

So the key difference is this automated journal ledger, and what that means is we can then process everything that comes in through the data feeds, including corporate actions. And I guess the other thing is the breadth of our data feed, so we have nearly 100 platform feeds so the RAPs and IMA, SMA type products that feed into Class directly.

The reason that we have, a major competitor has eight of those. The big difference there is really around that ability to process that data. There are a couple of key differences, there's a whole host of other differences like supporting international markets and other things, but at the heart of it, it's that automated general ledger that really the secret.

We look at a lot of companies and something that we really like is high retention rates, so we generally like companies that have retention rates north of like 80%. 85% is getting pretty great. 90% is really great. And then Class is over 99%.

Yep, 99.8!

So can we hear a little bit around why is that, why are the retention rates so sky-high, monstrously high, for that business?

So I think the key to it is that it's really hard to get accountants to move systems. It's really hard to get them to move what they're working on. One of the differences between what we do versus, say, MYOB and Xero is, because they're selling to, let's say Xero mainly, I think, 'cause MYOB can sell to the accountant as well, but Xero sells to the small business owner ultimately. They're the one paying the licence fee.

Our licence fee is paid by the accountant, and the reason for that is, within the small business space, it's the small business owner who's doing the day-to-day work on their business.

In a self-managed super fund, that work, the day-to-day accounting of the self-managed super fund is being done by the accountant. So getting the accountant to change what they do as a practise on behalf of all of those funds they might be looking after is a big deal. It's hard to do.

But once you get them to change that, it's hard for them to want to change again.So part of it is just that simple inertia. It's a bad thing to have to sell into them, but once you've got them across, then they're also not that keen to move.

So there's that, but I think the other thing is, we deliver on what the promise was. We're giving them that efficiency. They're seeing profitability. The practises that are using Class, over the last five years, have grown 20% per annum in the key, that small space, so we won't talk about the larger ones 'cause there's some different challenges for the larger clients, but in the 25-100 fund range, those accounting practises average 20% growth per annum over the last five years.

Take what was a marginal business and actually turns it into a profitable business, and growth centre for their business.

Right because it's more efficient.

Yeah, yeah.

So I'm curious, with such incredibly high retention rates, why would or why do you ever lose customers? What are the reasons that customers ever leave?

The clients that we tend to lose are the small ones. So, what we tend to find is, because we're all about efficiency, if you've got someone who comes on and they've just got 10 self-managed super funds, for them, it's not a key part of what they're doing as an accounting practise. It won't be 25% of their revenue, it'll be some smaller portion. And what tends to happen is, they'll go, "Oh yeah, I think maybe I'll grow my SMSF practise." And then they get distracted and do something else, and what they'll realise after a while is they haven't really been getting any benefit out of it.

Because they're not using it.

Because they're not really focused on it. They haven't gone and set the data feeds up, and so forth. If you look at our retention rate graph, it was lower back in, sort of, 2013, the 2012 period, and one of the things we changed back then to drive that retention rate up was we were finding that what was happening was we'd sign the accounting practise up.

They'd get the message and think, oh, this is great. And then we'd come back three months later, and they'd go, "Your software doesn't work. It's not very efficient, it's not helping." And it's like, well, have you set up the data feeds? No, have you staffed the training modules? No.

– Have you turned it on yet?

– Have you changed anything in your practise to actually take advantage of the software?

And so what we're finding is that the practises weren't necessarily good at change managing. They weren't very good at actually working out what they needed to do. So what we instituted back then was that, we built a consulting team, and every time we sign up a new client now, we take them through a 90-day onboarding period. And what that is, they get assigned a consultant. They basically do a plan with them to say, well, how many funds have you got? How are we going to move them across? When are going to move them across? Where are they up to from a tax processing point of view? What products are they using? Which data feeds can we get set up?

And really does, it helps them to do that change management plan to make sure they set up the data feeds, making sure they do a training plan for the staff, that they all go and sit the modules and do the self-assessment and do the training. So that by the end of that 90 days, the goal is that they have half of their funds on, and that they've got all their staff trained, and that they've got good progress, a good process in place for setting up their data feeds and proceeding.

And that's really helped with that retention rate, is to make sure that when a client does come onboard, that they really do know how to use the product effectively.

So one group that you've flagged since way before the IPO. I think you issued an extra prospectus about it was, about some customers whose portfolios are administered by AMP?

Yes.

So for members who aren't maybe that familiar, what happened? And also, it seems to have taken those customers a lot longer to move off your platform, and I'd be curious to hear a little bit about why that is.

Sure, yeah. So AMP started the AMP SMSF business in 2012. They had a 49% shareholding in SuperIQ. Just after that, they bought a business called Cavendish. So Cavendish and SuperIQ were both clients of Class. They also had another business already called MultiPort, which they acquired through the acquisition. And so they had a mixture of funds. Some on SuperMate, some on Class. They did a whole bunch of other acquisitions over the last five years as well, built up a fairly large pool of funds that they're administering, and they had an opportunity in 2015 to basically buy one of our competitors, a company called Super Corp, they had actually acquired a 20% shareholding or thereabouts a bit earlier, I think sort of 2013, or thereabouts.

So again, they'd had shareholdings in both Super Corp and Class through that period. I think opportunistically, they had an opportunity to buy that holding, and I think they just decided that owning the software themselves and being able to use that for what they were doing in that space, just appealed to them.

And that was, I guess, the rationale.

And at that point, they gave two years' notice on the SuperIQ funds, sorry. So they have about 11, I think the last number reported, at 11,300 funds on Class, so a reasonable chunk. About 7% of our revenue, I think. I think, since then, what they had to do was do some retooling, built some systems out to move across,and I think as generally happens with these large institutions, it takes them a little while to do that.

So I think the, it's October this year that that notice period runs out on the SuperIQ business. So, we'd expect them to move the funds at some point.

But as you said, they haven't really moved any yet.

Yes, it's been interesting to watch. So I guess it gives some show of just how sticky the product is in the sense that, it's not that easy to go out and build something like this to move them across.

It's certainly not.

I'd be keen to hear about the trends that are affecting the industry at the moment, particularly around the kind of super reform, so I think we talked about this last time that you and I spoke, so I'd be keen for our members as well, to hear a bit about those reforms and how they affect the industry they operate under.

Yeah, I think most commentators have been saying that these are the biggest changes in 10 years. So the biggest changes since Costello changed the superannuation rules in 2007. And they are, they're dramatic changes. There's a lot of work, we've got a lot of work to do in the next 12 months in terms of implementing the changes, and I think the industry has a lot of work in terms of working with the SMSF trustees around what the impact is on, particularly if they're over the 1.6 mil balance, but also just there are various other impacts across the board that are impacted.

One of the key ones for us is that, again, it makes it more complicated.

The more complicated it is, the more important it is to have technology to help you deal with that complexity.

But the other thing is the government is moving to real-time reporting, so they're more and more asking that the self-managed super funds, when they make a decision, that they record the impact of that decision. And so going forward, particularly around the balance transfer cap, around the 1.6 million limitation in money-moving in and out of pension phase, any time money moves in or out of pension phase, you're going to have to report on that within 10 days of doing it.

And what that means is, you can't wait until May the following year to actually decide whether the money you took out in the January before was a commutation or a pension payment.

You're going to have to decide at the time that you do it whether it's a commutation or not.

I think you will see that as a trend over time, that the regulators are going to more and more want to see that if you make a decision, that you report it sooner rather than later, and preferably in real-time. They started this in probably the Super Stream legislation around the contributions and having that basically be reported as it happens, and I think that it's a big change.

I think if you are using Excel spreadsheets or using a free copy of MYOB to keep track of your self-managed super fund. I think, they're not going to be able to meet those requirements, it's going to be very difficult to stay on top of the fund to meet those, and so for us, that's probably the biggest change.

Obviously, people have to take action and deal with the impact of the 1.6 million cap and so forth, but I think that the government is going to want you to report real-time.

And that, as you mentioned, is an advantage, right? Compared to some competitors that don't have those same feeds and links?

Yeah, I think one of the other big changes that you're seeing is particularly the desktop products are being end-of-lifed. So people talk about cloud and the fact that you need to move to the cloud, and basically you won't have a choice, so,what you're seeing at the moment, so in terms of competitors, the Super Corp product, the one now owned by AMP, is a cloud-based product. The BGL has both a desktop product and a cloud product.

Reckon used to have a desktop product called Desktop Super, creatively, and that product's been end-of-lifed, it was bought by AMP and sort of folded into what they're doing.

So that's due to be shut down in August 2018.

BGL has taken their desktop product off their website. They're not really marketing it anymore. They're under-investing in it, you won't be able to do tax lodgements from June this year, so they won't be implementing a new SVR2 technology to support that going forward, so using a desktop product is not really an option going forward.

BGL has also said that, if you're using the desktop product,they will make changes to support the Super reform, but you'll find it hard because they're not going to kind of do everything they need to do.

And how much of the market, do you think, still has to move to the cloud?

Yeah, so there's only about 30% of the market. 30% of self-managed super funds are in the cloud at the moment. So there's about, 70% a whole chunk that still got to move across.

We're waiting to see the latest investment trends to get this year's numbers, but based on last year's number, there was about 44% or thereabouts that's on desktop solutions that needs to move across.

There's about 15% that are accountants who are using Excel and general ledgers to keep track of self-managed super funds, so they're not using a purpose-built product at all.

And then there's about another 15% that, or around, again, the numbers are, it might be 12%, 15%, something like that.

That are the trustees themselves looking after the fund directly, and they're Excel and maybe a general ledger product to keep track of it.

So all of that, at some point's, got to move to the cloud.

So a very big push into the industry that you operate in. And it's one that you have

a very dominant share in. I think you had a release recently that said over 60% market share of the cloud segment. Why do you think that was, that you were able to capture such a big share?

Well, I think first, we launched in 2009. BGL didn't launch their cloud product until 2014. You know, they gave us a five year head start, so that was nice of them.

Yes, a good freebie.

Gave us plenty of time to get things right, so I think we got a significant lead in terms of the product, so we still have about an 80% win ratio. So when we're up against BGL, in head-to-head selection, we're winning 80% of those.

And I think that comes down to the ability to reference the product with the other accountants

who've been using it for, in some cases, up to five years, saying, "Yeah, it actually works." But the other thing is, I think, the product is just mature. We have a product that has been.

Tried and tested.

Yeah, exactly. It's already being used by over 1,000 accounting practises, and used by some of the biggest administrators in the country. So yeah, just. Good head start and continuing to invest, and I think that's really important in this sort of subscription software space. If you aren't continuing to invest in your product, it's a kind of Alice in Wonderland thing, you've got to keep running just to stay in the same spot. And we're doing far more than that, we're making sure we invest in the products and we continue to build.

We recently released the mobile application. We already had a responsive design solution that would work on a mobile phone. But having an app, you can download it from the app store, and it's just that much more kind of easy to use on your phone. You know, we continue to innovate and invest in the technology.

