Tracsis: a transport technology company with strong underlying growth drivers.
Overview
Tracsis is a provider of software and services to the rail and wider transport industry. It does this by acquiring small technology companies which have delivered first to market solutions in the transport sector and bringing them under the Tracsis umbrella. This makes the business somewhat difficult to understand given the number of different products it offers and is likely one of the reasons for the current value discrepancy. The new management have done a really good job of simplifying the message for investors, with the company now split into two operating segments.
The first is Rail Technology and Services. This encompasses a number of different solutions including train planning software, remote condition monitoring, smart ticketing and rail consultancy.
The second segment is the group’s Data, Analytics, Consultancy and Events (DACE) segment. This segment provides a number of services including transport surveys, passenger analytics, location data and event traffic management.
Although DACE contributes significantly to the group’s revenue, the margins generated are much lower; adjusted EBITDA margin was 6.8% in FY24 compared to 26.1% for the rail segment. Growth for the segment has also been strong over the past 8 years, with a CAGR of nearly 13%, only just below the rail segment.
Whilst it is therefore a significant part of the group’s business, I have chosen to focus on the rail segment for three reasons. Firstly, whilst I expect DACE to continue to grow, I don’t believe the growth has the potential to be as significant as that of the rail segment. Secondly, given the much lower margin, that growth will contribute less significantly to the business’ cash flow and subsequent valuation. Finally, there is some talk about the group divesting its events business (its largest contributor of revenue within the DACE segment) in order to focus on higher margin, recurring software contracts. This focus means we are also unlikely to see significant investment in the rest of the DACE segment, with the exception of Data Informatics, which the group sees as having significant cross sell opportunity with rail.
Rail Thesis Summary
o UK Rail Nationalisation – The UK’s plan to bring private rail services under public control is already underway and has the potential to significantly increase levels of investment in new technology. Private operators currently have little incentive to invest for the long-term which has led to an estimated £1.5bn leaving the UK railways every year. Under a public ownership model this money will be re-invested back into the railways, benefiting companies such as Tracsis. There is already significant evidence that Tracsis is likely to be a beneficiary of this trend.
o UK Rail Industry Health – Tracsis is an indirect play on the health of the UK rail industry which I believe has reached an inflection point. Given that its customers are the train operating companies and infrastructure providers, it benefits from increased levels of ridership and ticket revenue just as they do. The UK rail industry has undergone a challenging period, but there are signs this is now over as well as potential for a rebound to above pre-COVID passenger levels.
o US Rail Market Opportunity – The US market presents a significant opportunity for Tracsis, both in terms of growth, and to de-risk its operations going forward. The market is far larger than the UK, generating in excess of £70bn per year in revenue. It is also highly fragmented, with a large number of smaller rail operators not currently served by larger technology providers. There are already signs that Tracsis’ strategy is performing well, with strong revenue growth, significant opportunity pipeline expansion and a number of new contracts and pilots underway.
o Strong Revenue Growth – Tracsis has grown revenue at a CAGR of 27% over the past 14 years. This growth is built almost entirely on taking significant share of the UK market, in which it holds a dominant position. Successful entry into North America and then Europe, where both markets are highly fragmented, provides a large potential addressable market for the company.
o Margin Expansion – Although I have listed the current margin contraction as a risk for the business, I also think it represents a significant opportunity. Given the shares are currently priced at a level that assumes margins remain at their current supressed level, any expansion is likely to result in significant upside for investors. There are a number of factors that will affect this including changes to the segment revenue mix, the product mix, and an increasing focus on easily deployable, modular software.
o Successful Track Record of Acquisitions – The group’s acquisition policy is to buy profitable companies, with first to market solutions, and management teams that are keen to remain part of the business. This means that once these smaller companies are under the Tracsis umbrella, there are often clear synergies that can be recognised.
o Rock Bottom Valuation – The current valuation is significantly below my estimate of intrinsic value. The shares are currently priced as though the business will experience no growth and no margin expansion. Given the new contracts forecast to go live in FY25 this seems an unnecessarily punitive assumption. I believe that in the short to medium term there is the potential for >91% upside potential, with a generous margin of safety provided by the current rock-bottom share price.
Impact of the UK Railway coming under public control
The UK Rail Industry has been through a challenging period recently, with passenger perceptions over the quality of service they receive at all-time lows. Rising fares, delays and cancellations have been exacerbated by the recent strikes from rail unions over pay.
