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Descartes Systems Group (DSG) Stock | TSX: DSG.TO

A Leader in Logistics Software

The Descartes Systems Group provides a software solution that allows users in the shipping industry to communicate with one another. The core product is the Global Logistics Network, which is best understood as transaction driven. Descartes charges clients to send/receive messages, data, and documents on the GLN (the transactions). Customers typically contract for a monthly minimum over a multiyear period. The GLN platform allows for Descartes to upsell additional software modules as well, typically provided via a software-as-a-service model.

Growth

47

Valuation

59

Quality

73
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Where Are We Now

Updated on: 11/8/2021

Conviction Score

6

Descartes and its Global Logistics Network software have been simplifying supply chains and logistics businesses since 2001. We think “making things simple” is a great business model and one that will never go out of fashion. Nonetheless, we struggle with the company’s valuation today and would prefer to enter at a lower level if we were buying today.

  • Supply chains will only get more complicated as the economy expands and supply chains adapt to our changing world. Companies recognized that fact and helped propel Descartes’s revenue upwards by 25% since last year.

  • Descartes purchased another ~$110 million of companies over the last year to expand its new and existing Global Logistics Network services. Clients will be happy with the expanding number of services to manage their logistics and supply chain networks.

Investment Thesis

  1. Descartes’ marquee asset, the Global Logistics Network is a logistics communication software that has helped clients connect with each other in a supply chain to improve their logistics network and communicate seamlessly. This software has helped many businesses improve their network and increase efficiency.

  2. Descartes is a growth by acquisition company, completing over 27 acquisitions in the last 7 years, integrating each company into the business model to either provide new services or complement pre-existing ones on the Global Logistics Network.

  3. The secular growth of the logistics industry will help Descartes provide more services to clients as businesses are continuing to see the importance of having a robust logistics network.

The Basics

Descartes Systems Group is a Software as a Service (SaaS) company based out of Waterloo, Ontario. Their main area of expertise lies in logistics and supply chain, providing clients with software solutions to sort out their shipping services in addition to managing their supply chain. Descartes marquee product is called the Global Logistics Network. This communication software helps clients manage every component of logistics, from carriers and shippers, to even customs regulators and intermediaries through messaging services.

Descartes’ business is broken down into three different segments:

  • Software Services

  • Professional Services

  • Licensing

Licensing and Software Services is the core of their business. For clients to gain access to Descartes’ software, they are required to pay an upfront cost per year, making up the licensing segment. On top of that, as the software is based on communication and sending/receiving documentation, clients are also required to pay on a per usage model, making up the software services segment.

Descartes Revenue by Segment (Q2 2022)

Source: Descartes Investor Relations

For professional services, Descartes offers services related to consulting and training. They have designated departments to help clients with their logistics and operations for a fee.

The Comeback

Descartes was founded in 1981, focused on providing logistics solutions to corporations.

By 1999, the company listed for an IPO on the NASDAQ. They had perfect timing as it was right when the dot.com bubble began, skyrocketing the stock price by over 2200% in a matter of months.

Descartes would use a licensing model with their products, having customers pay for an access key to use their services.

In 2001, they changed their business to a Software as a Service (SaaS) model, becoming the first software provider in the logistics industry.

Initially this change was not very successful as Descartes had successive quarters of losses, nearly filing for bankruptcy in 2004.

In 2005, the company hired a new CEO who restructured the company completely. He fired 35% of the workforce and established a brand-new corporate culture.

Descartes is now known as “one of the most dramatic turnarounds in Canadian corporate history”, returning to profitability in 2005.

Since then, Descartes has been very successful, putting up record figures and being one of the top software supply chain logistics providers.

The Global Logistics Network

The Global Logistics Network (GLN) is Descartes’ prized possession. It has allowed the company to surpass others, being an industry leader, revolutionizing how we think of supply chain logistics software.

The GLN helps to manage the data flow of commercial, logistics, customs, and product information all in one place, connecting thousands of businesses in over 160 countries.

When dealing with logistics, there can be many parties involved and there are many considerations to be accounted for. Descartes’ solution is to provide messaging services between specific parties, to ensure communication is fluid amongst everyone involved. They believe the flow of information between trading partners is just as important as the movement of goods.

Descartes Global Logistics Network graphicSource: Descartes Investor Relations

The Logistics Industry

The logistics industry has been growing substantially over the last two decades, following a secular trend.

E-commerce sites such as Amazon are able to flex their logistics power, having the ability to ship out and deliver packages within a matter of hours. This is due to the robust logistics network that they have created to transport a product from a warehouse into a customer’s hands.

Businesses are taking Amazon as an example and are trying to rectify their own logistics network to ensure a product can be transported from point A to point B, prioritizing efficiency and costs.

Sparking this kind of interest creates a ripple effect as improving one part of the supply chain translates into improving every part of the supply chain.

Alongside retailers, carriers, manufacturers, and distributors are continually trying to improve their network. Despite the pandemic having a negative effect on many networks, it has helped businesses recover from their loses and strengthen them for the future.

Disciplined M&A

The Strategy

Descartes attributes most of its company success to its expansive acquisition strategy. In the last 7 years, the company has acquired over 27 companies, costing $900 million.

The company has a few criteria when it comes to making acquisitions.