Something that a lot of members are interested in is how much Class can keep growing.

You've talked already about quite a big tailwind, I think, that's pushing towards cloud, but what about the revamped BGL Super product, and what impact will that have on the business moving forward?

I think, I think when you look at the BGL product, effectively it's a new product, they've had to build it from scratch.

Because the other one wasn't working out?

Well, no because it was a desktop solution, and one of the things that you're seeing is that the desktop providers have found out the hard way. You can't just take a desktop product and just throw it in the cloud, that's not how it works.

So you saw Reckon and MYB try and do that. Didn't work very well for them. And you've seen that it's the businesses that take products and built them purpose-built for the cloud that are having success, so businesses like Xero and Class.

We've built a solution that works in the cloud, and I think it took a lot of the desktop providers awhile to figure that out, that you can't just take what you were doing and just translate it to the cloud, it doesn't work.

But I think the other thing is that, I don't think that the BGL product gets this idea that you need to automate the general ledger. I think they are still trying to replicate some of the things that we do, but then they miss the point on some of them. So, with their contract notes, for example, when they have data coming through from a broker they use.

Rather than go and build the feeds to plug into the broker-backed office systems, they're actually getting a copy of a contract note, so they get a buy and a sell. So they can deal with buys and sells, that's great. But if there's an off-market transfer, if there's a DRP, if there's a corporate action, they get nothing.

Whereas what we get, because we're plugging into the broking systems, we get daily balances. So we know at any day, what you held. So we know that you're entitled to a dividend. What's more, when it comes to the payment time, what we will see is we'll see you balance changed and went up by, oddly enough, about the amount for the DRP.

And we also get a chest adjustment that tells us, well, now specifically, it was for the DRP. And we can work out the difference in terms of what you're entitled to, so there's a residual there and we can kind of account for that as well.

So we can do all of that, whereas products like BGL just are blind on that, they don't see anything at all, 'cause there's no contract note.

So I think there's still a pretty significant gap in terms of where they're at in terms of their product and maturity, and what that leads to is their product just doesn't give the same level of efficiency as what they can get from Class.

And do you think some of that comes from their kind of roots in the desktop world? Although they are building cloud now, they're still thinking in that mindset?

Yes, they started as a general ledger system, and then what they did was added bits on top to support a self-managed super fund, whereas we started from the point of view of SMSF administrators, what do I need to do?

To do administration really well and provide that service? And the accounting has to be done, we get that. But the accounting is not the reason this thing exists, and in fact, I don't want to have to post journals manually, I want those to just happen. And we do all the journaling under the covers.

You still get all the financial reports and the trial balance and everything else, you can always begin and see where all the postings went. So the accounting absolutely has to be there. But you don't want anybody with their fingers in it trying to fix it, manually do that.

Absolutely. So given the, what I would refer to as customer captivity, I'm sure you don't put it that way, but customers are very sticky. There's a lot of across and upsell opportunity, so I'm just kind of curious, how do you think about other demands?

And one in particular I want to dig into first is Class Portfolio. So it's a new product you brought out. Just to kind of talk us through that product in particular, I guess to get started. What led you to launch that?

Actually, as far back as 2011,we had clients who were using Class Super, and we'd get a support call saying, "How do I load up this family trust? "I'm trying to load it up and I can't "load the beneficiaries anywhere," 'cause it keeps telling me to put members in."

And it's like, "You know it's a super product, right?" So what we ended up doing is that back then, we went, okay look, we'll turn off the super bit so you don't have members and whatever else. So we kind of took stuff away, and then we went, "Okay, now you can use it for non-super." And we had a few people who were doing that.

And it wasn't till much later when I guess, we were starting to think about, okay, we're getting good traction in the super space. This is working, it's growing nicely.

It's going to be another few years before we saturate that market, so we got plenty of time, but what are we going to do next? And so then we had a serious look at outside super. What we realised is that there's just as much money outside super as there is inside super, arguably more.

And in fact the feedback from the accountants was yeah, these same clients that I'm looking after their self-managed super fund for, I'm also looking after their individual portfolios, or I'm looking after the family trust.

And so, what we started looking at was, well what do we need to do to better support that? Let's add some stuff back that actually helps with the beneficiaries for the family trusts and dealing with their unpaid present entitlements and dealing with their loans and other things that are particular to that.

A product that's more suited for what they're doing in the non-super space. There's also some accounting changes that you have to support. In super funds, you have to carry the assets at market value. You're not allowed to carry them at cost. But in trust, you can carry them at cost. There's some few other bits and pieces that we had to do to support the different style of portfolio,  but essentially it's all that money that people have outside supers, again, the feedback is if somebody has a $1.1 million SMSF, then they've got just as much money outside super as well, and it'll be in various structures.

It seems like it could be quite a big new area for you. There's almost as much money outside super as in super-based products. Could it be a similar size portfolio count later on?

Yeah, absolutely. The challenging thing about the non-super space is it's a bit amorphous. There isn't like all the research that we get like we do with self-managed super funds. In self-managed super funds, the ATA publishes numbers every year, and there's a whole bunch of researchers that look at numbers in the self-managed super space, so it's really easy to get numbers.

When you talk about family trusts and other investment portfolios outside super, it's actually a lot harder to get the numbers, but having looked at what the ABS and Rice Warner and others have said about the private investment space, our conclusion is, we think there's about, we've taken out all of the really small portfolios of people who might have some (mumbles) because they got it when it floated, to whatever, or got other things, and they might just have one or two stocks.

So if you take all of that out, by the time you filter it down, there's about two million portfolios where we think Class Portfolio would be relevant. They're of appropriate size, appropriate complexity, where they're potentially. And we think there's about $2 trillion worth of assets there, so it's about three times as high as super actually.

Who are the major competitors in that space [Class Portfolio], and how do you see them competing? So a lot of people in this room have heard of Sharesight, for instance, so curious how you see them?

Look, no definitely, so Sharesight, I guess the main difference between us and them is they're a retail play, so direct to the consumer. We're, at this stage, still focused on providing the services to the accountant. So I think if you're running a Share portfolio, and you're working with your accountant, then if you looked at what Sharesight's doing, you look at what Class is doing, there's a fair bit of overlap.

In fact, Sharesight has a Sharesight Pro offering, and I would say we compete directly with that because the Sharesight Pro offering is for planners and accountants who are working with share investors, so definitely got some overlap there.

Probably the key one would be the Praemium V-RAP product. So Praemium is obviously involved in a lot of other things. Their key driver at the moment is their IMA/SMA offering, that's where they're getting all their growth. But in the V-RAP space, I guess we do a similar sort of service, so there's some overlap, you know, in that space as well.

Yeah, there's not. When we surveyed the accountants and said, "Well, what are you using?" Accountants don't tend to be using Praemium or Sharesight to track of this.

They're using Excel?

They're using Excel. 80% are using Excel

So I'm keen to just get your take on that, obviously, you have a lot of advantages within this sphere. Do you think that those would apply into other markets, or do you think it's better to focus on Australia?

At the moment, we're very focused in Australia. The self-managed super space is unique to Australia. There's really nothing like it in the rest of the world. There's the SIPs in the UK, which are somewhat similar, but other than that, there's not a lot out there. So super's really not that translatable into the rest of the world.

In the Class Portfolio space, I can't see any reason why we couldn't down the track, translate that to other regions.

I would be keen to get your thoughts on acquisitions. Do you see any opportunity for acquiring some of those companies that were desktop focused to move their customers over to the Class cloud, or is that not something that you're really interested in?

There's not a lot of competitors in this space, so it's not like there's a number of small players that we could look to buy up, but really the desktop super product from Reckon was about the only one that was kind of likely to come up. That's been purchased by AMP as part of a strategic arrangement between AMP and Reckon, so I think at this stage, given there are really effectively three major providers in this space, there's not a lot there for opportunity for consolidation.

What we are seeing more of is that within our partner ecosystem, there's potential there. We get approached pretty much every week by a Fintech start-up who wants access to the client base and has a great offering, you know, in various different sort of, whether it's peer-to-peer lending or it's advice or it's a number of other sort of new financial products, they're sort of keen to work with us.

Our general approach at this stage is to work with them as partners. We're more interested in working with them as partners and doing a revenue share where it's appropriate in terms of the services they're providing.

Over time, if it makes sense to fold some of those services into what we're doing, if something comes along where we go, "Actually, that makes sense to be really "just part of the inner circle," then we would look at those things.

And we've looked at a number of opportunities in those spaces, but nothing that.

Nothing current?

Yeah.

As I mentioned backstage, I think I'd seen you a Fintech conference, so I can see you're keeping your eye on these up and coming small companies and what they could do.

How does Class think about investing in R&D, some something that's been different between yourselves and some other growth companies in this space is that you are profitable, you're paying a dividend every year, so how do you think about balancing that, and how do you invest in R&D over time, and balance those two together?

I think early on, we very much had a discipline about, we want to be running a profitable business, we're not going to just grow for growth's sake.

I think that there are good reasons why other businesses might adopt that strategy.

But I think in our case, we felt that it was important that we were building out a commercial operation. I think it's good discipline, it makes you focus on where you're investing.

What we don't really do is limit that investment by saying, "No no, we've got to make "this particular profit margin," or so forth. So what you'll probably see us doing this year, for example, is the super reform requires significant investment.

We're going to have to make that investment, we have to do that work. Last year, you saw us make a significant investment in the Class Portfolio product. So we spent $2.5 million for the first half on development, and 1.1 of that was on the Class Portfolio product. I think you'll continue to see us investing in the products to develop them out.

As I said earlier, if you're not investing in the products, if you're not innovating, then you're going backwards.

Do you see the expect dividends to be increasing over time as a result of that progress, or do you expect to be piling cash back into some other new product launch?

Look, we're going to continue to run a profitable business. We will make investments where it's appropriate to make investments. The current level of investment in the products that we have but as I said, we then have to deal with market conditions, so if there are things like big regulatory reform, then we need to react to that. But look, our intention is to continue to run a profitable business, so there will be dividends.

And intention is obviously to increase them over time, but we're not going to do that at the expense of doing things we must do, you know, that the business requires us to do.

Completely understand, and I certainly appreciate that. Thank you very much for joining me, Kevin Bungard!

It's been a pleasure.

The post Pro Video Exclusive: Interview with Class CEO Kevin Bungard appeared first on The Motley Fool Australia.

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"The more stuffed the mind is with knowledge, the less one can see what's in front of him" – Lao Tzu

How good are your powers of observation? Watch the below video, and count how many passes the team in white makes?

How did you do?

The video catches a lot of us out because it uses our own attention against us. The analytical side of our brain is constantly whirring away, working on the latest task we've given it. When we tell it to count the passes, it springs in to action, ruthlessly focusing our attention on our latest goal. But by doing so we can completely miss what is hiding in plain sight. Even when it's a moon-walking bear!