The current hybrid model of ownership, where the infrastructure (rails, signals & crossings etc.) is publicly owned by Network Rail and the operators are privately owned, has been in place since privatisation in the 90s. Under this model, private rail operators bid for franchise contracts to operate services on the Network Rail infrastructure. This has created a fractured environment where long-term investment decisions are split between track and train.
To solve this issue the Williams-Shapps plan for rail was released in 2021. It proposed widespread changes to the running of the railway, including changes to the way private train operating companies (TOCs) function and the introduction of measures such as smart ticketing to improve the passenger experience. Another key facet was the creation of Great British Railways (GBR), a new governing body responsible for both the infrastructure and operation of the railways. The aim was of this was to allow joined up funding decisions to be made.
The original plan was for GBR to set timetabling and service requirements and then tender those contracts out to private companies. This would have meant little change for Tracsis as long-term investment by TOC’s would still have been discouraged by the length of their contracts.
Before the Williams-Shapps plan could be implemented however, the Labour government put forward a bill called the Passenger Railway Services Act, which was passed last year (2024). Under this act, privately owned services will pass into public control when their franchises expire. Current expectations are that all services will have moved under public ownership within 5 years. The majority of the other proposals outlined in the Williams-Shapps plan are set to remain under the Railway Services Act.
Under the Labour government, GBR will assume full control of both track and train. Whether this will be beneficial for the public is up for debate. Of more interest here is how this will affect the level of investment, and the subsequent opportunity it will provide for companies such as Tracsis. Tracsis are open about the fact that this is a fork in the road for the business, with the impact of bringing the railways under public control having the potential to be either positive or negative for the company.
Tracsis currently has at least one product with every TOC in the UK. Despite this healthy level of penetration, I believe it indicates Tracsis’ ability to grow despite the industry structure, not because of it.
TOC’s have little incentive to invest for the following reasons. Firstly, they predominantly operate on short-term franchise contracts, which discourages them from making longer-term investments. Secondly, TOCs generally don’t own their assets. They lease the trains from ROSCOs (companies that lease rolling stock) and operate on tracks owned and operated by Network Rail (publicly owned). This creates a fractured environment where the incentives to invest for the long-term are not there.
This problem is further exacerbated by the fact that railways are classic monopolies. If a passenger is not happy with the service they receive, they cannot simply move to another provider. These barriers to entry mean there is little incentive for TOCs to improve their services. It is also one of the reasons why there are operational requirements built into franchise contracts, to ensure TOCs don’t abuse this dynamic. Finally, TOCs have to get authorisation for any spending from the Department for Transport, further impeding investment.
“Private sector TOCs have to refer any quite low levels of spend to the Department for Transport” Chris Barnes, CEO
The threat of nationalisation has also led to profit taking by private TOCs, who have understandably been reluctant to invest given the uncertainty over renewal of their contracts. Overall, it is estimated that at least £31bn has leaked out of the UK Rail Industry during the last 30 years of privatisation; approximately £1.5bn every year in the form of profits for TOCs, rolling stock leases and other costs. Under a public ownership model, the majority of this capital would be re-invested back into the railways, benefiting companies such as Tracsis.
Whilst updating physical infrastructure will be a key area of focus, technology represents a significant value-add at a much lower capital investment. This is especially true for the rail industry, where working methods are outdated and small improvements in technology can yield massive benefits. There are stories of UK TOCs still using fax machines, so even small investments in technology can bring significant returns on investment in short periods of time.
As an example, delay repay solutions used to be incredibly manual. Passengers would submit a form, and a member of staff would then manually check which trains were running before validating the claim and then calculating the level of compensation the passenger is entitled to. Tracsis’ Delay Repay automates this process, with one TOC able to cut their annual claim processing costs by more than half (£1.3m). This is an example of how Tracsis is often not competing with technology to improve performance, but outdated and manual methods of working.
Another benefit to Tracsis is that investment in the short term is likely to be focused around improving the passenger experience. Given that passenger perceptions over UK rail are at near all-time lows, the Rail Delivery Group (RDG) and GBR are likely to initially focus on investments that move the needle for passengers. Providing PAYG smart ticketing to passengers provides greater improvement in service for less capital investment than, for example, electric signalling.
Pay as you go (PAYG) ticketing has already become a focus for the RDG and is a good example of why public ownership and centralised decision making will drive increased investment. PAYG ticketing, which involves the use of either smart or bank cards to pay for journeys, requires the use of gatelines (ticket gates) at stations. Investment in gateline infrastructure is the responsibility of the TOCs operating services from that station, but requires the permission of Network Rail, who own the majority of stations. This creates a fractured decision-making process, where decisions to invest in the required infrastructure are again impeded by the short-term nature of franchise contracts.
