Australia punches above its weight when it comes to producing niche technology winners.

Jira from Atlassian (NAS: TEAM) became the go-to task tracking tool for software developers. Wisetech Global (ASX: WTC) and its CargoWise software became the standard for freight forwarders. And now, it appears Siteminder (ASX: SDR) is well on its way to repeating the trick with hotel owners.

SiteMinder’s software lets hotels and other accommodation providers accept and manage bookings from several internal and external channels at once. By driving better room utilization, rates and profitability for clients it has become a mission critical supplier to over 40,000 accommodation businesses worldwide.

Siteminder also caught the eye of Morningstar’s Roy Van Keulen, who has opened coverage on the firm with a Narrow Moat rating and a Fair Value estimate far above the current share price.

What’s behind Siteminder’s Narrow Moat rating?

Van Keulen thinks that SiteMinder’s economic moat is strongest in its core channel manager product.

As is the case with many other software-as-a-service companies, SiteMinder’s products benefit from switching costs. These mostly arise from its mission-critical nature and the risks related to switching vendors. The process of switching could lead to downtime in important channels of demand, or these channels not working as well as they had before. There are also direct costs in the form of money and time to setting up a new channel manager.

Siteminder also offers several secondary tools including software for direct bookings, search engine optimization, corporate travel channel management, payments, and analytics. As customers adopt more products from SiteMinder’s suite, it becomes more embedded in the customer’s workflows and switching costs increase further.

But switching costs aren’t the whole story. Van Keulen also sees Siteminder’s relative size as a source of competitive advantage.

This is because building the infrastructure to connect demand channels and property management systems entails large upfront investments for each compatible demand channel, as well as additional costs for maintenance and updates. Bigger players can spread these costs over a larger revenue base and avoid sacrificing sales and marketing spend.

As Siteminder is at least twice the size of its closest competitors, Van Keulen thinks it is in a strong position to gain share from sub-scale players as the industry consolidates. Van Keulen also sees the growing number of integrations already offered by existing providers as a rising barrier to entry for new competitors.

Van Keulen’s Fair Value estimate of $10 per share is almost 100% higher than Siteminder’s current share price of around $5. His thesis rests on two key levers.

Lever #1: Market share gains

First, Van Keulen expects Siteminder’s market share to grow as the channel manager industry consolidates.

As the hotel business is one of high fixed costs, every extra booking counts and the ability to sell through channels other than the dominant Booking (NAS: BKNG) and Expedia (NAS: EXPE) websites is highly prized.

Depending on its location and type of visitor it usually attracts, different hotels will have different channels and websites they want to integrate with. This means the solution offering the broadest and best working range of integrations should win. For the reasons highlighted earlier, Van Keulen thinks that Siteminder's scale will help it emerge victorious.

Van Keulen also thinks that Siteminder’s new Channels Plus offering strengthens its hand here.

Although channel managers give hotels the opportunity to access hundreds of demand channels, most hotels only use a few because of the time and costs to integrate them. Through Channels Plus, SiteMinder is using its superior scale to attract various second-tier channels like Trip.com, Agoda.com and Hopper.com to a standardised channel that Siteminder clients can access through a single integration.

Van Keulen thinks existing and potential Siteminder clients will find this very attractive. Eventually, it could even evolve into network effects that deepen Siteminder’s moat.

If Channels Plus does prove to be a success, more second- and third-tier demand channels can be expected to join to access a large and growing pool of hotel inventory. This would, in turn, provide more value to Channel Plus clients and fuel a virtuous cycle. You can read more about network effects and 3 ASX shares that benefit from them here.

Lever #2: Switch to being a platform business

The second lever in Van Keulen’s thesis is Siteminder’s potential to evolve into a platform business.

Said differently, Van Keulen expects Siteminder to start earning more transaction-based revenue from various parts of its product suite. This looks especially promising for Siteminder’s payments, search engine optimisation and Channels Plus products that take a cut of transactions generated or processed.

Higher transaction revenues are key to Van Keulen’s estimate that Siteminder can grow its sales at 24% per year for the next decade. They also play a role in his assumption that Siteminder will be able to keep more of these sales as profit, with Van Keulen expecting operating margins to rise from negative territory today to 16% in 2033.

A common question asked of unprofitable companies is how long it will be until shareholders are diluted to raise money. Van Keulen sees little risk of this in the near term. Siteminder’s public debut in 2021 has left it with ample surplus cash on its balance sheet and it also has access to loan facilities should they be required.

Downside risks and fair value

While Van Keulen is clearly keen on Siteminder’s prospects, he acknowledges that there are still a broad range of potential outcomes.

He has assigned an Uncertainty rating of High to his Fair Value estimate of $10 per share, reflecting the fact that Siteminder’s customers in the travel business are vulnerable to economic downturns. This could become especially relevant if transaction-based revenues grow relative to Siteminder’s revenue from subscriptions.

While Siteminder’s scale advantage is significant, it is not insurmountable. And while there are high hopes for the Channels Plus product, there is always a chance it will prove to be a disappointment.

A higher Uncertainty rating means that a larger discount to Fair Value is required. At a current price of around $5 per share, Siteminder shares trade at almost a 50% discount to Van Keulen’s estimate of Fair Value. As a result, they currently command a five-star Morningstar rating.

Before you get to choosing funds or stock investments, we recommend you form a deliberate investing strategy. You can read more about how to do this here.

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.