Most of their acquisitions are either:

1.    Complementary technologies

2.    Companies that are close adjacencies in logistics

3.    Strategic sourcing companies to strengthen their network

DSG acquisitions over the yearsSource: Descartes Investor Relations

For complementary technologies, Descartes tries to acquire companies that may expand the current capabilities of the company’s software with added patents, ideas, and resources. As the Global Logistics Network is the centre stone of Descartes, they are continually looking to add new features and technologies.

Descartes also acquires companies that are considered competition or have close adjacencies to the logistics industry. Purchasing these companies allows Descartes to own more market share, being able to serve a larger target market.

For supply chain management, it is known that the most important step of the chain is sourcing. Businesses need to look for suppliers to produce their goods and services. They always strive to find quality products for the right price.

What Descartes does is acquire these suppliers and sourcing companies, to integrate them into the Global Logistics Network, to give clients easier access to high quality suppliers and goods, all in one place.

The main objective with any of their acquisitions is to widen their moat. By expanding their business through acquisitions, it ensures the company can introduce new features while also strengthening their already powerful software.  

The ShipRush Acquisition

A big part about the supply chain is the last mile, or anything related to delivery and transportation to a consumer. Having a strong delivery network can make sure goods are transported in a given time frame without jeopardizing efficiency and costs.

Descartes realized many of their clients were looking to improve their delivery methods and decided to acquire the ecommerce logistics management company ShipRush in 2017 for $14 million.

Descartes x ShipRush LogoSource: FedEx.com

ShipRush helps ecommerce small to medium sized businesses (SMBs) execute parcel shipments for last mile deliveries. With over 60 business systems in place, ShipRush was able to consolidate all the functions needed for a retailer to ship out their product to a consumer including comparing carrier rates, generating and printing shipping labels and order tracking.

Descartes realized that the ecommerce and retail world was evolving rapidly, and more businesses were looking to improve their network. The last mile delivery market is project to grow to $60 billion by 2022 in North America. This is a big opportunity that Descartes is capitalizing on.

Alongside other previous acquisitions of shipping software companies, ShipRush was intended to give Descartes customers a broad selection of solutions to address their parcel shipping needs.

How Descartes Comes into the Equation

Now with the logistics industry growing rapidly by the year and more businesses putting logistics management as a priority, it gives Descartes the ability to reach a larger market. The more clients in demand for supply chain management, the better business for Descartes.

For example, the company has been helping The Home Depot over the past few years improve their logistics network. Through their software and ShipRush, Descartes was able to create a real time delivery appointment schedule to help customers pinpoint times for delivery dates and locations. They were also able to optimize the routes that drivers would take to cut back on costs and increase efficiency.

This is what Descartes is able to do well. Find new clients who want to streamline their logistics network and provide them with services they need.

They have been able to do this with many other major companies such as DHL, Delta Airlines, and Coca Cola.

A Look at Financials

Before 2001, Descartes’ business model was based on licensing. Clients were required to pay a licence fee per year, and they were given access to the company’s software.

By changing their model to a subscription, they became the first Software as a Service (SaaS) company in the logistics industry. Users are required to pay a monthly fee to access the software and it is all based in the cloud. Their model is interesting as it is a mix of both subscriptions and a usage-based model as clients must also pay transaction fees per message/document sent on the software.

The transition did not have any short-term upside for Descartes, but it helped the company solidify their financial statements long term.

With any SaaS business, the core benefits stem from recurring revenues and high gross margins. A consistent inflow of revenue, while also being capital light ensures top line revenues are steady and have the potential to grow. For Descartes, they were able to accomplish both those things while also having growing free cash flow figures.

Descartes Revenue ($M) (Q2 2022)

Descartes Free Cash Flow ($M) (Q2 2022)

Descartes EBITDA ($M) (Q2 2022)

Growing by Acquisitions

As Descartes is a growth by acquisition company, a big risk lies in making a poor decision on an acquisition. As they have spent over $900 million in the last 7 years acquiring companies, Descartes must look towards paying the right price to gain the most value. 

A poor decision may affect the business heavily as each acquisition is intended to integrate into Descartes model.

Investors should keep track of Descartes’ acquisitions and seeing how they affect the business in terms of market presence and financials.

The Bottom Line

Descartes Systems Group can be referred to as the pioneer of software logistics services. They were the first company to create a Software as a Service that provides logistics solutions in the world. This experience in the market has allowed the company to create a business with a strong moat and consistent financials.

The Global Logistics Network is the marquee asset of the business. Clients can use this network to connect with any party among the supply chain, to sort out any issues and to have clear communication.

Through growth by acquisition, Descartes can acquire businesses that not only align with the company’s goals but may also help enhance clients’ experiences on the software. Their resume of acquisitions has been successful as they have been able to integrate each of the companies into their business.

Acting as a positive tailwind, the growing industry can prove useful to Descartes and their business. As many businesses look to improving their logistics network, Descartes can provide the services that many companies may need to improve their networks. 

In addition, the last mile delivery market continues to grow by the year and the company is able to capitalize on this opportunity through their acquisitions in shipping software companies.

As Descartes looks towards refining their software and giving clients the tools they need to succeed in a supply chain, they will continue to benefit from the growing industry, providing quality services to their clients.

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