There are already areas where the responsibility for operating services has moved under local government control. This can be for a number of reasons, but it provides insight into the effect that centralised decision making can have for investment.
Transport for Wales took rail services public in 2021 because of financial pressure from the COVID pandemic. Since then, they have invested £800mn in new trains as part of a total £5bn transport investment announced in 2018. They have also invested in PAYG ticketing across their entire network, a contract that was awarded to Tracsis.
ScotRail has also been publicly owned since 2022. It has recently completed a 6-month pilot program using Tracsis’ Hopsta smart ticketing app. This app uses location tracking to automatically calculate the best fare for each journey. It is particularly suitable for a country like Scotland with lots of small stations and without the necessary infrastructure to implement PAYG ticketing using gateline systems. The technology will initially be rolled out over a small area, but if it is successful will be expanded across the network.
Another interesting example is the case of Merseyrail. Unlike most other rail franchises in the UK, Merseyrail is managed at the regional level by Merseytravel. Although the services are still run by a private consortium (Serco & Abellio), the contract is much longer (25 years) and includes agreements to share the financial risks of longer-term investments. Although this is not the same as publicly owned and operated rail networks, it does give some indication of the effect that stability and longer time horizons can have on investment. Tracsis has recently won a contract to provide PAYG smart ticketing across the Merseyrail network.
Under the Passenger Rail Services Act, these devolved authorities are set to remain in place and continue running their services. This means that the contracts that Tracsis already has in place will remain. More recently, Tracsis has won a contract to provide the ‘tap converter’ system required to support PAYG travel across all urban areas of Network Rail. This is a massive contract and ensures that Tracsis will maintain 100% market share of the UK PAYG ticketing market.
Some services have also already passed into public control through the operator of last resort (caused by TOCs not meeting operating requirements). These TOCs give further insight into the effect that a public ownership model would have and have already exhibited greater levels of investment and more agility.
“The train operators owned and managed by the OLR appear to have… greater access to funds and the ability to move more quickly” Chris Barnes, CEO
The above examples show why I think that nationalisation will lead to greater levels of overall investment. I will go into more detail later on, as to why I think that Tracsis will be chosen as a provider of these solutions going forward.
Return to health of the UK Rail industry
As mentioned above, the UK rail industry has been dealing with a mixture of strike action, reduced passenger levels post covid and uncertainty over the future of privatisation. This has impacted operators’ ability to make longer term investment decisions.
Firstly, the strikes from unions such as RMT and ASLEF which took place over the course of two years had a significant effect on revenue and profitability within the industry. The UK government estimates that this has resulted in the loss of over £850mn in direct passenger revenue. Not only does this mean significantly reduced revenue for TOCs, but it also impacts Network Rail (one of Tracsis’ largest customers) who receive their revenue from track access charges. This resulted in a tightening of financial management by Network Rail for their most recent funding period (Control Period 7).
The majority of these strikes have now been resolved, with unions such as RMT accepting new pay deals. This will improve levels of reliability for most services, bringing more passengers back to the railways. This is turn means higher revenue for TOCs, greater track access charges for Network Rail, and increased levels of investment and revenue for companies like Tracsis. In the short-term however, we are likely to see reduced revenue in areas such as Ontrac (safety) and MPEC (remote condition monitoring) as National Rail manages finances for Y1 of CP 7.
Passenger numbers before COVID averaged approximately 1.7bn per year but fell to just 0.4bn during the pandemic. The rebound has been slow, with passenger numbers of 1bn, 1.4bn and 1.6bn in the years 2022, 2023 and 2024 respectively. This was caused by a mixture of WFH impacting commuter travel levels, increased fares caused by the drop in revenue during COVID and strikes affecting the reliability of services.
Passenger levels have almost fully reverted to pre-pandemic levels, but I think they could move even higher as WFH becomes less prevalent and services become more reliable. Green Air policies, such as ULEZ in London, will also push people away from roads and towards rail travel. Finally, ticket prices will likely be capped under GBR, which will further drive increased ridership. As mentioned above, this means higher revenue for TOCs and Network Rail and greater investment.
The final aspect affecting the UK Rail Industry is the uncertainty over its future, particularly regarding privatisation. Tracsis themselves said that the general election and the uncertainty it created had impacted investment decisions. I have discussed the impact that public ownership of the railways could have for investment decisions and Tracsis above, so I won’t belabour the point here. According to CEO Chris Barnes, Tracsis is “still seeing strong pipeline growth in the UK”. It is worth pointing out that there may be a short period of subdued spending as current private TOCs wind down their remaining contracts.
