An asset manager who I use last week wrote to say the firm had overcharged me. After reviewing its billing system over the past decade, I was owed $112!

This week, another firm informed me I needed to reconfirm some details as part of Know Your Customer (KYC) Guidelines and Regulations.

In my business, I’ve noticed the billing software I use to invoice clients has been upgraded. There seems to be a lot of new investment in billing software.

That’s good for software-as-a-service stocks (SaaS) that provide billing software for large organisations. Spending on this software has to increase this decade, amid heightened regulation for billing, cybersecurity risk, and the cost-of-living crisis.

Heaven help firms that accidentally overcharge consumers – or charge the wrong ones – due to poor billing systems. Look what happened to the big banks that slugged fees to thousands of dead people, partly due to poor internal processes.

Escalating cybersecurity risks are also driving this trend. The loss of customer information through a cyber breach can damage corporate reputation and value. Knowing who is being billed – and who has access to that data – is critical.

The cost-of-living crisis is another factor. If higher inflation and interest rates persist for longer, as I expect, more people will struggle to pay utility, telco, insurance and other bills. Firms will need strong data analytics and billing software to reduce the risk of bill defaults or late payments.

All this points to a steady increase in investment in billing software systems – and more work for technology companies that provide them. Yet some technology SaaS stocks tumbled this year, amid the broader equity markets sell-off.

SaaS is a great business when it gets traction. Successful SaaS companies have recurring revenue as companies renew subscriptions annually and large profit margins due to the low incremental cost of delivering a new subscription.

The best SaaS providers also have ‘sticky’ products. There are high switching costs for firms to change providers once the software is embedded in their operations and staff are trained to use the technology. That creates pricing power for SaaS clients who can lift fees without losing too many customers.

Australia has some terrific SaaS companies. Over the years, my preferences have been Xero in accounting software; Technology One and Data3 in tech services; and Life360 in geolocation software.

Current volatility is an opportunity to buy these and other high-quality SaaS stocks for less. The equity market sell-off and expectations of higher interest rates are bad for tech and other growth stocks, even though the best SaaS companies have defensive earnings and capital-light business models.

Here are two small-cap technology companies on the ASX that provide software or billing and other systems:

1. Fineos Corp Holdings (ASX: FCL)

The Ireland-based company provides software solutions for the life, accident and health insurance sectors. The Fineos AdminSuite covers new business, billing, claims, absence and policy administration. Fineos says its customer-centric technology replaces outdated legacy systems at insurance firms.

Fineos has an interesting market position. As I have written previously this year, the global insurance industry has improving prospects as higher interest rates lift earnings on bond investments held by insurers. The emergence of an El Nino weather pattern this summer should also support earnings. Although terrible, bushfires aren’t as costly for insurers as floods that emanate from La Nina weather patterns.

If the global insurance industry is ever going to increase its investment in legacy administration systems, it’s now. Insurance software has been described as a sleepier segment of financial services technology that is ripe for disruption.

Fineos listed on ASX in 2019 through a $211 million Initial Public Offering (IPO) that valued it at $712 million at the $2.50 offer price for its Chess Depositary Interests over its underlying shares. The market couldn’t get enough of Fineos at the start, driving its shares to $5.40 in late 2020 thanks to booming interest in SaaS stocks.

But Fineos has since fallen to $1.64. Shareholders in the loss-making company have lost capital, partly because the market expected faster growth.

Fineos’ earnings are hard to forecast. Replacing legacy technology systems in insurance takes time. Large projects can be delayed, and Fineos still has a concentrated customer base. Fineos needs rapid revenue growth to justify its valuation, but the insurance industry moves slowly on new tech.

Poor market sentiment has also battered Fineos this year. This is a terrible market for small-cap industrials generally and loss-making tech companies in particular. In a risk-averse market, stocks like Fineos are easy to sell. This valuation anomaly creates the opportunity for new investors to capitalise on asset mispricing.

For all the market gloom, Fineos has a tiny share of a multi-billion-dollar global insurance technology industry – and room for long-term growth.

As Fineos attracts new clients, its customer concentration reduces (thus lowering the risk of the loss of a key client), and it builds ‘touchpoints’ with existing clients by adding new services. Done well, that increases the company’s revenue and margins, and in time provides a steady stream of recurring earnings.

It could take time for Fineos to stem its share-price losses, consolidate and recover. This is a tough market for small-cap turnarounds. Prospective investors in Fineos will need patience, conviction and high-risk tolerance. Buying stocks when they are out of favour is the key to long-term outperformance, but never easy.

Morningstar’s valuation of $3.30 a share for Fineos suggests the stock is materially undervalued at the current $1.64. I’m not as bullish but can see significant valuation in Fineos emerging after its sell-off in the past 12 months. The stock is down from a 52-week high of $2.78, having fallen as low as $1.10.

Chart 1: Fineos Corp Holdings (ASX: FCL)

2. Hansen Technologies (ASX: HSN)

Hansen develops and sells billing software for utilities, energy, pay-tv, telecommunications and other sectors. That’s ‘mission-critical’ software for companies in these fields that rely on Hansen’s billing technology.

Hansen has been a long-term tech favourite of this column due to its consistency. The company has barely missed a beat over the past decade thanks to consistent revenue growth, rising earnings and low debt. It’s a steady rather than spectacular performer, but boring can be beautiful with SaaS companies.

Private equity firms have unsuccessfully tried to acquire Hansen. They, too, could see the value in Hansen’s market position in utilities software and its recurring revenue. The stock has a reasonably low market profile, even though it has been among the better-run small-caps in this market for a long time.

Hansen has held up well in this year’s market sell-off, up 17% over one year. Over 10 years, Hansen’s annualised total return (including dividends) is almost 19%. Most small-cap companies on the ASX would love that kind of consistency.

Hansen has guided for organic revenue growth of 5-7% in FY24 and for an underlying earnings margin to remain above 30% (and above its historical rate of 25-30%).

Margin enhancement could be the key to the next re-rating of Hansen shares. As the company grows organically and by acquiring other firms, it is developing greater economies of scale and more links with customers.

Hansen looks a touch undervalued at the current $5.38, judging by the consensus analyst estimate above $6. Hansen is no screaming buy, but a quality company for long-term investors to include in the small-cap allocation in their portfolio, particularly those seeking exposure to software companies.

Chart 2: Hansen Technologies

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal investment advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 25 October 2023.