Long-Term Service Agreements (LTSAs)

A Long-Term Service Agreement (LTSA) is a contract between a company and its customer where the company agrees to provide maintenance, repairs, support, and parts for a product over an extended period, often spanning several years or even decades. Think of it as an all-inclusive, multi-year warranty and support package for big, expensive, and critical equipment. You'll commonly find LTSAs in industries that sell complex capital goods, such as aerospace (jet engines), power generation (gas turbines), and medical technology (MRI and CT scanners). For the customer, an LTSA guarantees performance and predictable maintenance costs. For the company selling the equipment, it’s a golden ticket to a steady, predictable, and often highly profitable stream of recurring revenue. This transforms a one-time product sale into a long-lasting relationship, creating a powerful financial dynamic that value investors adore.

When a company has a large portfolio of LTSAs, it's a massive green flag. It points to a resilient and high-quality business. Legendary investor Warren Buffett talks about finding businesses with a durable competitive advantage, or an economic moat, and LTSAs are a fantastic way to build one.

The holy grail for any investor is predictability. A company selling, for example, a power turbine might see lumpy, unpredictable sales that fluctuate with the economic cycle. But the service revenue from the LTSA on that turbine flows in year after year, rain or shine. This creates a stable base of high-margin cash flow that makes forecasting the company's future earnings much easier and more reliable. This stability often means the company can better weather economic downturns, continue paying dividends, and invest for the long term without being a slave to the whims of the market.

LTSAs are a cornerstone of a business model often called the “razor and blades” strategy, but on an industrial scale. The initial product (the “razor”) might be sold at a competitive, or even low, price. The real profit comes from the long tail of services, parts, and consumables (the “blades”) sold over the equipment's life via the LTSA. This creates incredibly high switching costs for the customer. Once a hospital has a General Electric MRI machine, it's far easier and safer to sign the service agreement with GE, who designed and built it, than to bring in a third-party provider. This dynamic locks in customers, protects the company from competitors, and widens its economic moat.

You don't need a magnifying glass to find evidence of a strong LTSA business, but you do need to know where to look. The best place to start is the company's annual report (known as the 10-K in the United States).

Companies are usually proud of their service revenue. In the MD&A section of the annual report, management will often discuss the size and growth of their service business. Look for:

• Revenue Segmentation: Many companies break down their revenue into “Equipment Sales” and “Service Sales.” A healthy and growing percentage of revenue coming from the service segment is a fantastic sign.
• Backlog: Companies often report their service backlog, which is the total value of future revenue they have contracted through LTSAs but have not yet delivered or been paid for. A large and growing backlog provides excellent visibility into future revenues.

While LTSAs are generally a sign of a strong business, it's wise to consider the potential risks.

• Execution Risk: A company must be able to deliver on its service promises. Failure to do so can lead to costly penalties and damage the company's reputation.
• Technological Disruption: If a new technology makes the company's equipment obsolete, that long tail of service revenue can disappear much faster than anticipated.
• Customer Concentration: Be wary if a huge portion of the service backlog is tied to a single customer. If that customer runs into trouble, it could have an outsized impact on the business.

Long-Term Service Agreements are more than just a line item on a financial statement; they are an indicator of a durable, cash-generative business model. They provide the predictable, high-margin revenues that allow a company to thrive over the long term. For the value investor, finding a company with a strong and growing installed base of equipment under LTSAs is like discovering a well-oiled machine that prints money and comes with its own maintenance plan. It’s a hallmark of a business built to last.