The North American Rail Market Opportunity
Tracsis is incredibly dependant on the UK rail industry, with some of its offerings developed specifically for Network Rail (Ontrac). It therefore sees the North American Rail Market as both a significant opportunity for future growth, and a chance to de-risk its operations going forward.
The North American Rail Market is significantly larger than the UK. Total routes cover over 140,000 miles and it generates in excess of $70bn per year in revenue. It is also very different to the UK. Most of the infrastructure, for example, is privately owned, with the largest owners being the Class 1 Railroad companies. Passenger trains generally don’t own their tracks and lease them from these private companies. These differences result in a market opportunity for Tracsis that is vastly different than the UK. Despite this, the size of the market means that the opportunity has the potential to be transformative for Tracsis if it can get it right.
‘The size of the average opportunity is much bigger in North America than it is in the UK.’ Chris Barnes, CEO
One of the biggest differences, however, is between the safety records of the two countries. The UK has one of the safest railways in the world, with no fatalities since 2007. In contrast, there were 995 deaths on the US rail network in 2023, most of these being trespassers. There are also an average of 1000 derailments every year, including several high-profile crashes like the one in East Palestine, Ohio.
This poor safety record has led to increased scrutiny for the US rail industry, with congress passing the Rail Safety Improvement (RSI) Act of 2008. Among its provisions was the mandate requiring the use of Positive Train Control (PTC) on most of the network. This technology automatically monitors trains and detects derailments or train on train collisions. With PTC mandated since 2015, US rail companies have begun to experience the benefits of increased technology, with the rate of digitisation in the US now significantly outpacing that of Europe.
“There was this enormous lift in the US to deliver PTC, and we’re coming out of the back end of that now. There’s a real shift towards, OK, what else can we do?” Chris Jackson, Tracsis President of US
This has created a significant potential market for Tracsis’ products, which already have proven and successful use cases from the UK. Tracsis sees its initial opportunity in PTC, software it acquired through its purchase of RailComm in 2022, and has since implemented the solution with a number of operators. Going forward there is also significant potential for the company to replicate its successful development and implementation of safety focused software in the US market.
The other market driver comes in the increasing importance of rail in the de-carbonisation of transport. For freight, rail is the most environmentally friendly solution by far; 0.05 pounds of CO2 per ton-mile compared to 2.57 for Air and 0.4 for truck. Despite this, the total volume of goods transported have remained relatively stable over the past decade, with only small levels of annual growth currently forecast. This is caused by fierce competition from trucking companies that currently offer greater transparency on shipment location, faster and more reliable service and the ability to ship door to door.
Despite this, there is still a place for freight in the current transit landscape. The rise of intermodal transport, where goods are shipped in the same container across multiple modes of transport allows companies to exploit the advantages of each method. Rail remains unmatched in its low environmental impact and cost effectiveness but requires significant investment to bring it up to scratch. For freight companies to improve, and take back market share from their trucking competitors, they must improve the speed and reliability of their service. Technology remains the most effective form of investment for them to do this.
Passenger rail is another area where there is significant opportunity for the US to de-carbonise their transport. Most journeys in the US are made by car, with just 1% of people opting to travel by train. In recent years however, passenger rail has been making a comeback, with a record number of journeys made on Amtrak in 2024. The passenger rail market is forecast to grow at a CAGR of around 5% until 2030. This is expected to be driven by a desire for more sustainable travel, congestion in cities, and the alternative that high-speed intercity rail would provide to air travel. Investment in technology has the potential to create a flywheel effect where improved service leads to higher ridership, which in turn means greater investment in technology.
Tracsis sees its market opportunity as the short line freight operators and the commuter railroads. Unlike the larger Class 1 railroad and the smaller inner-city transit operators, these operators are reliant on external supplier expertise.
“What is important in our strategy in the States is where we target our sales efforts. There are much larger operators in the US that have their own resources, and they don’t rely very heavily on external suppliers… There are others that don’t have any real depth to their internal capability because they’re much smaller, and they rely very heavily on external partners” Chris Barnes, CEO
In some senses the opportunity set for commuter rail is similar to the UK TOCs during the past decade. Passenger experience has typically been poor, with a lack of off-peak trains limiting their viability as an alternative to road transport. This has begun to change in recent years, with many operators now offering ‘round the clock’ services. Ridership for these ‘round the clock’ operators has increased, with the Fairmount Line now at 130% of pre-COVID levels and providing a blueprint for other operators. Commuter rail ridership as a whole has increased by 10% from 2023-2024 but remains below pre-pandemic levels for most operators.
In the short term, the opportunity for US commuter rail is in PTC, which it has invested over $4.1bn in implementing. As discussed above, this technology is mandated by law and is essential because commuter trains often share their tracks with Class 1s. Computer aided despatch (CAD) is another area where Tracsis is seeing strong demand. As the density of commuter services increases, so does the importance of effective CAD solutions. This not only helps to improve the operational performance of the railway but also reduces the possibility of human error in train despatching.
Short line railroads run much smaller distances than the Class 1s and usually handle what is known as the ‘first’ and ‘last’ mile of the network. This essentially means they serve as a distribution and feeder system for the overall rail network. Despite their small size in relation to the class 1s, they collectively operate more than 50,000 miles of track (nearly 40% of the total network). Short lines own a large percentage of their tracks, with the majority being acquired from Class 1s who no longer want to operate these sections. This is important for Tracsis because it streamlines investment decisions and expands the range of potential solutions to include infrastructure.
Short lines are one of the most capital-intensive industries in the country, typically reinvesting on average between 25 and 33 percent of their revenue in maintaining their infrastructure. There is also a significant need for investment, with an estimated $12bn necessary to bring the railroads up to the standard required to meet modern freight requirements.
Joe Biden’s Infrastructure Investment and Jobs Act, passed in 2021, provides circa $1bn in funding per year (with authorisation for an additional $1bn) to the US rail network. In Sept 23, $1.44bn was awarded in the first round of grants, with $720mn going to 47 short line operators. By 2024, this number had increased to $2.4bn, with $1.29bn (52%) going to short line projects. The projects selected include those that address worn-out tracks (the number one cause of derailment), reduce emissions, and deploy rail safety technology.
This creates a significant opportunity, and source of government funding, for Tracsis. The company already has several yard automation contracts with short lines, and a number of new contracts that are expected to start delivering revenue this financial year. Tracsis also sees a significant opportunity in PTC for short lines, which are also required to use the software by law. Remote condition monitoring is also a natural area of opportunity given the large distances of track these companies are required to maintain. Finally, there is already evidence of Tracsis developing unique solutions for the market, such as its Digital Track Warrant, which facilitates safe trackside working.
Overall, the US market has the potential to be a significant area of growth for Tracsis. Despite the difficulties that the industry is currently facing, as a provider of solutions to many of these problems, Tracsis stands on the right side of underlying trends. There is already evidence of this, with Tracsis’ growth in revenue at a CAGR of 91% during the past 8 years, albeit from a low starting point.
Why Tracsis?
Tracsis is open about the fact that changes in the US and the UK market represent an inflection point for the business. The question here is whether Tracsis will be a benefactor of these industry tailwinds, I think it will for the following reasons.
The UK market is easier to predict than the US given that Tracsis already enjoys a dominant market position. The reasons I expect Tracsis to maintain this position are different for each of the group’s segments, so I will go through them individually.
Network Rail is the group’s largest individual customer (8% of FY24 revenue), with the majority of the solutions it purchases focused on Remote Condition Monitoring (RCM) and trackside work planning software (Ontrac). RCM requires the use of sensors fitted at key locations such as signals and data loggers to collect the sensor’s data. It also requires a software element called Centrix to facilitate analysis of the data. Given the harsh operating environment, the hardware elements last anywhere for 10-15 years, while the software is licenced on a recurring basis.
Looking at the segment revenue for MPEC (the group’s RCM segment) we see consistent revenue of £3-5mn from the acquisition in 2011 to 2020, where the group stopped reporting segments individually. Given that during this period there was virtually no contribution to revenue from the US, and because MPEC’s focus is on infrastructure sensors, this has to have come from Network Rail. This also means that given the 10-15 year hardware lifespan, Tracsis is likely to have already seen revenue from replacement spending. Because the original investments were also made gradually, RCM hardware replacements will continue to happen gradually.
“In the UK there is somewhere in the region of 20,000 of those units installed… they are typically on a 10 year plus MRO cycle” Chris Barnes, CEO
Network Rail is unlikely to look for another supplier of RCM for several reasons. Firstly, if it were to replace Tracsis’ RCM sensors with another supplier, it would have to invest in new data loggers and software. This would then mean it would have to run multiple software licences at once as it wound down the lifespan of its other sensors. The other alternative is to replace them all at once which would be incredibly expensive. The final reason is that they work. The UK rail has one of the best safety records in the world, so there is currently very little reason for them to jeopardise this. This means that Tracsis has a reliable and semi-recurring form of revenue in the UK that is unlikely to be impacted.
Tracsis’ rail safety software segment, Ontrac, allows users to plan and deliver safe work on railways. It was designed specifically for the UK market and covers applications from fatigue management to the creation of SWP’s. As an example, the SWP software enables users to create what are called Safe Work Packs. These are required by Network Rail before companies can carry out work on the railways. The software replaces manual methods of working that were slow and prone to error.
Tracsis is currently the market leader for these solutions in the UK, with over 45,000 users across the rail industry. There are competitors entering the market, but I believe that Tracsis will remain the supplier of choice for the following reasons. Firstly, they are one of the first providers. This is not to be underestimated in the rail industry where the uptake of new technology is very slow. Tracsis also offers a range of different solutions under one software package, RailHub. Given the interoperability of these solutions, it increases the value of each significantly. To illustrate, the SWP software can utilise the National Hazard Directory (which Tracsis manages on behalf of Network Rail) to manage risk when planning work and the Access Points software to plan workers entry to a site. No other provider has the breadth and depth of different offerings that Tracsis does.
Moving on to the group’s ticketing segment, iBlocks, Tracsis has a dominant market position in this area as well. Their SmartTIS product is the only Rail Delivery Group (RDG) approved provider of PAYG ticketing and currently have a 100% share of this market. Given that the RDG is set to become part of GBR, the new rail governing body, they are likely to remain the supplier of choice going forward. The rail industry is also conservative, and they are likely to choose a supplier with a proven track record of success, especially given the importance of ensuring accurate fares and concession charges. The final reason is that the group has already experienced the challenges of implementing PAYG ticketing and developed solutions for them, for example apportioning revenue from journeys made between different TOCs.
As I mentioned above, Tracsis has also won a contract to provide PAYG ticketing across all urban areas of the network. SmartTIS generates revenue by taking a small percentage of fares, so this provides significant source of future recurring revenue. It also means they are likely to manage PAYG ticketing across the entire UK network once the solution is expanded. The group’s delay repay software is also part of the iBlocks segment and currently processes over 50% of all submitted claims, making it the UK market leader.
The group’s operations and planning software is probably the most precarious of its segments. Despite its widespread use across the network already, there is always the potential that the contract to provide these services across GBR could go to another provider. Coupled with the fact that this is a software only solution, there are minimal barriers to other providers.
There are a few points to consider however, which I think provides Tracsis with some stability in this area. Firstly, given the cost of training staff on new software, GBR is likely to choose a supplier which already has widespread use among UK TOCs. Secondly, Tracsis currently has contracts with devolved transport authorities which are set to remain in place. Thirdly, Tracsis has relationships with the RDG who are likely to play a central role in choosing a supplier in this area. Finally, Tracsis already has an abundance of successful use cases across the UK Network.
As these examples show, Tracsis already enjoys a dominant position in the UK market. Although it says that the recent changes to the UK rail industry could be either positive or negative for the group, there is already significant evidence that Tracsis stands to benefit from these changes.
In terms of the US, the position is less clear. Tracsis’ research indicated that there is no direct mid-market competitor. They have also found a real demand for differentiated technology from rail operators, and a desire for alternatives to current solutions.
The focus from most larger software providers has been the Class 1s, given that they offer the potential for far larger contract sizes. This has meant that smaller rail operators have been neglected, with a lack of specific technology in the market. Given the level of configuration that is often required when implementing these rail technology solutions, Tracsis has the potential to win contracts outside the area of interest for larger incumbents.
“There is a lot of technology in the market developed for the Class Is specifically, and it doesn’t always easily adapt to the needs of the smaller railroads” Chris Jackson, President US
Tracsis has already begun to experience some of this underlying demand. They currently have a number of RCM pilots underway, a deployment of their Computer Aided Despatch software with a commuter rail customer and a growing pipeline of Yard Automation opportunities. Concrete evidence is minimal at this stage, but they have managed to grow rail technology revenue from £32,000 in 2016 to a peak of £8.8mn in 2023, so there is clear demand.
Tracsis has recently invested in a new sales team for North America and has seen its subsequent opportunity pipeline grow. Whilst it does not provide detail into exactly how many new opportunities it has, but management says that the growth is ‘significant’. Total opportunity pipeline growth, including the UK, is 200%, and represents a series of multi-year software contracts that are either at final offer stage or at the end of the funding approval process. Tracsis sees having a diverse opportunity pipeline as a source of optionality within the business. Given the difficulty in guaranteeing the timeline of these contracts, having a large and diverse pipeline helps to de-risk this.
