AVDX - AvidXchange: Remain Hold Rating Until Growth Trend Stabilizes

2023-06-01 09:53:53 ET

Summary

• AVDX reported strong 1Q23 results, with a 22% increase in revenue and positive adjusted EBITDA for the first time, indicating improved fundamentals and an accelerated path to profitability.
• The company's expansion into the hospitality industry through a partnership with M3 and its ability to maintain stable sales cycles in a challenging macroeconomic environment are encouraging signs for future growth.
• Despite a near-term hold rating, there is optimism for AVDX's long-term potential and the possibility of outperforming expectations if growth trends stabilize and the macro backdrop improves.

Overview

AvidXchange ( AVDX ) specializes in providing AP software and payment solutions targeted at middle-market businesses. COVID-19 has hyped the demand for flexible, cloud-based solutions for organizations. AVDX is undeniably well-positioned in the market, with its in-demand solution digitizing the entire AP process. It is encouraging to see the share price react positively (about +10%) to AVDX 1Q23 results as it show that the stock is picking up some momentum from a sentiment perspective. It was very positive to see AVDX's outperformance, especially since management kept a cautious stance regarding the remainder of the year and repeated its prior commentary on the volatility of B2B spending in the current environment. While 1Q trends were stronger than anticipated, I should point out that the company will soon lap the comparisons in its media vertical, making the rest of the year more difficult in terms of comps. So, while I am optimistic about the company's long-term potential, I am maintaining my near-term hold rating while I wait for growth trends to stabilize.

Improving fundamentals

AVDX's 1Q results were significantly better than I expected, with a 22% increase in revenue. There are three things to highlight beneath the headline growth figure. The first encouraging sign is that FY23 volumes are tracking with AVDX's projections, suggesting a possible turnaround in FY24. The second is that AVDX's sales cycles have only lengthened by a matter of weeks despite persistent macro challenges (given that their average duration is already two to three months, this may not seem like much). Third, the Hospitality Vertical may be another promising opportunity for AVDX to fuel expansion. Management claims that AVDX has signed 50+ Hospitality customers out of an estimated 10k US middle-market customers. As part of its expansion into the hospitality industry, AVDX has formed a strategic partnership with M3 , a hospitality-specific ERP system. Under the terms of the agreement, M3 will integrate AvidPay into its ERP functionality in order to increase transaction volumes, allowing AVDX to access M3's customer base of 1,000 management groups, which includes roughly half of the top US hotel managers and operators. All these shows that things might not be as bad as I thought, and if the macro backdrop turns for the better, AVDX could outperform more than I expected. As AVDX's management noted at the most recent JP Morgan 51st Annual Global Technology, Media, and Communications Conference , demand for the company's product remains high. In particular, AVDX is experiencing high levels of top-of-funnel activity in each of the nine industries in which it operates, as prospective customers look to expand their back-office operations without increasing their workforce size. This positive trend should continue as businesses become increasingly price-conscious and seek out efficient methods of boosting productivity at a low per-unit cost. Along with expansion, I attribute AVDX's positive adj. EBITDA for the first time to the positive effects of higher float revenue and steady expense control. Achieving positive adj. EBITDA is a big thing as it highlighted by an accelerated path to EBITDA profitability in 2023. Investors in the market that are not expecting profits this year will need to adjust their model to shift profitability timeline to FY23 (thereby increasing the value of their calculated intrinsic value due to timing of cash flow).

Guidance

The raise in guidance was also more than welcomed. In 2023, management now anticipates revenue between $363 million and $368 million, with a relatively small contribution from the political media vertical. As for profits, management anticipates adjusted EBITDA between $2 million and $4 million, which I believe has a strong impact on sentiment as the business in not guided to be profitable, vs the previous notion of breakeven vs profitable. What's more crucial is that management's macro expectations for the rest of the year have not changed despite the increase in guidance. Similarly to what has been previously disclosed, they are still dealing with lengthened sales cycles and reduced spending discretion among their clientele. What I infer from this is that management is being very conservative here. As such, there is a good chance for AVDX to beat its FY23 guidance. This holds particularly true when considering middle-market enterprises seeking avenues to enhance operational efficiency within a demanding macroeconomic environment.

Secular tailwind

As the world becomes more technologically advanced and the expectation of frictionless, work-free operations grows, I am confident that AVDX will continue to benefit from its secular tailwind. Management claims that currently more than half of all platform transactions involve paper checks, for which the buyer is responsible for paying the standard fee per transaction but the seller is not. As the yield and margin from transactions are negatively affected, this is obviously not the best solution, especially when compared to electronic payment methods. Thus, I think the value proposition for electronic transactions is much better (convenient, fast, and safe), despite what the bulls may say about check being a better payment method, such as check payment providing more check and balance.

Valuation

My updated model follows the same assumption that AVDX will continue growing at a high rate over the long-term, albeit with pockets of volatility (like in FY23, which I used consensus figure). The basis of this assumption is made possible because the TAM is huge, so there should be no issues for AVDX to continue capturing share, as long as they keep executing like they are now. I expect AVDX to generate $635 million in revenue in FY26. Assuming AVDX does that and trades at the same forward revenue multiple as today, it should be worth $14.17

Risks

Exposure to mid-market

In a recession, I would expect more mid-market players to face a higher risk of shutting down relative to larger enterprises. Since AVDX over-indexes in this aspect, it will suffer a heavier impact during an economic downturn when the underlying clients shut down.

Conclusion

In conclusion, AVDX has demonstrated strong performance in 1Q23. The company's ability to track volumes in line with projections and maintain relatively stable sales cycles in a challenging macroeconomic environment is encouraging. Furthermore, AVDX's expansion into the hospitality industry through a strategic partnership with M3 presents a promising opportunity for future growth. The achievement of positive adjusted EBITDA for the first time highlights the company's improved fundamentals and accelerated path to EBITDA profitability in 2023. The raise in guidance, coupled with management's conservative outlook on the macro environment, suggests a potential for AVDX to surpass its FY23 targets. Overall, while maintaining a near-term hold rating, there is optimism regarding AVDX's long-term potential and the possibility of outperforming expectations, provided that growth trends stabilize and the macro backdrop improves.

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