BL - BlackLine: Positioned To Weather Near-Term Headwinds And Disrupt The Global Financial Software Market

2023-05-09 15:27:19 ET

Summary

• BlackLine is a cloud-based financial software provider that is making monthly accounting close process(es) more automated, efficient and error-free.
• The company has a demonstrated, multi-year track record of double-digit revenue and free-cash-flow growth. Its solutions are also proving to be very “sticky” with a net retention rate of 106%.
• Management is projecting near-term headwinds in 2023 due to economic uncertainties, but given BL’s competitive advantages, the stock is positioned to offer longer-term compounding returns.
• BL, however, has struggled to reach net profitability over the years. In the current macro environment, this is another headwind to the company's overall valuation.

Company Overview

BlackLine, Inc. (BL) was founded in 2001 as a cloud-based financial automation software provider. The primary product of the company is a platform that automates and streamlines accounting and finance processes, such as financial close management, intercompany accounting, and balance sheet reconciliations.

Customers of BlackLine come from a variety of industries, including manufacturing, healthcare, and retail. The company is publicly traded on the NASDAQ stock exchange under the symbol "BL" and has offices in the United States, Europe, Asia, and Australia. BlackLine has been designated a Leader in Gartner's Magic Quadrant for Cloud Financial Close Solutions for multiple consecutive years in recognition of its technology and impact on the accounting industry.

Products & Services

BlackLine's cloud software product portfolio is primarily comprised of the following solutions-

Financial Close Management is designed to automate and expedite the financial close procedure. It assists businesses in managing duties like account reconciliations, journal entries, and variance analysis.

BlackLine's intercompany accounting solution , Intercompany Hub , enables businesses to manage intercompany transactions, such as loans, investments, and inventory transfers, across multiple legal entities.

Account Analysis : BL's account analysis product assists businesses in gaining a deeper comprehension of their balance sheets and income statements. It allows them to monitor, categorize, and analyze their accounts in order to identify trends and potential problems.

Smart Close: This product is designed to automate and standardize the financial close process for organizations with complex reporting needs. It allows businesses to create a custom close task list, configure approval protocols, and automate reporting.

Continuous Accounting : BL's Continuous Accounting platform is designed to assist businesses in transitioning from a periodic to a continuous accounting cycle. It allows businesses to automate mundane accounting duties so they can focus on more strategic endeavors, such as analysis and forecasting.

Overall, BlackLine's products and services are designed to assist businesses in enhancing the efficacy, precision, and control of their financial operations while minimizing the risk of errors and fraud.

Investment Case & Competitive Advantages

The products and services outlined above help build a strong investment thesis for BlackLine. One of the expected primary drivers of the company's future success is that its products help make finance and accounting organizations around the world much more efficient. BlackLine's software is designed to automate and accelerate routine accounting tasks, including the preparation of reconciliations and monthly journal entries, thereby saving time and greatly reducing the risks tied to financial reporting. Time saved + increased efficiency are 2 huge value drivers for administrative-based organizations like the finance and accounting world.

Another key benefit of BlackLine's solutions is that they easily and almost seamlessly integrate with a wide range of existing ERP financial systems including NetSuite, SAP and Oracle/Peoplesoft. There are multiple benefits of this approach. For starters, it positions BlackLine as a peer and value enhancer to the companies above rather than a competitor. Additionally, the easy integration process allows corporate customers to position BlackLine as a component of their existing financial processes and systems, thereby avoiding expensive setup and customization activities.

BlackLine's products are also cloud-based and offer real-time data, analytics and reporting capabilities. The cloud-based approach allows end-users to access their information from anywhere, including remote locations, thus making BL's tools more flexible than on-prem deployments. In addition to this level of accessibility, BlackLine's products also provide real-time access to data, information and analyses. This eliminates some of the waiting game that organizations have traditionally experienced while manual accounting entries are prepared and booked.

As a result of the benefits above, BL's software offerings are proving to be very "sticky" with customers. Their products make customers more efficient, have significant switching costs and changes to a new solution would likely require additional end-user training. Companies therefore, are incented to continue using BL's offerings well beyond initial implementation.

In addition to the above competitive advantages, there are several growth opportunities available to BL, that further the investment case. For starters, the company's products are ideally situated to harness the power of the classic "land and expand" strategy. Indeed, as the chart below shows, over time the company has proven very adept at not only retaining customers but selling customers additional value-added products/services.

Further support to the thesis above is that when it comes to annual recurring revenue, the company has generated a 67% CAGR with customers spending $1M or more annually since 2016 and a 26% CAGR with customers above $250k in annual spend.

The overall growth opportunity for BlackLine also can't be ignored. According to management and industry estimates, BL's current total TAM is $39B. This includes $18.5B of annual spend for the financial close market, $10B for the accounts receivables market and $11B for intercompany financial management. In total, management believes there are greater than 200k potential customers. In comparison, today BL has LTM revenue of $542M and 4,200 customers.