“Just because you’re told that you’ve won something, doesn’t mean to say you’re going to see a purchase order immediately… our overall objective is just to continue growing that pipeline” Chris Barnes, CEO
One thing to note about Tracsis’ US opportunity is that the software contracts they are selling are on a perpetual licence basis, with lower demand for recurring SAAS type contracts. Given that the company is attempting to transition to a more SAAS based software business this is a slight headwind for the group. Much like the UK however, it appears keen to implement its solutions and then target this transition down the road.
I see Tracsis UK operations as being a stable base from which it can go out and grow internationally. The real growth will come from whether it can succeed in the US market. Although it is very early stages currently, I think there are already positive signs.
Acquisitions
I wasn’t going to mention the group’s acquisition policy, but given it forms such a fundamental part of the group’s strategy it seems strange to ignore it. Tracsis uses technology for two strategic purposes. The first is to provide entry into new markets, as in the case of the acquisition of RailComm in 2022. The second is to add first to market technology solutions to its portfolio. The group is also very specific about the companies it is interested in buying.
“We’re looking for long-term profitable businesses… [with a] proven product that has recurring revenue behind it, that’s got a defensible market position and a management that wants to stay with the business… What this means is there’s not a huge number of targets for us that fit those criteria, but where we do find them, we are happy to pay a premium for those targets” Chris Barnes, CEO
It is difficult at this stage to judge Tracsis’ acquisition success given that a number of them have been made so recently. That said, its ROIC including the effects of goodwill and acquired intangibles measured at cost is healthy for a company that is still making acquisitions, with the exception of the last year which was affected by a much lower NOPAT margin.
I do think that some of the acquisitions made in the DACE segment were outside Tracsis’ obvious circle of competence, but these we’re made by the previous management teams and are not likely to be repeated. I think there is also a possibility that some of these will be divested. The events business is an obvious area, and given one of their competitors was just acquired by private equity, there should be no shortage of buyers.
Finally on acquisitions is why I think Tracsis acquisitions are greater than the sum of their parts. Firstly, a lot of the companies that Tracsis acquires are run by technologist founders, this means that they have often developed effective and innovative solutions but often don’t have the commercial acumen to fully drive their sales and marketing efforts.
“We’d done successfully and we’d done well through word of mouth and through our skills, but we needed the ability and power of a bigger engine to driver that sales focus”. Tim Brewer, Managing Director iBlocks
The other reason is that Tracsis keeps the original management in place and looks to exploit the entrepreneurialism and technology focus that got them there in the first place.
“In our business we’ve bought 17 companies that we bought because they’re really entrepreneurial and were first to market with a piece of technology. My secret so far has been to really energise those individuals and say what got us here, let’s do more of that, but if we’ve got a group structure behind that can provide the financing and the support etc. then surely we can do more of that and faster.” Chris Barnes, CEO
Whilst this does sound somewhat like good PR, there is already evidence across many of the group’s segments that this is the case. The operations and planning segment has developed Tracs Enterprise post-acquisition. The retail segment has developed the Hopsta app in response to issues it has with a lack of appropriate gateline infrastructure. Tracsis North America has also just developed its Digital Track Warrant for the US market specifically. These examples show that Tracsis is able to leverage these entrepreneurial management teams but take advantage of the significant capital the group has access to.
“When we buy a business it’s not the financials that are the key thing, it’s the culture” Chris Barnes, CEO
The final thing to note about acquisitions is a change to the way the group is now selling its products. Whilst this used to be done by the individual companies, the accounts are no being managed centrally, allowing the group to cross-sell much more effectively.
“In Rail Technology, were selling our whole portfolio on a key account basis. So rather than silo-selling, we’re trying to make sure that we’re picking up the most that we possibly can” Chris Barnes, CEO
One final thing to note about the acquisitions is that they are generally funded through cash with remaining management teams often remunerated through earn outs. This means that there has been little dilution to shareholders in recent years and has allowed the business to benefit from the full effects of synergies it achieves.
Risks & Concerns
Re-privatisation of the UK Railway
Whilst this is a risk worth considering, I don’t think it has much merit for the following reasons. Firstly, even if a different party comes into power, they are unlikely to reverse the decision to nationalise the railways given the amount of money that would have been invested by this point. Secondly, given the support nationalisation has received from the public and the decades of problems surrounding private railways, reversing this would be very unpopular. Even if this were to happen, Tracsis has already performed well in an era of privatisation and would likely revert to previous relationships with private operators.
