Tyler Technologies: Big Fish, Small Pond

Welcome to Episode 16 of the Preferred Shares Podcast.In this episode, Douglas Ott walks us through the origin story of Tyler Technologies to the present day.In this episodeIntroduction to Tyler Technologies [0:00-1:40]Tyler Technologies is described as a “big fish in a small pond,” focusing on software solutions for municipalities and state/local governments.The market is around $24 billion in total revenue, which is too small for larger tech companies but provides a good opportunity for Tyler.Tyler's competition is typically small, private, unscaled players.Early History as an Industrial Conglomerate [1:40-3:30]Tyler’s history began in the late 1960s with Joseph McKinney, who formed a venture capital business.McKinney formed Saturn Industries, acquiring several small businesses, then acquired Tyler Pipe in 1968, changing the company name to Tyler Corporation.Over two decades, Tyler acquired various businesses including a trucking company, an explosives company, a specialty chemicals company, and an electronics distributor.By 1987, Tyler reached $1 billion in revenues.Divestment of Holdings [3:30-4:30]In the late 1980s, McKinney started selling Tyler’s holdings, distributing over $400 million to shareholders by the mid-1990s.By 1995, none of the former companies remained at Tyler Corporation, leaving a cash shell holding company.Downturn and New Acquisitions [4:30-5:30]McKinney acquired Forest City Auto Parts and Institutional Financing, which were different from Tyler’s B2B industrial focus.These acquisitions performed poorly, leading to a $52 million write-down and McKinney’s departure by the end of 1996.New Leadership and Strategic Shift [5:30-6:30]Bruce Wilkinson was hired, aiming to return Tyler to its industrial roots.Louis Waters acquired a 10% stake in Tyler and advocated for a shift to software and information services.Louis Waters and Browning-Ferris Industries [6:30-9:30]Waters co-founded Browning-Ferris Industries (BFI), a waste management company, and saw similarities between the fragmented waste management industry and the software market for local governments.BFI grew rapidly through acquisitions due to new environmental regulations.Waters saw a similar opportunity in the software space for municipalities.Tyler’s Pivot to Software [9:30-11:00]Waters won the debate, Wilkinson resigned, and Tyler began acquiring software companies.By the end of 1997, Tyler acquired three software companies and stated its plan to consolidate the information industry for local governments.In 1998, they made four more acquisitions for $90 million.Tyler sold Forest City and Institutional Financing at a loss.Acquisition of Munis and Key Personnel [11:00-12:00]In 1999, Tyler acquired Munis, an ERP and land information management systems company.The acquisition of Munis also brought in John Marr, who became CEO of Tyler in 2004 and later executive chairman.Significant Acquisitions [12:00-14:00]New World Systems was acquired in 2015 for $670 million, providing software for dispatchers, first responders, and financial management for state and government agencies.Micropact was acquired in 2019 for $185 million, marking Tyler's foray into the federal customer segment.NIC was acquired in 2021 for $2.3 billion; NIC designed and implemented websites for states and their agencies and was a payment processor specializing in state government payments.Market Share and Financial Performance [14:00-15:00]Tyler’s market share is estimated to be in the low teens, with significant opportunity for growth.The company has experienced high-teen revenue growth and free cash flow compounding north of 20%.Recurring revenues are north of 80% based on subscriptions and maintenance.Market Dynamics [15:00-17:00]There are over 88,000 government entities in the US.These entities have similar service needs but different rules and processes.There is a constant need to modernize outdated software and IT systems.Population growth and new regulations drive additional transaction growth.Business Qualities [17:00-18:00]Tyler’s current market share is 15% of a $13 billion market, with a total addressable market of $24 billion.The market is highly fragmented, with many small, uncompetitive software companies.Tyler is the only publicly traded company focused on this government software niche.Countercyclical Nature [18:00-19:00]Government grants for modernization benefit companies like Tyler.The business is stable, funded by real estate taxes.Customer Base and Revenue [19:00-20:00]Tyler has a 98% client retention rate.There is a need to replace old software systems.Tyler replaced a 40-year-old court judicial system in Cook County, Illinois.Capital Allocation [20:00-23:00]Tyler has been selective and opportunistic with share repurchases.From 2002 to 2011, Tyler reduced its shares from 48 million to 30 million, but it is now back up to 43 million.They issued shares to fund acquisitions and attract/retain talent.Potential Threats [23:00-27:00]A major threat is prioritizing operating margins over customer service, which could lead to customer dissatisfaction.With cloud-based software, customers might find it easier to switch to competitors if not satisfied.Acquisition Strategy [27:00-30:00]Tyler tends to expand capabilities rather than consolidate specific niches, such as acquiring a jury selection software company that complements their existing court system products.They focus on smaller, bolt-on acquisitions, which are less risky than transformational ones.Comparison to Roper Technologies [30:00]Both Tyler and Roper were formerly industrial companies that transitioned into the software space.Tyler’s move was driven by Waters’ belief in the specific government software market, while Roper's was a longer evolution based on financial characteristics like recurring revenue.Risks: Mission Creep and Lack of Focus [31:00-33:00]A key risk is losing focus by pursuing growth in other areas rather than sticking to their niche.Trying to go too hard into the federal space could be a risk.Opportunities in Fragmented Market [33:00-35:00]Many small businesses in the space may be looking for a buyer.Constellation Software is also acquiring smaller niche businesses but has not taken a cohesive approach like Tyler.Private Equity Competition [35:00-36:00]Private equity firms have been in this space, but their high leverage could make them less stable competitors.Conclusion [36:00]Episode ResourcesTyler Technologies“Q1 2023 Letter: Tyler Technologies is Ready to Run”, Douglas Ott (Andvari Associates) published April 2023.“Tyler Technologies Q2 2024 Results”, Douglas Ott (Andvari Associates) published August 2024.Tyler Technologies - Investor OverviewBrowning-Ferris Industries“Salad Days in Garbage”, TIME, November 20, 1972.“Four-Father”, Waste 360, October 1, 2009.“Browning-Ferris Industries”, Texas State Historical Association, November 1, 1994.Additional ReadingCurious to see what else we’ve been working on? Below are some pieces we’ve written independently that we think you’d like:“Imperial Brands: Doubt-Driven”, Devin LaSarre (Invariant) published December 2024.“A Few Thoughts On Diversification Strategies”, Lawrence Hamtil (Fortune Financial) published October 2024. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit www.preferredsharespodcast.com