The Internet of Things (IoT) describes a world where everything is connected through networks of chips (sensors) so that the real world can easily be replicated in a digital one (digital twins). That digital world will be monitored in real time by AI algorithms who will then make changes in the real world to make everything more efficient. Humans will stand around twiddling their thumbs until artificial general intelligence either a) eradicates them with a deadly virus or b) creates a simulation that’s ten times more pleasurable than heroin where everyone finishes out their pointless lives. Isn’t IoT great?
Until humans are eradicated and/or exiled to a digital paradise, we want to make money on the emergence of IoT. Perhaps the best way to play that theme across multiple industries would be through an investment in Trimble (TRMB), but not everyone sees it that way.
Trimble Stock – Space, IoT, or Something Else?
Our classification of Trimble as an IoT stock doesn’t mesh well with leading ETF providers. It’s nowhere to be found in the GlobalX IoT ETF, while it proudly sits atop the ARK Space ETF at position numero uno. Perhaps that’s possible if you conceive Trimble as an industrial technology conglomerate with a focus on agriculture, construction, and transportation – then encapsulate the entire thing with a geospatial wrapper. As risk averse investors who are always hunting for pure plays, Trimble is an exception to our rule of growth at all costs. It’s hard to get a collection of unrelated business to see double-digit growth over extended periods of time. Instead, you get varying levels of growth across all segments which – hopefully – leads to lower but more consistent and predictable growth. That’s what we see when looking at Trimble’s revenue growth over the past decade.
Several years ago, we noted an 8.4% compound annual growth rate (CAGR) over the past 15 years which was notable given Trimble’s diverse portfolio of businesses. The above chart reflects a 6% CAGR over the past decade, and guidance for this year – around 5% on the low end – isn’t helping those numbers. Since one key reason we’ll sell a tech stock is because of slowing growth, would that not apply to Trimble?
Connect & Scale
If the market closed tomorrow for a decade, we wouldn’t lose any sleep over holding Trimble. With a simple valuation of 3.5 (compared to our catalog average of 6.5), the company seems fairly valued given the single digit growth expected. What may close that valuation gap would be the company’s focus on building out annual recurring revenues as a majority of the business.
Trimble’s new CEO (joined early 2020) is championing a strategy called “Connect & Scale 2025” which the company says, “will accelerate our move toward subscription business models both in software and hardware, we will connect our solutions into bundled offerings, and we will begin to enable a data strategy that we believe we are uniquely positioned to fulfill.” A key metric being used to track the progress of this initiative is annual recurring revenues (ARR) which has been seeing very strong growth in contrast to overall revenue growth.
A few points to make here. Trimble talks about connecting their solutions into “bundled offerings” which allows salespeople to upsell existing clients, perhaps even cross-segment. Are there overlaps between construction / transportation / agriculture? Probably, but we’re excited about more predictable recurring revenues which have higher margins than their hardware sales and would command a higher valuation from investors. The more recurring revenues grow, the more attractive the valuation gap becomes. Should Trimble hit $2 billion in ARR by the end of this year as they expect, that means the majority of their revenues will be recurring. That represents 66% growth over the $1.2 billion in ARR when they began the Connect and Scale journey in 2020 (a CAGR of about 18%). That transformation has resulted in a lower valuation over time, so we’d expect that to reverse at some point if they can keep growing ARR as a percentage of total revenues.
Revisiting Our Thesis
Remember this graphic we posted several years ago on the industries that could use technology advancements more than others?
Two of those – agriculture and construction – are what attracted us to Trimble in the first place. It’s where 61% of revenues came from last quarter, and there should be lots of “low hanging fruit” when it comes to creating efficiencies using technology. Trimble’s strategic partnership with Microsoft helps make selling easier as even the most weathered construction manager knows the brand – nobody ever got fired for buying Microsoft. Late last year, Microsoft’s CEO showed up to help Trimble announce “an enhanced partnership with Microsoft Azure” which will focus on further building the Trimble Construction Cloud to enable connectivity and collaboration. Archaic industries often manifest themselves in loads of applications and vendors cobbled together using old school “standards” such as EDI. Much better solutions await when you start working with the world’s biggest technology vendor – and Trimble.
Kicking Trimble out of bed for only growing 5% this year doesn’t seem merited. The progress of the Connect & Scale strategy seems solid – at least based on ARR growth – and perhaps that Microsoft cloud partnership needs some time to mature. We’re content with leaving Trimble in our portfolio and checking back a year from now to see how they’ve progressed.
That diversification effect we’re seeing from their portfolio of industry offerings is a double-edged sword. We’re sacrificing consistent conservative growth for the rapid volatile growth that comes with industry verticals. As we talked about in our piece on Procore, investing in a single industry vertical can result in disaster if suddenly that industry stops growing. As risk-averse investors, we see Trimble as a “sleep well at night” tech holding that may take some time to be recognized for its efforts. ARK might argue the real value lies in all the big data they’re collecting, but that’s where we start investing in futuristic stories. We’re investing in the progress we see happening today, though it’s not all rainbows and butterflies.
Acquisitive Growth at a Cost
With operating margins last year of just 9.7% (compared to at least 27% for the other three segments), Trimble’s transportation segment hasn’t been a shining star of profitability. That might change with this year’s acquisition of Transporeon, a cloud-based transportation management platform that manages $53 billion of freight spend worth $209 million in annual revenues (90% are recurring with a 110% net retention rate).
A negative side effect is the explosion of debt on Trimble’s balance sheet which requires some hefty interest payments to maintain, not to mention the $4.6 billion of goodwill that could incur impairment charges in the future (these are non cash losses that show investors the company pays too much when they acquire, and which usually create buying opportunities if you’re willing to overlook the aforementioned incompetency). Using debt – or leverage as it’s called – to build a business is an art that’s difficult to hone, though Trimble’s managed quite well so far. In next year’s checkup, we’ll be keen to see how this acquisition has improved Trimble’s transportation segment over time.
Conclusion
We’re not keen on investing in stories or promises, but Connect & Scale seems to be working as evidenced by the consistently strong growth in ARR for Trimble over the past several years. Whether it’s a space company, an IoT company, or something else, Trimble generates loads of data across both proprietary software and hardware that has value associated with it. That’s another argument for more value being realized down the road, but a more likely creator of value will be the recurring revenue streams being developed across their client base. We’ll check back in a year to see how Trimble has been progressing.