This simple video is a perfect parallel to the challenge we face as investors. To find the truly great opportunities that the rest of the market is missing, we need to quiet our analytical mind, and simply observe the world as it is. Business schools place a big premium on things that can be quantified and analysed in a spreadsheet, but often the most profitable investing insights come from just reflecting on the world around us.

In The Tao-Jones Averages, author Bennett Goodspeed makes a strong case that we must learn to tap in to our creative and intuitive side to be able to stay alert to investment opportunities (and threats!) before the rest of the market:

"analysts are prone to be surprised by developments outside their focus, just as, say, the Swiss watch industry was unprepared for developments in the semiconductor field"

Goodspeed's book provides dozens of examples of how the power of observation can lead to surprising investment insights. A classic case was that of Jim Rogers, co-founder of the market-trouncing Soros Fund.

In 1973, Rogers was reading the newspaper and became puzzled by the outcome of air battles during the Six-Day War between Egypt and Israel. Always in tune with oddities in the world around him, Rogers noticed that the Israelis, who had better trained pilots and superior aircraft (supplied by the U.S.), were losing the air war to an Egyptian air force that, on paper at least, should have been vastly inferior. Most analysts at this point would dismiss the thought and head back to their trading terminals.

But Rogers was always on the lookout for pieces of information that didn't fit with his model of the world and just couldn't let it go.  Rogers inferred that, with inferior aircraft and training, Egypt's success in the air battles must be the result of superior "smart" electronic weaponry such as guided missiles. Fascinated by the insight, he dug deeper, reviewing defence spending, interviewing pentagon officials, and even contacting Senator's to get their take.

At the time, U.S. companies that designed "smart" electronic weaponry were deeply out of favour, after years of under-investment from the pentagon. At the time even Lockheed Martin (NYSE:LMT) was rumoured to be going bankrupt. But Rogers' observation and research led him to realise that a vast wave of future investment was coming and so he bought large positions in several electronic weaponry system designers.

Over the next decade the shares Rogers purchased exploded in value with returns of 2,000 to 5,000 per cent, and Lockheed became a "blue chip" share at the top of every fund manager's buy list.

During the decade Rogers worked with George Soros, their fund generated a cumulative return for investors of a whopping 4,200%. As for Rogers, a handful of astute observations such as these was all it took to make him a multi-millionaire, before deciding he'd had enough and retiring at just thirty-seven.

At Pro we are always on the lookout, trying to catch the next 800-pound Gorilla that's still hiding in plain sight. As we introduced in How to Catch a Monster, over the past 21 years, shares in energy drinks maker Monster Beverage (NASDAQ:MNST) have soared a mind-numbing 2,400-fold. Every $10,000 investment in 1994 would be worth over $24 million today. During those early years, think of all the thousands of Wall St analysts that could have seen Monster Beverage cans taking over their local store, or being guzzled all around them, and yet never took the time to look up from their spreadsheets to capitalise on the opportunity right in front of them.

From time to time we all need to take some time out, give our analytical brains a break, and just observe the world as it is. Whether it's chatting to friends and family around the barbeque, or relaxing on holiday in some exotic location, let's keep our eyes open. The next shareholder-return-Gorilla could be moon-walking right in front of us.

The post Take The 'Investor Observation' Test appeared first on The Motley Fool Australia.

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To make money in stocks you must have "the vision to see them, the courage to buy them and the patience to hold them." Patience is the rarest of the three. – Thomas Phelps (original quote: George F. Baker)

Do you have what it takes to catch a monster?

Thomas Phelps wrote one of the all-time great investing books titled '100 to 1 in the stock market' after studying companies that had returned 100-fold or more to investors over the previous few decades (investing trivia bonus point: the legendary Chuck Akre names Phelp's book as core to his philosophy).

These 100-to-1 businesses were so incredibly successful that if you had invested just $10,000 in one of them, it would have turned in to a $1,000,000 fortune over time. Phelps found 365 companies that reached the prized 100-to-1 level or higher, and among those incredible winners he found four common attributes.

First, they almost all started out small – giving them a lot of room for future growth. Second, they were relatively unknown at the outset – less analyst coverage meant lower starting prices. Third, they almost all had a unique product or competitive advantage – something which gave them an edge over other firms. Fourth, the companies were headed by smart, research-minded management teams.

In Phelps view though, more important than what made the companies special, is what made the investors who hung on special. The shareholders that, despite all the noise, and despite all the emotion, were patient enough to hold on throughout the share market's volatility to reach that prized 100-fold return. These were investors that managed to master their inner monkey brain.

Let's look at what it would have taken to hold on to a modern version one of these mega-winners as detailed in '100 Baggers' by Christopher Mayer.

Over the 21 years through last October the shares of Monster Beverage (NASDAQ:MNST)— the beverage company best known for its large cans of Monster brand energy drinks — increased in value by a mind-numbing 2,400-fold. That is almost too big of a number to wrap our heads around, so let's put it like this: for every $10,000 investment in 1994, shareholders that held on would be sitting on $24,121,512.

In 1994 that $10,000 might have bought them a decent second-hand car, after investing in Monster Beverage it would buy them a helicopter to go with their cliff-top mansion.

How did Monster Beverage do it? The company started off very small and was overlooked by Wall St for a surprisingly long time. Monster also invested heavily in marketing and innovated in product, being one of the first companies to recognise the demand for a larger energy drink can (a part of the market that red-bull had neglected). The management team were also incredibly savvy, building a capital-light business model that allowed them to iterate and scale quickly.

The biggest question though, is how did the investors do it? Think of all the times a shareholder had to resist selling if they wanted to reap those 2,400-to-1 long-term gains. Even assuming they could resist selling somewhere along the line for a gain of 40%, 400%, or even 4,000%(!), they also needed to deal with all the volatility that came along with the ride.

During Monster Beverage's run there were 10 separate times where its share price fell more than 25%. Even worse, in three different months Monster Beverage's shares lost more than 40% of their value. Think of the courage it took to hold on to your huge winner when the shares fall by 40% – in a month!

Returns of the kind that Monster Beverage reported are extremely rare. But the lessons of such mega-winners apply to all great long-term investments. To catch a monster, we need the vision to find, the courage to buy, and the patience to hold. Patience is often the toughest of the three.

The post How to Catch a Monster appeared first on The Motley Fool Australia.

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If we just followed the simple rules of Buffet-style investing we'd all be a lot better off. So without further ado, here are the Buffet Investing strategy's four rules for investment success.

Rule #1: Avoid The Bread

What is the first thing awaiting you at the start of the buffet table? Bread. Sure it looks harmless, but do not be fooled. The bread is a trap!

Bread is there to distract you. It is the siren luring your mighty open plate onto the rocks of mediocrity. I get it. It's hot and it's fresh, and there is a little sachet of butter sitting next to it that you just know would melt in seconds. But did you really come here to fill up on bread like a sucker?

Much like your tabula rassa plate, the first step to building a Buffet Investing portfolio is to ensure you take your time, do your research, and ensure that you don't fill your portfolio with a bunch of mediocre 'me-too' businesses.

Which bring us to rule number two.

Rule #2: Sample Widely

To find the hidden gems of the Buffet we must leave no casserole cover unturned. It is easy to focus on the most obvious plates in front of us, but that is not where real value lies. Hiding under the next hard-to-reach steel lid could be some of the best Mongolian Black Bean Beef or Sweet and Sour Pork known to man! Sure… a lot of the time it will be half-cold steamed fish. But those disappointments are there as a test, to discourage the less dedicated.

Great Buffet Investors know that they will have to turn over a lot of rocks to find the very best investment ideas. Most of the time you will find stagnant and perpetually struggling businesses complaining about how the weather hurt their earnings. But every once in a while you will find a hidden compounding machine that is poised to take the market by storm.

And when you do…

Rule #3: Double Down on Your Winners

Once you have made your first pass and sampled all that the Buffet has to offer, now is the time for the pros to distinguish themselves from the rest of the pack. The second plate strategy is the "meat and potatoes" of serious Buffet Investing. Although if you know what you are doing it should involve a lot more than just meat and potatoes.

Each dish has its own strengths and weaknesses and the second round is the time to double down on the winners. Maybe there's a juicy Peking Duck, or some steaming-hot melt-in-your-mouth Lobster that just got wheeled out. Now is the time to pounce!

Double down on your winners and back yourself. When everything is aligned the true Buffet Investor is willing to stock up. Having a hundred things on your plate is a sure-fire path to disappointment. The "di-worsification" that plagues most of the investment world is not for you. There is only so much room on that plate of yours. Make sure it's chock full of only the highest quality offerings. You deserve no less.

Rule #4: Always Leave Room for Dessert

Hubris my friends. It is how the mighty fall.

If mediocre bread is the biggest trap for new players, then this is the biggest pitfall lying in wait for the experienced entrant that over-reaches.

How often have we seen a friend who started out strong, only to collapse before the finish line? They put away plate after plate of honey-baked ham and burger sliders, only to overdo it and peak too soon. They start to feel queasy. Beads of sweat form on their forehead. Soon they are heading for the parking lot. And before they can even touch the sweet candy wonderland that is the dessert buffet!

Although we might think we are on to a great thing early in our Buffet Investing adventure, we should be in no rush. The miracles of Buffet Investing do their best work over time, and we don't need to leverage up in the meantime. Always make sure we leave enough dry powder in our portfolios so that if an incredible investment opportunity comes along (like a hot caramel fudge sundae with chocolate sprinkles) we have the room to snap it up.

The Buffet Investing Way

Buffet Investing is an idea whose time has come. Unfortunately, there seem to be a lot of confused people out there.  There are dozens of articles written every day about how to "How to Invest like Buffet!" or "Discover Buffet's secret!" but all of these are very wide of the mark. In fact, although they get the headline right, most of the time these articles make the highly embarrassing mistake of writing their analysis on the strategies of some guy named Warren (not even a system of serving food!).

If you ever come across one of these poor folks, please send them this article so they can discover the incredible power of Buffet Investing!

The post Invest like Buffet appeared first on The Motley Fool Australia.

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Imagine having a front row seat as the CEOs of Australia's fastest growing fintech start-ups share their hard-won insights. I was fortunate to have the opportunity to join just such an event on Thursday, at the second annual FinTECH Summit in Sydney.

Fintech is generating a lot of buzz lately, and for good reason. For decades the sleepy behemoths of the financial industry have resisted many of the biggest advances in technology. Whereas most of us hold access to the world's information in our pocket, most of our banks are still running on archaic systems built in the 1980s. Mullets were popular in the '80s. It wasn't an advanced time.

But a new wave of innovative technology companies are changing all that, and fast. Fintech companies are redefining financial services across many areas: lending, payments, big data, cryptography, blockchain, insurance, security, personal finance & robo-advice, to name a few. And on Thursday they gathered together in Sydney to share the latest news from the forefront of the industry.

Here are 3 key takeaways from inside the Australian FinTECH Summit:

#1: Machine Intelligence is Big and Getting Bigger

"With access to this [technology], half the office at a lot of companies will be able to go home at 10am" — Tim Baker, Global Head of New Content Initiatives at Thomson Reuters

There is often a lot of discussion about which new areas in technology are hype and which are genuine opportunities.  But one area that every panellist agreed was already a key differentiator and with huge potential ahead was machine intelligence and 'cognitive computing'.

One particularly impressive demonstration came courtesy of Tim Baker from Thomson Reuters, who highlighted the company's development of its Knowledge Graph. The system reads through tens of millions of sources of content such as news articles, company updates and contracts, and identifies the key entities (company's, employees, etc.) identified in each document, and their relationship to one another. The Knowledge Graph then compiles that vast ocean of data in to a graph which displays the links between every entity.

This technology is only made possible through recent advances in machine learning, and has the potential to disrupt multiple industries. Insurance companies must keep on top of thousands of new 'risk events' every day, from natural disasters to legal scandals. Through applying this tech an insurance agent could instantly get a picture of every insurance contract that is affected by a particular risk event, and to what degree, generating huge savings and opening new opportunities.

Almost every company that presented was already utilising machine intelligence to some degree, and noted how much more potential they saw ahead for future use.

Sadly most of the advancements in machine intelligence have happened outside of Australia, leaving us with few publicly listed opportunities. But we are always on the lookout to strengthen our portfolio with companies that are operating in this space, or more likely that are using the latest advances to get a leg up on their competition.

#2: Some Tech is Still Not Ready for the Primetime

'I think we'll still be sitting here talking about the coming rise of blockchain in 3 years time'– John Fildes, CEO, Chi-X Australia

Blockchain first entered the public consciousness through an odd (and slightly dodgy) alternative to money, known as Bitcoin. But the core technology is now gaining a lot of attention for its potential to replace many complex systems that currently rely on trust – everything from banking, to share trading, to legal contracts.

For those who aren't familiar with Blockchain, the technology allows you to have a single shared ledger, where there is a cryptographically secured and agreed history of transactions. In simple terms, smart technology is used to ensure that everything is kosher, instead of relying on trust.

One core benefit is that you avoid the time-consuming and expensive ledger reconciliation process that normally slows down transactions (think of how long it takes to clear a cheque). Replacing that process with a shared central ledger therefore provides a lot of efficiencies.

But while some speakers were bullish, the general consensus was that the blockchain was still a long way from replacing existing systems. We recognise the vast potential of the technology, but at MDP we'll be taking a cautious approach to any companies in this space until we see more signs that the technology is gaining broader acceptance.

#3: Australian Investors have a Huge Untapped Opportunity

'Australia is a small country with 23 million people, but we have the 4^th largest pool of retirement funds in the world. When we look at the $550 billion in self managed super funds, over $200 billion of that is sitting in term deposits. If you look at what we invest that huge pool in, banks and miners, is that really the best sectors for Australians to invest in?'

Why didn't Atlassian invest in Australia! The government needs to find ways to support the tech sector. We need to have an attitude that it is ok to get wealthy by innovating.' – John Fildes, CEO, Chi-X Australia

As you might expect from a conference dominated by cash-hungry start-ups, every CEO thought that Australians were missing a huge opportunity by not investing more in technology.

That advice might be a little self-serving, but they have a point. Australia has a terrible history of supporting our tech start-ups, with one panellist noting that our total venture capital funding was just one ten-thousandth the size of the United States.

While most of the market is slow to catch on we are sitting up and paying attention. We see the market's misunderstanding of the outstanding economics of software companies as a core opportunity for our portfolio – and one we are working hard to exploit!

The Foolish Bottom Line

The opportunity for financial technology innovation is vast. Plenty of today's start-ups will fail. But among them there will also be huge winners, with the potential to fit in to the higher-risk section of our MDP portfolio. By keeping our ear to the ground, meeting with CEOs, and sitting in on leading-edge discussions, we remain alert and ready to seize new opportunities when the market presents them to us.

The post 3 key takeaways from inside Australia's FinTECH summit appeared first on The Motley Fool Australia.

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The ASX might be desperately short of successful tech companies but Technology One (ASX: TNE) is a big exception. For long-time Technology One shareholders the returns have been incredible. Over the past 5 years total shareholder returns have been a whopping 37% per year for a total five-year gain of over 380%. So what is the story behind this shareholder hero, and are the shares still a bargain today?

The Technology One model

Technology One provides deeply integrated enterprise software for a wide range of customers, and with a particular focus on government clients. The beauty of enterprise software is its high switching costs. If a company wants to change its enterprise software platform it will need to retrain thousands of workers, rework a large chunk of its internal processes, and potentially risk destabilising the entire business.

Those switching costs mean that the average customer sticks with Technology One for a very long time. In fact, the company is proud to say that it still retains many clients from when it first launched almost 30 years ago. That staying power means Technology One doesn't need to spend as much on continuously chasing new business, and has pricing power in existing client relationships; both of which add up to high returns on capital. Technology One has posted a return on shareholder's equity of over 30% for several years.

One of Technology One's critical points of differentiation among enterprise software providers is that the company provides an end-to-end solution without use of third party implementation partners or resellers. This gives Technology One full control over its software and allows it to ensure that new customers aren't disappointed by the myriad problems that typically derail new software implementations.

The power of founders

Founder-led companies have a tendency to outperform. It is hard to match the passion and ownership that comes from having started the enterprise from scratch. Technology One is a classic example, with founder CEO Adrian DiMarco still at the helm almost 30 years later. The Technology One model, with its focus on long-term customer satisfaction, is arguably only possible because of DiMarco's leadership.

Where competitors will use third party vendors in order to juice short-term growth, Technology One has instead focused on building a solid foundation for long term gains. That long-term focus shows up in multiple domains.

In product innovation, Technology One currently spends almost 20% of its revenue on reinvesting in research and development. Compare that with an industry average of around 12% and you can see why customers have been willing to stick around. As the company finishes up its current investment in a new cloud product over the next few years it expects R&D spending to fall to a, still high, 15% of sales – providing a nice boost to the bottom line.

In sales, the company begins engaging with potential clients as much as 7 years before they expect them to need new software. That marathon-length lead time enables Technology One to build a strong relationship with key stakeholders and understand precisely what the customer will need, so they are poised and ready when it comes time to switch.

Is the price right?

Technology One has generated incredible returns for long-term shareholders, but the flipside of those returns are that the shares today are a lot less attractive than they once were. My intrinsic valuation estimate suggests that Technology One is trading a little above fair value today.

The post Technology One Is A Shareholder Hero appeared first on The Motley Fool Australia.

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It's still under most investors' radars, but Hansen Technologies (ASX:HSN) is a high-quality Aussie tech company that is winning big overseas. Hansen provides the mission critical customer care and billing software for service providers in a wide range of different industries in over 40 countries.

Sticky recurring revenue

Hansen's clients provide everything from Pay TV to telecommunications to electricity and water utilities, but they all have one thing in common – they are hugely dependent on Hansen's software. Hansen does all the work behind the scenes to make sure that the bills their clients send on to the end user are delivered on time and without any errors. That dependence makes for super-sticky customer relationships, which in turn means that Hansen pumps out very stable cash flows.

An effective billing system needs to deeply integrate with the client's internal systems in order to reliably provide accurate and timely invoices to the end user. It takes Hansen anywhere from 6 months to 2 years to get a new client up and running.

Changing billing software providers is a costly distraction at best, and a near-fatal error at worst. That risk makes it very rare for a customer to switch providers. The relationship is more like a marriage than a casual fling. The average Hansen customer stays with the company for ten years (that's actually a year longer than the average length of an Australian marriage!).

Those switching costs mean that Hansen is protected behind strong barriers to entry that enable it to earn high returns on invested capital. Hansen is debt free and regularly reports returns on equity of a juicy 20% or higher.

Growth

Hansen has grown sales at a compound annualised rate of 14% over the past three years, with most of that growth coming from acquisitions. Hansen's underlying organic growth is lower, at around 5-8% per year. But there are plenty of reasons to think that Hansen can keep finding suitable acquisition targets that will boost growth for many years to come.

The customer care and billing industry that Hansen operates within only really took off in the late 1990s when many utilities and telecommunications companies were privatised. These large, formerly state-owned companies had typically built their own internal billing systems, but then spun these out as separate entities soon after they were privatised. This legacy of one-off specialised systems, and the product's naturally high switching costs, means that the industry is still highly fragmented.

That fragmentation provides Hansen fertile ground for the company to acquire and consolidate the most promising of their smaller competitors. Hansen then brings its expertise and scale advantages to bear, improving the economics of these standalone businesses even further.

That is a big win for Hansen's shareholders. We calculate that for every dollar Hansen spends on acquisitions, it immediately creates over two dollars in shareholder value. That figure then rises to over three dollars in value within the first two years, once the newly acquired business has been brought up to Hansen-level economics.

The latest Telebilling acquisition is a perfect example. Hansen paid six times earnings before interest tax depreciation and amortisation (EBITDA) for the Danish company. That is some strong value-creating arbitrage considering the market values Hansen with a multiple of over thirteen times EBITDA.

The post Profit from paying bills appeared first on The Motley Fool Australia.

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Cyber security is the first-world challenge of our age. Every other day we seem to be hearing about a new multinational company that has been hacked. Those data breaches are costly, which also means that companies are willing to spend up big to prevent them happening. One small Australian company is helping them do that, and its industry leading technology means that it is poised to profit.

Senetas (ASX: SEN) is a world leading developer and manufacturer of high-speed network data encryption hardware, based in Melbourne. Senetas customers trust the company to securely transport vast volumes of highly sensitive information quickly. Its customers include global multinationals, government departments, banks, financial systems providers, even national defence forces (the data is so sensitive that specific customers cannot be named).

Growing demand

For the past three years Senetas has reported compound revenue growth of 53% per year, following a key new distribution deal. That growth isn't showing any signs of slowing down either. In the most recent half year Senetas clocked up revenue growth of an incredible 68%.

Even better, in recent years Senetas has shifted its pricing structure to generate more of its revenue from ongoing maintenance fees rather than one-off sales. These maintenance fees are typically set at around 20% of the up-front cost of the hardware. That structure means that every new sale not only gives Senetas a one-off revenue boost, but also provides reliable recurring revenue for several years to come.

High added-value

Australia is often criticised for the low added value of our exports. We are said to import flat screen televisions and export lumps of rock. Senetas puts the lie to that myth. The precision engineering required for security at Senetas' world-class level means that a single Senetas encryptor – about the size of a Sony Playstation – can sell for tens, or even hundreds of thousands of dollars.

The company isn't resting on its laurels either. Senetas is constantly re-investing in research and development to push the technological envelope forward. The current project is to develop a high-speed encryptor capable of operating at 100 gigabits per second which the company expects to release to the market within the next twelve months. That is an order of magnitude faster than the best of the current technology, and the company expects strong customer demand.

This constant technological evolution is a boon for Senetas. By staying on the cutting edge, they are able to regularly sell to the same clients over and over again, as they upgrade to the latest and fastest technology. The rise of cloud computing is also providing a tailwind, as companies need to secure the huge volumes of traffic between their monolithic data centres.

Concentration risk

The biggest risk that investors in Senetas needs to be aware of is distributor concentration. Although Senetas products are ultimately used by leaders in multiple different industries (not to mention government departments), the path to reaching those customers is controlled by one key distribution partner – Gemalto.

In exchange for the improved pricing terms that have helped turn around Senetas fortunes, the company agreed to an exclusive distribution deal with SafeNet (later acquired by Gemalto) a few years back. If Gemalto decided to renegotiate terms, or worse, walk from the deal entirely, it would be a devastating (though, likely not fatal) blow for Senetas.

The post How to profit from the cyber-threat appeared first on The Motley Fool Australia.

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Ben Bernanke was one of the most powerful people in the world, serving as the chairman of the U.S. Federal Reserve during the worst financial crisis since the Great Depression.

That meant Bernanke had to be extremely careful choosing his words. His slightest utterance could send markets into a panic. But Bernanke stepped down from his chairman role last year.

Now that he is finally free to say what he wants, what would he say? When we heard he was speaking at the World Business Forum in Sydney yesterday we had to go to find out. Here are the highlights from his presentation, and why they matter to Aussie investors:

On getting subprime wrong:

"Subprime mortgages were a small asset class. We calculated that if all subprime mortgages went bad on the same day it would have only been the size of a bad day on the stock market. The problem was how fragile the system had become."

[Foolish takeaway: If there is one big, huge, unmistakable lesson to take away from Bernanke's presentation, this was it. The Federal Reserve had not just considered the risk from subprime mortgages, they had thoroughly analysed it. And yet, they still determined that there was no chance that subprime mortgage defaults could cause a crisis.

That's like finding a red-back spider on your pillow, squinting at it for a bit, turning on a light to get a better look, then deciding that something so small couldn't possibly hurt you, and rolling over and going back to sleep.

Of course, as we now know, that judgement was terribly misguided. The lesson: In today's interconnected world, even small problems can have huge ripple effects.]

On China's slowdown:

Bernanke was asked if he thought China's growth would slow. He responded that a slowdown in China was "inevitable" and that the current growth model was unsustainable:

"China can no longer grow through its old model of construction, heavy industry and exports. The economy needs to move toward consumption. They are making progress towards that. The move away from command and control is difficult"

"There are risks in the Chinese system of a hard landing. For example, Chinese banks have significantly increased credit, and a lot of those loans are not very good loans."

Bernanke went on to explain that despite the risk he still feels that a hard landing is a "low probability" because the Chinese government's control of the economy should enable it to aggressively intervene if needed.

[Foolish takeaway: Joe Magyer and I visited China at the start of the year. We came away convinced that China was on an unsustainable path, and that the debt-fuelled growth model would not end well. So there are no arguments from us!

We are less confident though that the probability of a hard landing is low. The Chinese government does wield formidable powers. But as we saw with the subprime crisis, even problems that seem small and containable at first can quickly spiral out of control.

The lesson for Aussie investors: China's growth model is unsustainable. The mining industry, which has been propped up by China's construction boom should be treated with extreme caution.]

On the potential for housing and stock market bubbles:

"The Central Bank's point of view is not asking 'are asset prices where they should be?' That concern is for investors. Our concern (as the Central Bank) is whether there is a threat to the financial system.

I don't see anything that looks like the tech bubble, or other past bubbles, nothing that looks like it could threaten the system"

[Foolish takeaway: In Bernanke's view, it's not the Federal Reserve's job to worry about whether asset prices are too high, that is a concern for investors. The only concern for the Central Bank is whether there is a risk to the system itself. Given that the last two major U.S. recessions were caused by asset price bubbles, that dichotomy is debatable.

But either way, the lesson for investors is clear. Don't expect the Central Bank to save you from the market becoming overvalued. That responsibility sits with you. And as your Advisors at The Motley Fool, with us. The secret, as always, is remaining patient and investing in great businesses only when they are available at fair prices.]

On the Aussie dollar:

"If Australia finds it has a strong Australian dollar and it has higher unemployment, then it would have to respond and that would either be by increasing domestic demand or by weakening its own currency"

[Foolish takeaway: There should be no surprises here, but it is worth remembering. If the Aussie economy continues to struggle there is only one way that interest rates and the Aussie dollar are heading. Down.]

On moves to tackle the Aussie housing bubble:

"In Australia, the UK and other Commonwealth countries (they) are being particularly good at using various kinds of prudential policies to address concerns about housing prices, so I think that's the best approach."

[Foolish takeaway: Bernanke thought Australia's move toward macroprudential policies were a step in the right direction. After much nudging from the RBA, several Aussie banks have moved to slow the growth of their loans to property investors in recent months. Commonwealth Bank of Australia (ASX: CBA), the country's biggest lender moved to remove discounts for investment home loans, and its subsidiary, Bankwest, implemented a maximum loan-to-value ratio of 80 percent for investment loans. National Australia Bank (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) have also moved to scrap discounts for new property investor customers.

The measures seem to make a lot of sense to us, and its always good to hear an expert of Bernanke's calibre say you are on the right path. Although given the current level of property prices in major Australian cities, it's worth asking if those initiatives are too little, too late.]

Bernanke's lessons

Ben Bernanke's presentation provided clear lessons for Aussie investors. China's slowdown is inevitable. Problems in small sectors of the economy (just like subprime mortgages) can quickly spiral into big problems for the whole system. It is our job as investors, not the Central Bank's, to be on guard against asset price bubbles (Sydney house prices anyone?).

With the mining boom fast turning in to the mining crash, capital expenditure falling, and unemployment rising, Bernanke's visit to Australia could not have come at a better time.

Yet despite Bernanke's presentation being so applicable to Australia today, it seemed like a lot of his lessons from the crisis were falling on deaf ears. By the time he had finished talking many in the audience had already left to beat the rush-hour home. Or perhaps they wanted to be first in line for five-o'clock beers.

She'll be right, mate.

The post 3 critical lessons from Ben Bernanke appeared first on The Motley Fool Australia.

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It might still be under most investors' radars, but Hansen Technologies (ASX: HSN) is a high-quality Aussie tech company that is winning big overseas. Hansen provides the mission critical customer-care and billing software for service providers in a wide range of different industries in over 40 countries.

Sticky recurring revenue

Hansen's clients provide everything from Pay TV to telecommunications to electricity and water utilities, but they all have one thing in common – they are hugely dependent on Hansen's software. Hansen does all the work behind the scenes to make sure that the bills their clients send on to the end user are delivered on time and without any errors. That dependence makes for super-sticky customer relationships, which in turn means that Hansen pumps out very stable cash flows.

An effective billing system needs to deeply integrate with the client's internal systems in order to reliably provide accurate and timely invoices to the end user. It takes Hansen anywhere from 6 months to 2 years to get a new client up and running. Once a client has invested that time and effort in joining Hansen, they are reluctant to switch to a competitor.

Those switching costs mean that Hansen is protected behind strong barriers to entry that enable it to earn high returns on invested capital. Hansen is debt free and regularly reports returns on equity of a juicy 20% or higher.

Up go the bills

Hansen has grown sales at a compound annualised rate of 14% over the past three years, with most of that growth coming from acquisitions. Hansen's underlying organic growth is lower, at around 5-8% per year. But there are plenty of reasons to think that Hansen can keep finding suitable acquisition targets that will boost growth for many years to come.

The customer care and billing industry that Hansen operates within only really took off in the late 1990s when many utilities and telecommunications companies were privatised. These large, formerly state-owned companies had typically built their own internal billing systems, but then spun these out as separate entities soon after they were privatised. This legacy of one-off specialised systems, and the product's naturally high switching costs, means that the industry is still highly fragmented.

That fragmentation provides Hansen with a golden opportunity to acquire and consolidate the most promising of their smaller competitors. Hansen can then bring their scale advantages to bear and wring out inefficiencies to further boost returns. This industry fragmentation could be the fuel that powers Hansen's acquisition growth engine for many years to come.

More acquisitions means more value

The challenge with valuing a company like Hansen is that its future is heavily dependent on that continued flow of acquisitions, which will vary in size, frequency and quality. If we assess Hansen purely on its current business and an estimate for future organic growth, then its shares are currently trading at around fair value.

However the real upside potential comes from the company's ability to acquire and integrate new companies in the future.

The post Picking up the bill for investors appeared first on The Motley Fool Australia.

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After more than 30 years of unrivaled investment success, Warren Buffett may be losing his magic touch.

But there's more to Berkshire's weak showing than just the operating and investment performance. To be blunt, Buffett is viewed by an increasing number of investors as too conservative, even passe. Buffett, Berkshire's chairman and chief executive, may be the world's greatest investor, but he hasn't anticipated or capitalized on the boom in technology stocks in the past few years."– Andrew Bary, Barron's

It was December, 1999. The Nasdaq had just posted another stellar result, up a whopping 85% in the past year, as investors clamoured to get in on the next hot tech pick. Meanwhile the share price of Buffett's company Berkshire Hathaway had fallen 30% from its high, dramatically under-performing the market.

Had the Oracle of Omaha lost his touch? Buffett claimed he was exercising patience in a world gone mad, with share prices running well ahead of intrinsic value. But to most observers, Buffett's underperformance was a clear indication that he was over the hill. Unable to adapt to the "new world" that was being brought about by rapid advances in technology.

Buffett's inactivity may have looked like ineptitude, but it would not be long before he emerged once again as a genius. In early 2000 the NASDAQ index – the primary index for high-tech companies – began to crash, plummeting 75% over the next two years.

Patience pays

"The stock market is a device for transferring wealth from the impatient to the patient." – Warren Buffett

Buffett's patience and discipline may have led to ridicule, but it is one of the core competitive advantages that makes him the world's greatest investor.

Watching Buffett (84 years old) and Munger (91) on stage at the Berkshire Hathaway annual meeting celebrating the company's 50th anniversary and talking about planning for "the next 50 years", I was struck by the incredibly long time horizon that both men still think in.

During the meeting Buffett even talked about using a one hundred year time frame when considering an acquisition. One hundred years! Contrast that with the hyper-short-term focus of most investors on Wall St, where analysts pile on top of each other in their attempts to guess the next quarterly results.

For well over 50 years Buffett has thoroughly smashed the market by sticking to what he knows and understands – by investing within his circle of competence. In 1999 that made him appear out of touch, but the truth was Buffet was one of the few investors that was in touch with what truly mattered – underlying intrinsic value.

Key Takeaways for Pro

Joe and I face constant temptation.