Beyond their current markets and products, management believes there are several growth opportunities available to pursue. Today, BL's solutions are largely used by companies headquartered in the US. Given the complexities of international financial reporting, management believes there is ample room to secure international customers and growth in the coming years. Additionally, BL is not done building out its product portfolio and the company is evaluating adjacent markets for entry. Finally, management is also actively evaluating ways to expand its partner ecosystem. This expansion could quickly lead to a more robust pipeline if partners are successful in cross-selling BL's products.

Closing out the investment case is the strong recognition that BL receives for its product. Every year, BL's offerings are consistently named as leaders in many software rankings including Gartner's magic quadrant, G2's best accounting & finance software list, The Software Report's top 100 companies list and others.

Potential Investments Risks

Although the investment case outlined is very robust, BL will continue to need to navigate several risk areas in both the near and long-terms.

The most immediate risk facing BlackLine is likely a management transition. On March 6th , it was announced that current CEO Marc Huffman would step down and that Co-CEOs would takeover. The new CEO's include Therese Tucker (founder, director and former CEO) and Owen Ryan (former board Chair). Ultimately, we hope this change drives growth for BL and it's good to see a founder and board chair getting involved given that they both have strong familiarity with the company. However, it's worth noting that the Co-CEO approach can sometimes be a difficult dynamic to manage.

Another watch area for potential BL investors is the level of industry competition. Thus far, major finance and accounting software providers like SAP, Oracle and NetSuite haven't shown a strong indication toward developing competing products with BL's solutions, but such a turn would likely completely change industry dynamics. BL also works directly with some of the above companies as part of its partner ecosystem which could result in a direct hit to sales.

A near-term risk that the company must navigate is the projected recession that may hit later in 2023. Although the company has a net revenue retention rate above 106%, the recession may impact customer spending plans and lower new customer revenue growth over the next 12-18 months.

Regulatory risks and cybersecurity risks are some final areas for investors to consider. Financial data is both highly regulated and very sensitive. Any breaches to the company's systems or products/solutions that fall outside of compliance, could result in significant liabilities for BL.

Financial Overview

As seen in the chart below, BlackLine has long been on a path of revenue growth. Growth has consistently been above 20% over the last 7 years and re-accelerated in 2022 to almost 23%.

Management has also proven that it can consistently execute on a quarterly basis. The chart below shows quarterly revenue over the last 5 years where the company has grown revenue in all but a handful of cases.

In the current market environment, the challenge facing BL likely isn't one of sales growth, nor is it the overall market opportunity facing the company. Instead, it's likely a challenge of profitability. Over the last 10 years, the company has yet to register a year of net income profitability, even with all of the competitive advantages discussed earlier. In the previous growth-oriented stock market environment, the lack of profitability didn't matter much, but that situation has now changed. To the company's credit, net margins appear to be consistently improving and BL looks poised to flip to consistent net profitability sometime over the next 4-6 quarters. In fact, Q4 2022 net income margin was positive at 8.1%, though Q1 2023 slid back to -6.7%.

It's also encouraging to see that over the longer-term, BL has consistently been able to generate Free Cash Flow. Down the road, we expect the gap between net profitability and FCF will narrow as the company slows some of its core investment areas including SG&A and R&D.

Turning to the balance sheet, there appears to be minimal risk at the moment. BL reported a $223M cash balance at the end of Q1 2023. The primary watch area is likely the company's debt load, which stands at $1.4B vs. total common equity of just $117M. Although the $1.4B of debt is high, as evidenced from the FCF chart above, BL appears to be generating plenty of cash to support this debt load and the $223M on the balance sheet provides further support.

Management also appears to be shareholder friendly. Minimal dilution has occurred in recent years, total diluted shares outstanding have increased about 10% over the last 5 years from 55M to 59M. It's also a good sign in our view that Co-CEO and founder Tucker holds over 7% of the shares outstanding. Management appears to be significantly aligned & incentivized to continue to drive growth.

The Q1 earnings call did provide important guidance for the rest of the year. Total revenue is expected to be in the $586M to $596M, representing 12-14% growth vs. 2022. Management provided important context for this slowdown, primarily that broader macro uncertainty and the possibility of a recession will be a strong headwind in 2023.

Valuation & Outlook

The competitive advantages, growth outlook, largely quality financials and return of key management provide a strong investment case for BlackLine. However, the near-term revenue and business headwinds that management highlighted do give some pause. Based on a current market cap of $3.6B and expected revenue of $586M+, the stock is currently trading at just 5.9x sales. This represents the lowest level over the last 5 years, where the stock traditionally traded in the 10x - 22x range. Given the uncertainty tied to this year's outlook, the current level of 5.9x does not provide a sufficient margin of safety to potential investors in this analyst's view. If a recession hits, BL's stock could fall another 20-30% and sales growth is also likely to take a hit. A more reasonable entry point would likely be a market cap in the $2.6-$2.9B range or a price per share of $43-$47. These ranges offer a much more adequate margin of safety for potential investors. BlackLine is a quality stock/company with solid long-term potential, but is rated a hold at the current valuation.

For further details see: