There is ample room for Fineos to deploy new modules to existing customers and grow penetration over time

Business Strategy & Outlook: 

Fineos is a core software vendor to the global life, accident, and health, or LA&H, insurance industry. Customers are primarily large multinationals and midmarket insurers. The firm generates revenue mainly from subscriptions and product implementation services. About 80% of revenue is generated from the U.S., the rest from Asia Pacific and Europe. Fineos help insurers streamline workflow, save costs, and win new business. Benefits of Fineos’ products to insurers include automating/unifying work processes, centralizing data, reducing the time to market for new products, and enabling greater user interface, assisting business wins and client retention. Fineos is currently migrating customers to a cloud-based offering (from on-premise products). This makes it easier to roll out new features and support at lower marginal costs, while also providing more recurring subscription revenue.

The firm executes a classic land and expansion strategy. Building on its leadership in claims and absence products, Fineos aims to cross-sell its broader product set including payments, billing, data and more. It intends to expand the use of the Fineos platform across multiple jurisdictions with existing multinational clients. Higher customer expectations, cost pressures, regulatory requirements, or increasing competition are prompting insurers to switch from clunky internal systems to external software like that from Fineos. There is ample room for Fineos to deploy new modules to existing customers and grow penetration over time. This further increases switching costs. To date, more than half of insurers globally still use inhouse legacy systems with limited functionality and high operating costs. Fineos has built multiple reference accounts from doing business with large insurers, who help with additional business wins. Risks include competition from larger competitors, and customer concentration, which may limit price hikes. These may be offset by Fineos’ high switching costs and the risk aversion of insurer clients in changing core systems. Fineos’ product switching costs are contingent on the group continuing to invest (such as in product development) to add value to customers.

Financial Strengths: 

Fineos’ investment efficacy was exemplary on grounds that it consistently prioritized higher returning investments and has a sound track record of execution. This gives us confidence that its future investments will be value accretive. Fineos secured a dominant position in the life, accident and health, or LA&H, insurance industry–a less contested space than the property and casualty, or P&C, industry–at the get go. The firm had a short stint in the more competitive P&C space several years back, but promptly pulled out from this low-returning pursuit. The focus on selling a comprehensive module to existing insurer customers (and in the process entrenching itself within more mission critical functions) is strategically sound. This strengthens switching costs, and may turn customers into credible reference accounts that assist Fineos with new business wins. While there’s need to grow its client base, Fineos will be selective and note that it has so far gone for larger insurers (who also write more annual premiums), putting it in a position of strength relative to vendors to mid-down-market insurers. In contrast, Fineos wouldn’t command much of a switching cost if it was distracted with winning deals rather than capturing more touch points within an existing insurer customer. The move to migrate clients to the cloud is also sensible. Rather than relying on licensing and services fees that can be volatile, this initiative creates a more recurring subscription revenue stream that is also higher-margin. Hosting its products on the cloud allows for a more seamless and rapid deployment of product features and upgrades. This enhances the value added to clients, and increases switching costs. While investments are sound, there are concerns on Fineos’ weak earnings quality, which may expose shareholders to further equity dilution or gearing risk. Fineos might generate positive free cash flows long term before it is comfortable in its balance sheet strength to both withstand a material downside event and self-fund its growth. The need to invest in product development or make feature-driven acquisitions meant that investing cash flows often outstripped operating cash flows, necessitating capital raises. Fiscal 2021’s cash balance barely moved from fiscal 2018 levels despite revenue doubling over the three years to fiscal 2021. Prospective business acquisitions over the next five years will likely require equity raises. However, Fineos is deploying capital sensibly to strengthen its economic moat and operating metrics are trending in the right direction.

Bulls Say:

• Fineos has low penetration in a sleepy industry that’s ripe for disruption. Operating metrics are solid and trending positively.
• Switching costs are high. A competitor who creates a better product only wins half the race. The other half is to build credible reference accounts and convince insurers to switch, which can be lengthy ordeals.
• Fineos will remain the leader in its niche space, as it continues to reinvest in its products or pursue acquisitions, bolstering its capabilities, increasing the switching costs of its product suite and expanding the modules on offer.

Company Description:

Fineos Corp Holdings PLC is an Irish company engaged in providing software solutions that include management and administration of policies and claims to the life, accident, and health insurance industry. The company’s platform, Fineos AdminSuite, comprises Fineos Absence, Fineos Billing, Fineos Claims, Fineos Payments, and Fineos Provider, among other solutions.

(Source: Morningstar)

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