Every day the market is offering to sell us part ownership stakes in thousands of Australian companies, and we must determine when we are being offered a bargain.

We are constantly scouring the market for strong businesses with great long term prospects that are misunderstood and undervalued. We may spend days or even weeks digging in to a particular company – reading annual reports, talking to customers and competitors, meeting with management – only to face the cold hard truth that we are not yet being offered a cheap enough price.

When we've just finished a tonne of research and the company falls short due to a high valuation it would be very tempting for us to lower our standards. To go along with the rest of the herd and increase the price that we are willing to pay.

But to do so would be to invite disaster. It may not happen right away, it might even take years, but eventually our precious Pro portfolio would pay dearly for those slackened standards. Just as the over-excited tech speculators of 1999 ultimately faced judgement day.

Instead we will keep our focus on the task at hand, add the newly researched company, and its valuation to our regularly updated watch list, and move on to the next potential Pro target.

It's not always easy, but remaining patient and focusing on the long term is the only way to build lasting wealth. Just ask Warren.

The post Buffett's lost it appeared first on The Motley Fool Australia.

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The financial press is buzzing about the epic battle shaping up between Xero (ASX:XRO) and MYOB. But is it possible that Xero has already won?

Here at Motley Fool Pro we love to dig deeper, and some of the latest data we have found should raise a big red flag for anyone considering buying into the upcoming MYOB IPO.

The thesis for investing in Xero is that this innovative upstart from a tiny country will be able to overthrow its much larger and established rivals. A great parallel is the story of Facebook (NASDAQ: FB) vs. MySpace. Here we had a very dominant competitor (MySpace) that most people thought had already won the game when it came to social networking. And yet Facebook ran a freight train straight past MySpace, by focusing relentlessly on user experience and innovation.

One metric that was fascinating in that battle was the popularity of searches on Google (NASDAQ: GOOG). Once Facebook had overtaken MySpace in Google search term popularity it was already game-over for MySpace – in only a matter of months Facebook was also winning on user count and engagement.

So, to test the Xero thesis we started off by comparing the search term popularity for 'Xero', 'MYOB', 'Quicken', 'Quickbooks' and 'Reckon' (ASX: RKN) amongst Google users in Xero's home market of New Zealand.

Xero overtook MYOB in Google search term popularity in New Zealand way back in July 2011, and has continued to put daylight between itself and MYOB ever since. After first winning Google searches, Xero's New Zealand market share almost doubled over the following year, and has showed no signs of slowing down. Xero is now the undisputed leader of cloud accounting services in New Zealand, counting over a quarter of all small New Zealand businesses as customers.

Winning the Google search race was a big turning point for Xero in its conquest of New Zealand. So, how does the data look if we take the same companies, but instead focus on the share of Australian Google searches?

As you can see, over the past few months Xero's Google search term popularity has surged past MYOB. This should be a hugely encouraging metric for Xero investors, particularly considering that MYOB still has a large installed base of traditional desktop accounting users in Australia.

Even more interesting was when we zoomed out to Xero vs. MYOB in global search term popularity. Investing in Xero is far from just about winning in New Zealand and Australia – it is about Xero's ability to create a truly global platform. When we look at global share, we can see that Xero actually overtook MYOB in August of 2013, and since then Xero has only widened the gap.

This performance is a testament to the wall of innovation that Xero has been releasing, not to mention the company's relentless focus on user experience and customer engagement. Xero still has a big mountain to climb in the United States, but Xero's massive cash injection from one of the world's biggest and most successful VC funds is a great indication that Xero is armed and ready for battle there too.

We will keep watching this metric over the months and years ahead. If I was MYOB, I'd be worried.

Fool on!

Matt Joass

The post Has Xero Already Won? appeared first on The Motley Fool Australia.

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"What do you guys think about Company XYZ?"

We get that question a lot at Motley Fool Pro, and for good reason. With over 2,000 ASX-listed companies putting out glossy results presentations, it can be tough to cut through the spin.

So this time, instead of talking about what makes a great company, we're going to run through 6 signs the company you are looking at is a dud…

1. It's Constantly Diluting Shareholders

Dilution might just be the dirtiest word in investing. And it can strike right when you least expect it.

Everything seems to be going swimmingly, your high-growth company's revenue is soaring and the share price has been rocketing up along with it. You are feeling pretty happy with yourself.

Then… boom! Out of nowhere the company is issuing more shares to raise equity, and diluting away the ownership stake of all its loyal shareholders. Suddenly a big chunk of that growth has to be shared with the new investors. The pizza got bigger, but it's been cut into more slices.

Even more painful is when that dilution comes after a fall in profits. The company hits a rough patch and management chooses to dilute current holders at the exact wrong time – while the share price is at record lows.

Unfortunately it is all too easy for low quality companies to raise extra cash by issuing more equity, often at a discount to the current share price. Existing shareholders are hurt, but management's corner offices remain undisturbed.

That is a big part of the reason we put a premium on trustworthy management. It's also why we love capital-light businesses with strong operating leverage – they can boost sales without having to stump up loads of extra cash.

The dilutionary equity raise is all too common in Australia, and especially with speculative miners. This insidious destroyer of long-term value is the first warning sign that the company is not deserving of your hard-earned capital.

2. Salvation Is Always a Year Away

A cheeky pub in New Zealand used to have a big sign beside the bar that read "Free Beer… Tomorrow".

Some companies seem to be perpetually stuck in gonna status. Next year we're finally gonna get approval for that experimental drug. Next year we're gonna start pumping all that oil we think we've found. Next year we're gonna launch our market beating product.

You get the idea.

Sadly, just like the punters at that bar, we eventually need to face up to the fact that for some companies, tomorrow never comes.

3. They Are Always Talking About the Size of the Opportunity – Not Their Progress

It's great to invest in companies with a big vision for the future and that are scaling in to ever larger markets. A huge international market opportunity can make the difference between a company becoming a stable local player, or a world-beating home-run.

But when the size of the market opportunity takes up the first 20 slides of the company's presentation, and there is no mention of current revenue, it's a sure sign that management have their heads in the clouds.

Big market opportunities are great, but only if the company is actually making progress to deliver on that potential. To do that, they need to actually get out in the real market and prove that they have a competitive advantage that will allow them to turn that potential into pay dirt.

If management are all talk and no walk, then there is no reason you need to keep listening.

4. It's Never Management's Fault

As investors we strive to take personal responsibility for our actions. There are always a lot of variables out of our control, but only by having an attitude that 'the buck stops here' can we learn from our mistakes and plan for the future.

The least we ask of our management teams is that they do the same.

If your company's management team is continuously blaming the weather, commodity prices, or challenging market conditions it's a sign that they are incompetent, it's genuinely a terrible business – or both!

We can check this out by reading through past presentations and seeing how the management team have faced up to previous failures. If it looks like management have a habit of shirking their responsibility, it's time to walk away.

5. Management Keep Selling Shares

Every now and then management will need to sell some of their shares for personal reasons. Perhaps they are purchasing a house, or a new jet ski, or buying a private island (I would if I could!). There will always be the occasional necessary sale.

But there is no surer sign that management don't really believe in the company than a pattern of steadily selling down their shareholding.

If we have to choose between actions and words we'll choose actions every time. If your company's management team are preaching a bright future while also offloading their shares as quickly as they can, then it might be a sign you should follow their lead.

6. A History of Losses

Jerry Maguire said it best: "Show me the money!"

All the glossy reports and bullish predictions don't matter if the company isn't able to turn their potential into positive cash flows. A long history of losses is a sure sign that the company has not been able to deliver on its promises.

Perhaps it's just a terrible industry, perhaps the company is poorly run. Either way it doesn't need to be your problem.

The only exception is when the company is going through an intense investment phase and pumping everything it can back in to feed its growth machine. But if that is really the case we can check the company's progress through revenue growth and market share, both of which should be soaring in response to their aggressive investments.

If a company has been continuously losing money and is showing no signs of gaining traction then it's time to cut the cord.

The post 6 Signs Your Company is a Dud appeared first on The Motley Fool Australia.

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It has been 24 years since Australia's last recession, but there are plenty of signs that our long lucky streak may be coming to an end. Prices for our biggest exports have plummeted, mining investment is tumbling, and the dollar is falling faster than a drunk koala. But surely there are plenty of companies that can do well in tough times? Of course, nothing can be guaranteed to be completely recession proof – but there are steps you can take to set your portfolio up to combat the impacts should an economic downturn arrive on our shores

The truth is, recession-resistant businesses are tough to find. Some products will see a lot of units sold — people still need cereal after all — but will face margin pressure as consumers downgrade to cheaper brands and smaller sizes. When times are tough, those home brand 'Wheat-Bricks' suddenly look a lot more appetising.

So to single out the best recession-resistant business models, Motley Fool Pro took a look at how different US-listed companies performed during the Global Financial Crisis. A few industries caught our eye, but one in particular stood out: Auto-parts. All of the largest US listed auto-parts suppliers that we looked at actually increased their revenue each year throughout the GFC.

But how does that help Australian investors? Enter Burson Group (ASX: BAP).

Burson: recession ready

Burson Group is Australia's largest trade-focused auto-parts distributor, with 121 stores nationwide. It won't be a household name for most Australians because the company's focus isn't do-it-yourselfers. Instead, around 80% of Burson's revenue comes from selling auto-parts to more than 30,000 independent auto-repair workshops, with the remaining 20% coming from retail purchases direct from their warehouse shop-fronts.

Burson Group's resilience comes from the nature of its product. Consumers will put off a lot of expenses during tough times, but when their car breaks down they need to get it sorted out pronto. That makes for some steady revenues. And during recessions, consumers tend to put off upgrading to a new car and instead spend more on keeping their existing ride running. A double win for Burson.

Pricing power

One more reason to trust in Burson is the company's ability to pass price increases from parts manufacturers onto its workshop customers, who then pass the costs on to drivers like us. Burson can pull that off because when workshop customers need a part, they need it right now.

In its latest half year results, Burson faced increased costs from suppliers of around 3% due to the falling Aussie dollar. How did Burson respond? They simply passed these higher costs straight through to their own customers, the workshops. Burson even later added their own additional price increase to reflect general cost inflation (and improve margins) of around 2-3%. Nice – especially as CEO Darryl Abotomey says "It has not decreased volumes one little iota".

And remember, the auto-parts themselves are usually less than half the cost of the repair job. Put it all together and this pricing dynamic is one more reason why Burson wins during tough times.

Foolish takeaway

The Reserve Bank might have been worried enough about an Aussie slowdown to cut interest rates, but Burson has just keep on truckin'. In its latest half year results, Burson posted strong results — same-store-sales growth of 4.3%, total revenue growth of 9.7%, and a net profit boost of 14.3%.

It's hard work finding a truly recession-resistant business, but Burson measures up. When you need a repair done, you need it done fast, giving Burson strong pricing-power. Even better, during a recession penny-pinching consumers tend to stretch out the life of their existing cars, instead of upgrading to a new ride. Investors looking for a way to prepare their portfolio for a recession should make a pit stop at Burson Group.

