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[SMALL CAPS] The 'cloud'

Victor Gomes is a portfolio manager with UBS

Our team likes uncovering examples of structural change in industries and businesses as these have often proven fruitful sources of new investment ideas. Structural change has the potential to deliver highly disruptive outcomes for businesses that can either create significant new wealth opportunities or otherwise materially damage or even completely wipe out incumbent and legacy industries (think newspapers and magazines). Cloud computing is one such example of structural change resulting in a number of material wealth creation opportunities in the small caps sector. 

Our small companies portfolios have exposure to a number of businesses benefiting from the significant structural change being wrought by cloud computing. Some examples discussed in past weekly notes include Next DC (national data centre footprint providing the Australian 'home' for many cloud applications) and Technology One (shifting their ERP software to cloud-first and mobile-first platforms delivering significant benefits to customers and rising margins to TechOne). 

Another of our cloud based holdings is Aconex, the software company. Aconex (ACX) provides cloud based construction collaboration software to the construction industry that allows for more efficient collaboration of the complex and historically unstructured or poorly managed information flows/processes that occur between the large number of parties involved in a large-scale construction / engineering project. Examples include, information sharing, project design, project management, messaging and mail, cost control, document management, quality and safety, bidding and tenders, workflows, field inspections / checklists...and the list goes on. The inherent inefficiency and low margins of the construction industry makes it ripe for the introduction of an innovation such as cloud based collaboration that connects all the disparate parties involved in the process with the 'one set of truth'. The outcome is simply better efficiency and greater predictability of construction outcomes.

ACX was founded in the early 2000s and has built up a leading position in the construction collaboration market globally. It is the leader in Australia and one of the leading providers across Europe, Africa, Mid East, Asia and the Americas. The most penetrated markets (most advanced) for cloud based construction collaboration software are Australia and parts of Europe such as the UK and Germany. This week ACX announced the acquisition of one of its key European competitors, Conject, which had leading market positions in the UK, France and Germany. Conject has a very similar offering to ACX and appears to be a very good fit operationally. The combination means that ACX is now the clear European leader in cloud based construction collaboration. 

The Conject acquisition is very positive for ACX as the market is currently in a stage of rapid land grab. The network benefits of scale means that 'winner takes most'. With Conject, ACX is now positioned as the clear global leader. This is important owing to the very low customer churn in the industry. Once converted to a cloud collaboration solution, customers become very sticky and are hard to dislodge (ACX becomes embedded as part of the company's critical internal systems) so capturing these customers first is key to success. 

We acknowledge that there is still some risk in ACX holding onto their global leading position given the still large share of the construction market yet to shift across to using cloud collaboration software. However, at current prices we believe this risk is more than offset by the very large size of the ultimate prize if they can continue to build on their clear leading global position via organic and acquisition growth.

Published on: Friday, March 18, 2016

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