September 2016: Oracle Financial – Leader in an under-penetrated market

While the market was steady through most of the month, volatility over the last few days drove the Nifty down 2% for the month. Our portfolios continue to do reasonably well.

The rally over the last 6-7 months has been driven by the laggards of the last couple of years – the PSU banks, commodity companies and others who have been steeped in problems over the last few years. This was led by some recovery in commodity prices, and equity infusion by the government into the PSU banks. The steady performers, who have been leading from the front, took a slight back seat over the last few months.

We wanted to take this opportunity to discuss one of our portfolio holdings – Oracle Financial Services Software (OFSS). OFSS provides core banking solutions to its clients – primarily banks, spread across the globe. It is the market leader in core banking solutions. Many of you would be surprised to know that most US banks do not run on core banking software and are instead still working on legacy systems developed over decades. On the other hand, newer banks like HDFC Bank and now National Australia Bank (among the top 20 banks in the world) are on a core banking platform. Core banking platform allows various conveniences to both the customer and the bank, which allows the bank to offer a superior service efficiently (for instance an SMS telling you that a certain amount has been withdrawn from your bank account, instantaneously) which can be a great help in offering a competitive advantage in a crowded and commoditized banking space. The reason most of the top banks have not shifted to a core banking platform, is that it involves a huge investment both in terms of money and time. An observer compared moving to a core banking platform something akin to changing the engine of an aircraft mid-flight. Hence there is a lot of resistance to move from existing legacy systems to core banking. However in any banking environment, if one player is able to install a core banking platform it allows that bank to establish a competitive advantage over its competitors and thus becomes a driving force for other players in that environment to also adopt core banking.

OFSS’s business model fits in with the characteristics we look for in our portfolio companies. Its relationship with its clients is long term and sticky in nature as changing core banking vendors can be cumbersome. As of now only 1 of the top 20 banks have adopted core banking – the market is expected to grow along with internal growth of existing clients and as also more top banks adopt core banking over the next decade. Such under-penetration of a market and the prospect of owning a market leader with extraordinary business characteristics, are not easy to find. The company is also extremely profitable and cash generative. While current growth rates may be moderate, we are happy to wait until the pot at the end of the rainbow materialises – meanwhile we get paid for our patience with a 3% plus dividend yield at current prices, and steadily growing revenues and earnings.

The Indian equity market remains very stock selective with a mix of over-valued and fairly valued situations among the stocks in our universe. One must add here that the fairly and under-valued situations have thinned in recent months. However volatility is par for the course in equity markets and sometimes opportunity can present itself quite quickly. We continue to tread the path of safety and continue to avoid broken balance sheets and commodity and high capital intensity plays.