The post Recession-proof your portfolio appeared first on The Motley Fool Australia.

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Xero (ASX:XRO) shares are up over 20% this morning on some great news — U.S. venture capital juggernaut Accel Partners just made a whopping US$100 million investment in Xero. Not only that, but Xero's largest current institutional investor Matrix Capital Management, agreed to invest a further US$10.8m.

We at Motley Fool Pro are very impressed that Xero was able to attract an investor of Accel's caliber, and we are not alone judging by the shares' big leap this morning.

Accel Partners are a big deal in venture capital circles. They manage over US$8 billion and have a history of picking big winners, with Facebook, Spotify, Dropbox and dozens of other top-tier online businesses in their catalogue.

After this latest raise Xero now sits with a war chest of over $270 million (NZ$285 million). The funds were raised at a valuation of NZD$20 per share, or around $19.14 per share in Aussie dollar terms. That is above where shares were trading yesterday, and well above the price where we told Pro members to double down.

That $19.14 valuation does put the raise at a discount to our estimate of Xero's intrinsic value, but we are more than happy to trade that for the big boost the extra cash will bring Xero. Doing the cash raise now, well ahead of when its needed, means that Xero can focus 100% on what it does best: building a world beating cloud accounting platform.

Now, as if a massive cash injection from one of the world's biggest and most successful VC funds wasn't enough, Xero also announced some top notch new hires.

Russ Fujioka, former Dell Executive has been appointed at President of Xero's U.S. operations. Fujioka has significant experience in sales and digital marketing – two key areas that Xero's US operation will focus on as it builds its direct-to-customer sales model.

Xero also stocked up on high profile Software-as-a-Service (SaaS) talent with Graham Smith, the former Salesforce CFO, joining Xero's board. Saleforce is one of the world's most successful SaaS companies, and Smith will bring a wealth of relevant experience to Xero's board.

The pedigree of a major VC firm investment and the addition of top industry talent puts Xero in a great spot for a future U.S. IPO which is planned for later this year.

All up, it was an excellent announcement from Xero, and we are looking forward to seeing the company continue to unleash its 'wall of innovation' throughout the rest of 2015.

The post Xero's Huge Cash Injection appeared first on The Motley Fool Australia.

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We went to China to separate fact from fiction. We met with economists, professors, hedge-fund analysts, dot.com company leaders, everyday consumers, and manufacturers from a whole range of different industries. At each meeting we put commonly held beliefs about China to the test.

Here are 7 big China myths that it's about time we all dropped:

Myth #1: The Chinese people have a cultural bias that makes them big savers

The funny thing about this myth is that in the 1950s and 1960s everybody 'knew' that the opposite was true. As Singapore's former Prime Minister Lee Kuan Yew complained in 1974: Singapore's Chinese "spend freely and save less".

Once Asia started to grow rapidly in the 1970s our understanding of East Asian culture's impact on saving reversed. Suddenly Confucianism was all about saving, and this was assumed to be the backbone of strong growth.

We met with Michael Pettis in Beijing, a renowned expert on the Chinese economy, and Professor of Finance and Economics at Peking University, who was quick to dispel this myth. As Pettis notes in his excellent book, The Great Rebalancing:

"High Chinese savings, as we will show, are largely a consequence of domestic policies that constrain consumption, and have little to do with cultural values."

China's sky-high savings rate is really driven by the government and state owned enterprises. It is actually the result of policy – not culture.

China's miraculous economic growth has been realised through huge distortions which favour investment over consumption. There are three primary ways that the government implements this investment bias: constraining wage growth, maintaining an undervalued currency, and keeping interest rates artificially low.

To give an example of how one of these mechanisms work to increase national savings, imagine that the Aussie dollar dropped by half tomorrow.

The price of imports would immediately double. All imported goods now cost a lot more, which means Australian households have less money left over with which to buy local products. As a result, households reduce their total expenditure on foreign and local goods in order to maintain their desired balance between savings and consumption.

Meanwhile, Australian production increases to satisfy greater international demand for our (now cheaper) Aussie exports. The devaluation has reduced total consumption and increased total production. That means the Australian national savings rate, which is the difference between production and consumption, has increased. And all without having learned a thing about Chinese culture!

Facts on the ground: China's huge savings rate is primarily caused by its unbalanced investment-led growth model – not an innate savings culture.

Myth #2: China has huge pools of untapped labour

Like a loaf of bread in a hot pantry, this is a truth that has gone stale over time.

For decades, the Chinese economy benefited from a 'demographic dividend', a continuous increase in the size of the country's working age population. All those extra workers provided an expanding pool of low-cost labour for China's factories and helped the growth machine keep chugging along.

But that population growth has now long since come to an end. As the Financial Times reports: "China's working-age population peaked in 2011 and is expected to fall at an accelerating rate in the coming years, thanks largely to the decades-old one child policy. China's working-age population fell 3.7m last year, after falling 2.44m in 2013"

All of the exporters that we met with in Shanghai were struggling under the burden of rapidly rising labour costs and looking to relocate to cheaper areas, both within China, and throughout the rest of Asia.

Facts on the ground: Demographics are a powerful force, and they now pulling against Chinese growth.

Myth #3: Rural to urban migration will save China from any overbuilding problem

China has witnessed the largest migration in human history. Over 300 million people migrated from farms to cities in the past 30 years.

Over the next decade, the Chinese government plan for another 200 million people to migrate to cities, or around 20 million per year. Assuming an average of 2.5 people per household (the national average is 3 per household) that means there will be demand for an extra 8 million urban dwellings a year.

That is a staggering number of additional housing units needed, and so it's not surprising that many people assume that means China has no danger of building ahead of demand.

But, as Joe reported recently in The Future of Iron Ore, researchers at China's Southwestern University of Finance and Economics found that 49 million sold Chinese apartments were sitting empty, waiting for a family to move in. That is 22% of all apartments nationwide. It is also a big, big, gap between current supply and expected demand.

China could stop building apartments tomorrow and have several years' worth of housing supply on hand. As Joe notes "there are enough empty apartments in China to house 6 years' worth of urban migration."

Facts on the ground: China's upcoming urban migration is big – but the scale of overbuilding is even bigger.

Myth #4: China's biggest comparative advantage has been its low cost labour

Ask almost anyone what China's greatest advantage is and they will probably say the country's huge pool of cheap and increasingly productive labour.

That low-cost labour has been a big advantage, and the Chinese government has implemented many policies that keep labour costs low. But the truth is, China's artificially low costs of capital have been an even bigger source of their growth.

As Pettis explains:

"If China's comparative advantage were cheap labour, we would expect its growth to be heavily labour intensive as businesses loaded up on the most efficient input. But China's growth is actually heavily capital intensive. Chinese businesses behave, in other words, not as if labour were the cheapest input they have, but rather capital were the cheapest input. They are right. Labour may be cheap, but capital is free. If may even have a negative cost."

The continued availability of that capital is now a big problem. All three of the textile manufacturers that we talked to were cautious to limit their exposure to other Chinese businesses, preferring the safety of international export customers.

Facts on the ground: China's low-cost labour is cheap, but artificially abundant capital has been even cheaper.

Myth #5: They might be politically appointed, but China's government and state-owned business leadership is a meritocracy

A core myth of the Chinese government has been that the political elite's ruthless focus on economic development ensures a meritocracy. The leaders with the best ideas and who make the most effective economic decisions will rise to the top of the political totem pole.

Not so.

In 2012 a team of political scientists challenged this myth. Using a biographical database of Central Committee members they concluded that there was: "no evidence that strong growth performance was rewarded with higher party ranks at any of the post-reform party congresses…Suggesting that promotion systems served the immediate needs of the regime and its leaders, rather than encompassing goals such as economic growth."

Facts on the ground: The Chinese government is no less susceptible to political in-dealing than any other.

Myth #6: The Chinese government are superb economic managers that can get China out of any economic mess

China's government won a lot of praise for the way they powered their economy out of the Global Financial Crisis. Just when it appeared China's high growth period was over, the government launched a massive stimulus package and opened the taps for new lending. The credit-fuelled expansion that followed appeared to be yet another sign that the Chinese government had the tools to get the country out of whatever trouble it faced.

The Chinese economic miracle has been impressive. But these policy successes have almost always involved targets that could be reached primarily by increasing investment.

As Pettis notes, the real lesson "was not that Beijing was able to manage the economy efficiently and intelligently; it was that Beijing was able to increase investment whenever it wanted. Given low transparency, limited political accountability, and near-total control over national savings and the banking system, perhaps this should not have been a surprise. "

Facts on the ground: When it comes to summoning investment, the Chinese government have been Superheroes. But spreading the wealth around? That has so far proved their kryptonite.

Myth #7: If Chinese GDP growth falls to 2% or 3% it means the Chinese consumer growth story is doomed

Ok, it's about time for some positivity! And there's good news, great news actually.

Yes, China's economy is massively unbalanced, with the government having used every trick in the book to boost investment, at the expense of households.

But that distortion also means that there is a huge coiled spring sitting under Chinese consumption. Chinese household consumption is currently sitting at around 34% of GDP. A level so low that it is unprecedented in economic history anywhere. For some context, U.S. household consumption is around 70% of GDP. Even other major Asian economies like Taiwan, India, and Japan are around 55% to 60% of GDP.

China's GDP is currently a little over 10 trillion U.S. dollars. Which puts household consumption at around the 3.4 trillion dollar mark.

In other words, if the Chinese economy didn't grow at all, but instead just gave households a fairer shake, it could unleash a vast wave of consumer spending. If that 34% share increased to 55% of GDP – then China could add a whopping 2.1 trillion dollars of consumer spending each year.

That would be a huge increase in the standard of living for the average Chinese citizen. It would also mean a heck of a lot of extra demand for Western products, services, and tourism.

Facts on the ground: If China's government can successfully navigate the difficult task of rebalancing, then China's consumer growth story is really just getting started. And that would be a big win for all of us.

Yours Foolishly,

Matt Joass

The Motley Fool has a disclosure policy.

The post 7 Big China Myths Busted appeared first on The Motley Fool Australia.

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China is the word on every investor's lips. Its demand for our exports, industrialisation and impact on the global economy is enormous. But there are risks, too. We've just returned from a research trip to China. We met with economists, professors, hedge-fund analysts, dot.com company leaders, everyday consumers, and manufacturers from a wide range of different industries. Here are 3 big China myths that it's about time we all dropped:

Myth #1: The Chinese people have a cultural bias that makes them big savers

We met with Michael Pettis in Beijing, a renowned expert on the Chinese economy, and Professor of Finance and Economics at Peking University, who was quick to dispel this myth. As Pettis notes in his excellent book, The Great Rebalancing:

"High Chinese savings … are largely a consequence of domestic policies that constrain consumption, and have little to do with cultural values."