Funding shortage for Control Period 7
The current tightening of financial management at National Rail is leading to reduced revenue for Tracsis, particularly within its remote condition monitoring segment. Whilst this is a short-term headwind, we can already see that the passenger numbers for the latest quarter were 9% ahead of the previous year. Whilst National Rail’s revenue comes from track access charges and are therefore dependant on the number of trains, not passengers, this is still a good proxy for the density of services currently operating on Network Rail infrastructure.
Margin contraction
One of investors’ biggest concerns has been the margin contraction experienced by the business. The most recent trading update (26/02/25) reported a further decline in adjusted EBITDA margins for H1 FY25, when investors had been promised a return to FY23 levels. This is my biggest concern for the business, but it is also one of the reasons that the attractive entry point exists so let’s unpack the numbers a bit.
The first thing I looked at was whether the decline in operating margins over the past 6 years had been caused by a decline in gross margins or an increase in operating costs. The answer here is a mixture. Underlying administrative costs (excluding amortisation, depreciation, SBC and exceptional items) have increased slightly as a % of revenue over this period, but the biggest contributors are increased amortisation costs and falling gross margins.
Gross margins have declined steadily over the past 14 years. I wanted to see whether this was caused by an increase in contribution from the DACE segment. Taking the numbers from FY16-FY24 (the longest available period) we can see there is a strong negative correlation of -0.83 between changes in revenue contribution from DACE and the change in gross margin. In plain English, when contributions from DACE increased, gross margins declined.
Looking at the trend for gross margin more closely, we see that there were significant drops in FY12, FY14 and FY16. These were all years when the group recognised its first 12-month period of revenue for an acquisition; MPEC (RCM), Sky High (traffic consultancy) and SEP (event traffic management). MPEC is part of the rail division but has lower gross margin because it includes a hardware element. Sky High and SEP are both part of the DACE segment, indicating that increased contributions from DACE have led to margin contractions for the business as a whole.
The amortisation charge predominantly represents amortisation of acquired intangibles, with only a small amount representing internally generated intangibles. The company is also quite strict with the expenses that it chooses to capitalise, preferring to expense most R&D for example. For this reason, I think this expense should start to come down as the number of acquisitions per year falls and current acquired assets reach the end of their accounting useful lives.
One other area I checked was the group’s staff costs, its largest expense. Total staff costs as a % of revenue increased significantly in 2015 but have since remained in a relatively tight band of between 49% - 55%. Revenue per employee has fluctuated during this same period, with the company not exhibiting the kind of operating leverage you would want to see from a ‘software’ company. This is likely caused by changes to the business mix discussed above.
I am confident that we will see a reversal in the current margin trend for the following reasons. Firstly, if my thesis on the potential growth in the rail segment is correct, then we should see margin expansion simply from changes in the segment contribution mix. Secondly, two of the company’s new PAYG contracts are expected to start contributing revenue in FY25. The PBT margin for this segment was 30% at the time of acquisition and although it hasn’t been reported since, I would expect that it is now closer to 35-40%. This means that changes to product mix in the rail segment should also drive margin expansion. They are also transitioning most of their software to modular solutions. This will allow for simpler deployment to new customers, reducing the current level of configuration required and the associated expenses. The final reason I see margins reverting to previous healthy levels is the group’s decision to stop pursuing low margin business in order to focus on high-margin recurring software opportunities.
Valuation
The current margin contraction that the group is experiencing is causing it to look very expensive on an earnings multiple basis. Current trailing 12-month PE is 237x, which obviously does not sound like a bargain. If we look at the free cash flow for the business, this is much more healthy and less volatile than the earnings measure.
Current estimated FY25 FCF yield is 4.4% reflecting an attractive return on a conservative estimate of growth and margin expansion. The business has historically averaged around 25% in ROIC, including the effect of goodwill and acquired intangibles at cost, which I believe it will return to once we see greater contribution to revenue from the acquisitions of iBlocks and RailComm.
With the expected margin improvements, I think we will see Tracsis trading at closer to the 40x FCF it experienced in 2023, rather than its current 22x multiple. Given my current conservative estimate of FY25 revenue and FCF, this would imply a share price of £6.50 - £7.00; and a potential upside of >91% (based on the current price of £3.40).
Catalyst
Contributions to revenue from go-live of current PAYG ticketing, along with associated margin expansion from higher segment EBIT margin.
Further clarity on CP 7 funding from Network Rail including a return to normal order levels for the groups RCM segment.
Conversion of the group’s North American sales pipeline and contribution to FY25 revenue from PTC contract delivered with North American rail commuter.