China's sky-high savings rate is actually the result of policy – not culture. Its miraculous economic growth has been realised through huge distortions which favour investment over consumption. There are three primary ways that the government implements this investment bias: constraining wage growth, maintaining an undervalued currency, and keeping interest rates artificially low.

To give an example of how one of these mechanisms work to increase savings, imagine that the Aussie dollar dropped by half tomorrow. The price of imports would immediately double, which means Australian households have less money left over with which to buy local products. As a result, households must reduce their total expenditure on foreign and local goods in order to maintain their desired balance between savings and consumption.

With your Aussie dollar salary staying the same, and with less being spent, your savings rate would immediately increase. And all without having learned a thing about Chinese culture!

China's huge savings rate is primarily caused by its unbalanced investment-led growth model – not an innate savings culture.

Myth #2: Rural to urban migration will save China from any overbuilding problem

Over the next decade, the Chinese government plan for another 200 million people to migrate to cities, or around 20 million per year. Assuming an average of 2.5 people per household that means there will be demand for an extra 8 million urban dwellings a year.

But, researchers at China's Southwestern University of Finance and Economics found that 49 million sold Chinese apartments were sitting empty, waiting for a family to move in. That is 22% of all apartments nationwide.

China could stop building apartments tomorrow and have "enough empty apartments in China to house 6 years' worth of urban migration".

China's upcoming urban migration is big – but the scale of overbuilding is even bigger.

Myth #3: If Chinese GDP growth falls to 2% or 3% it means the Chinese consumer growth story is doomed

Ok, it's about time for some positivity! And there's good news. Great news actually. Yes, China's economy is massively unbalanced, with the government having used every trick in the book to boost investment, at the expense of households. But that distortion also means that there is a huge coiled spring sitting under Chinese consumption.

Chinese household consumption is currently sitting at around 34% of GDP. A level so low that it is unprecedented in economic history anywhere. For some context, U.S. household consumption is around 70% of GDP and in other major Asian economies it is around 55% to 60% of GDP. China's GDP is currently a little over 10 trillion U.S. dollars. Which puts household consumption at around the 3.4 trillion dollar mark.

If the Chinese economy didn't grow at all, but instead just gave households a fairer shake, it could unleash a vast wave of consumer spending. If that 34% share increased to 55% of GDP, China could add a whopping 2.1 trillion dollars of consumer spending each year. That would be a huge increase in the standard of living for the average Chinese citizen. It would also mean a heck of a lot of extra demand for Australian products, services, and tourism.

The post Three China myths busted appeared first on The Motley Fool Australia.

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The smart machine revolution has arrived. Everything from toasters to the family car is now filled with processing power. And one Australian company is reaping the rewards. Altium (ASX: ALU) may not be a familiar name to most investors, but its software has helped design the electronics that power thousands of the products that we use every day.

Altium's main product is an advanced piece of software called 'Altium Designer' that helps engineers design printed circuit boards (PCB). You can think of it as software that helps design the parts that put the smart into all those smart devices. And demand for that software has been growing fast. Despite growing revenues at 14% per year for the last three years there are signs that Altium is just getting started.

A solid quarter

Altium announced its latest quarterly results last Friday. Revenue for the half year was up 17% from the year prior, and in constant currency terms rose by 21%. Much of that revenue boost came from the one-time gain of a 36% increase to Altium's perpetual license fee. Most customers have accepted the price increase as fair, providing a great demonstration of the pricing power that the company enjoys.

Altium shows no signs of slowing down either, with second quarter with revenues up 23% on a constant currency basis. And yet, despite the solid growth numbers, Altium's share price has been see-sawing, and is currently down around 9% since the news.

Some investors may have been spooked by the company's comments that it faces some currency headwinds for the remainder of the financial year. Altium sells its software all over the world, but reports its results in US dollars. So a stronger greenback compared to other major currencies lowers Altium's US dollar reported revenues.

But if that's the fear, then investors need to wise up. For every gain in the US dollar vs. the Aussie, the value of Altium's US dollar cash flows to us Australia-based investors increases, pushing up the company's intrinsic value. In other words, a rising US dollar is actually a big win for Altium's Australian investors.

Juicy economics

Like most successful software companies, Altium is capital light, with high margins and high returns on invested capital. Once all those zeroes and ones have been written, there is very little extra cost to add another customer to the platform and the additional revenue drips to the bottom line like hot butter. In the latest half year a 17% revenue increase flowed straight through to a 17% increase in operating cash flow.

Once a customer has made the decision to integrate Altium's software into their design process it's tough for them to jump ship to a competitor: staff need to be retrained, processes need to be redesigned, and the library of existing product designs need to be transferred. All of those switching costs make for sticky revenues and loyal customers.

Altium's financials are in great shape too. The company has no debt and over 18% of its market value in net cash. At current prices Altium pays a 4% dividend yield, and with profits steadily increasing we can expect that yield to keep on rising for years to come.

Foolish takeaway

Growing fast in a fast-growing industry, Altium is a business with a long runway ahead. A rock-solid balance sheet that is overflowing with cash, coupled with recurring revenues, and a solid dividend yield give investors plenty of downside protection. With the smart machine revolution in full swing, and a falling Aussie dollar as the cherry on top, its time investors switched on to Altium.

The post The smart machine revolution appeared first on The Motley Fool Australia.

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New Year's resolutions are all about challenging our weaknesses. Whether it's over-indulging with food, or under-indulging with exercise, it's the one time each year that we recognise our human foibles and resolve to do better. So what better time to consider an investing strategy that promises to rid us our profit-killing emotional biases?

Joel Greenblatt may not be a household name here in Australia, but he is one of the world's best investors. Over a 19 year stretch, Greenblatt's 'special situations' hedge fund generated compound annual returns of an astonishing 45% per year. That is enough to turn an initial investment of $10,000 into over $11 million!

Working his magic

Today Greenblatt is managing over $5 billion with a quantitative value strategy that is based on an expansion of what he calls the Magic Formula. The premise of the Magic Formula is simple: buy statistically good companies at statistically cheap prices, without regard for how beautiful or ugly they may look.

Greenblatt is quick to point out that we should make sure to diversify when using this approach. The Magic Formula is a numbers game. Aside from a couple of hidden gems, most of the companies will have something obviously wrong with them. Others will be downright hideous.

Here are the good, the bad, and the ugly from the Magic Formula's top 30 ASX picks for 2015:

The Good: Webjet (ASX: WEB)

Webjet is a classic example of a good company available at a cheap price.

For many Australians, heading over to webjet.com.au is their first and last stop when booking a flight. That automatic brand association has allowed Webjet to grow sales at a compound annual rate of 28 per cent.

Yet despite that strong performance, Webjet trades at less than 12 times trailing earnings, with many analysts fretting over new international competition. But at the current share price Webjet should handily beat expectations, even if its growth slows significantly from the recent past.

The Bad: Reverse Corp (ASX: REF)

Reverse Corp's current market capitalisation of $11.5 million is a far cry from the peak of over $300 million that the company reached in 2007.

Reverse Corp's primary business is the provision of reverse calling services under the 1-800-REVERSE brand in Australia. Make no mistake about it, this is not a great long-term business. The rise of instant messaging and free phone systems such as Skype make this an industry in long-term structural decline.

But keep that $11.5 million market capitalisation in mind, and then consider that Reverse Corp is sitting on over $6 million in net cash, reported net profit of $1.6 million last year, and expects to report EBITDA of over $1.35 million in the first half of this financial year alone.

The Ugly: Vocation (ASX: VET)

Over the past three months, Vocation's shares have plummeted a nausea-inducing 91%.

The education and training services company has been reeling after announcing that the Victorian Government would cancel funding, forcing it to significantly restructure its business model. To top things off, the company faces a class-action lawsuit over alleged breaches of disclosure and deceptive conduct.

You'd be hard pressed to find an uglier investment.

Remember though, that the Magic Formula only works through diversification. If 60 per cent of companies in Vocation's position go to zero, but the rest triple in value, the Magic Formula would still clock up a solid 20% gain on the group.

The post 3 magic stocks for 2015 appeared first on The Motley Fool Australia.

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Matt Joass is a Motley Fool analyst. He owns shares in Vocation. You can follow Matt on Twitter @TMFMattJoass. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

Joel Greenblatt is a first class super-investor that should need no introduction. Over a 19 year stretch Greenblatt's hedge fund generated compound annual returns of an astounding 45%.

Over 19 years that turns a $10,000 jet ski in to an $11,641,046 private yacht.

Today, Greenblatt has pivoted 180 degrees from his origins in special situations. He is now managing over $5 billion with a quantitative value approach that is based on an expansion of his famous Magic Formula.

The premise of the Magic Formula is simple: buy good companies at a cheap price. Quality is measured by return on capital employed, while cheapness is measured by the earnings yield (EBIT/Enterprise Value).

Applying this test to the Australian market, and filtering out financials we arrive at the following list.

(Data Source: Capital IQ)

This list will always be full of names that make investors squeamish. There is, after all, a reason that these companies are cheap.

But that is also why Greenblatt advocates a mechanical adoption of the Magic Formula strategy. When we add our own human biases to the process we are more likely to under-perform, not less.

There are two companies within this list that are recent additions to my own portfolio: Vocation (ASX:VET) and Reverse Corp (ASX:REF).

Neither are pretty businesses. Vocation faces a class action lawsuit regarding its disclosure practices, and Reverse Corp's reverse calling 1-800 number faces long term structural decline. The bear case is easy to make for each, but that is the nature of deep value investments.

What matters is the price that we pay for a given level of quality. Reverse Corp's main business may be in structural decline, but with $6 million in cash and expected half year EBITDA of $1.35 million, it doesn't take much to justify the current $12.5 million valuation.

Following a mechanical quantitative-value approach empowers us to avoid the gag-reflex that these type of companies typically engender.

I back tested this approach over the past 12 months. The results were encouraging. The December 2013 portfolio of 30 companies is up 8.01% for the year, compared with the All Ordinaries which is down -1.07%.

However it must be noted that this back test is subject to survivorship bias. I have taken a list of the 2,144 companies that currently make up the ASX and then selected based on what their rankings would have been a year ago. This excludes any companies that would have been selected a year ago but which have since stopped trading under that name (bankruptcy, reverse listing etc).

I will be revisiting this list throughout 2015 to see how it is doing, and  re-balancing the portfolio. I am also looking at a couple of ways to tweak the algorithm and underlying data to better target what Greenblatt is reaching for.

It is easy for us to dismiss the Magic Formula as too simple to be taken seriously. But with one of the world's all time greatest investors now managing over $5 billion using a modified version of this strategy, it's about time the Magic Formula gets the attention it deserves.

The post 30 Aussie Magic Formula Picks for 2015 appeared first on The Motley Fool Australia.

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Motley Fool analyst Matt Joass owns shares in Vocation Limited and Reverse Corp. You can follow Matt on Twitter @TMFMattJoass