ESMT - EngageSmart: Capitalizing On The Growing Demand For Digital Interactions

2023-06-09 12:43:07 ET

Summary

• EngageSmart is capitalizing on the demand for digital interactions in the behavioral health sector, with a focus on innovative product strategies and effective go-to-market approaches.
• The company's vertical approach in the practice management platform space and emphasis on customer success contribute to strong unit economics and position it well for ongoing industry trends.
• I have an end of year price target of $30 on the stock.

Investment Thesis

EngageSmart, Inc. ( ESMT ) is taking advantage of the current demand for digital interactions, such as scheduling, invoicing, and payments, as customers increasingly seek these capabilities. The company is actively targeting the group practice opportunity within the behavioral health sector, improving products and adopting a go-to-market strategy to connect Managed Care Organizations and Employee Assistance Plans with clinicians. The COVID-19 pandemic has accelerated adoption of digital payments and I believe the long-term prospects for EngageSmart look promising as it operates at the intersection of software and payments, with a focus on innovative product strategies and effective go-to-market approaches. The company's vertical approach in the practice management platform space and its emphasis on customer success contribute to its strong unit economics and position it well for ongoing industry trends. I derive a target price of $30 using a 9x multiple to my FY24 revenue estimate.

Q1 Review: Strong Customer Additions

EngageSmart had a positive first quarter in terms of financial metric. Despite the typical seasonal trends, the company added more new customers in the first quarter than in the fourth quarter, including 5,466 new customers for SimplePractice and 56 new Enterprise customers (compared to zero in the first quarter of the previous year). The progress made in the development of the revenue cycle management solution and the expansion into larger healthcare groups were also noteworthy.

One particularly interesting aspect of the results and earnings call was the company's focus on addressing the group practice opportunity within the behavioral health sector. With recent success in this area, management is actively pursuing this opportunity by improving products and adopting a go-to-market strategy that targets Managed Care Organizations and Employee Assistance Plans, connecting them with clinicians through SimplePractice Enterprise. These opportunities are considered attractive and likely to gain traction more easily compared to expanding beyond the company's core Mental Health vertical. However, it should be noted that further investments may be necessary to achieve success in this area.

In the long term, I see EngageSmart as an innovative software vendor that operates at the intersection of software and payments. The company's shared success model is expected to lead to strong unit economics over time. Additionally, its product leadership and effective go-to-market strategy position it well to benefit from the ongoing digital transformation and payment industry trends.

SimplePractice Dominates a Large TAM with an Innovative Vertical Product Strategy

One prominent topic in the realm of Enterprise Software currently is the emergence of "practice management platforms." These platforms encompass various operational aspects of a business and provide an interactive and proactive interface for customer interactions, ranging from scheduling appointments to processing payments. EngageSmart's SimplePractice platform is positioned as a strong contender in this industry trend by combining back-office management of Electronic Health Records ((EHR)) with front-end patient engagement.

What sets SimplePractice apart is its specialized approach, focusing on specific healthcare segments such as mental health practitioners or physical therapists. This vertical orientation distinguishes it from most EHR systems that adopt a more generalized, horizontal approach to product functionality. By tailoring its features to the unique needs of specific healthcare verticals, SimplePractice has established itself as a dominant player in mature target markets.

Contrary to competitors, whose horizontal approach often results in challenging implementation and limited long-term adaptability to evolving industry demands, SimplePractice's vertical functionality provides significant advantages. This advantage is expected to drive sustainable market share gains and exceed expectations for subscription revenue growth.

Efficient GTM Strategy

EngageSmart employs a distinctive go-to-market strategy that varies across different business segments, utilizing direct sales, digital marketing, partnerships, and referrals. This differentiated approach to go-to-market tactics is expected to play a significant role in the company's future market share growth. Around 60% of the company's sales and marketing expenditure is allocated to sales activities. In the SMB segment, marketing comprises the majority of S&M spending, while in the Enterprise segment, sales activities account for most of the expenditure.

EngageSmart benefits from a network of product partnerships and integrations that are specific to each solution. These integrations and partnerships enhance the value of the EngageSmart ecosystem over time. By offering user-friendly and flexible products combined with a comprehensive suite of integrations, EngageSmart simplifies historically manual integration processes, providing convenience to all users.

Valuation

I have a price target of $30 for EngageSmart, which is determined using an EV/revenue valuation approach. This methodology allows for consistent comparisons among Software-as-a-Service ((SAAS)) companies. EngageSmart shares trade at 7.7x of FY23 revenue estimate. SaaS companies like EngageSmart have historically traded at 2-15x forward-year revenue multiples, but certain companies have traded above the high end of the range, most recently due to growth becoming more durable at higher levels of scale. While some SaaS valuations have expanded to 15x -20x, some hyper-growth SaaS companies have experienced multiple expansion to 50x on a PE basis . I believe peer SaaS companies with comparable mid-20% or better revenue growth rates are currently trading closer to 10x, depending on profitability levels. I believe ESMT's strong operating model suggests a valuation nearing a 10x multiple valuation. As a result, I derive a target price using a 9x multiple to my FY24 revenue estimate.

Risks

The potential impact of a challenging macro environment could lead to a delay or decrease in IT spending, which may affect EngageSmart's business. Additionally, the cyclical nature of payment processing could pose further uncertainties. EngageSmart operates in a fragmented competitive landscape, facing competition from established companies as well as emerging start-ups. These competitive pressures have the potential to impede future revenue growth.

Conclusion

ESMT is taking advantage of the current demand for digital interaction capabilities in various customer actions such as scheduling, invoicing, and payments. The majority of growth is anticipated to come from the SMB sector as SimplePractice expands its customer base and increases subscription average revenue per user. However, there are also opportunities for customer expansion across the entire business. In terms of financial performance, ESMT maintains an impressive balance between growth and profitability, positioning itself among the top-tier software companies. Hence, I view the stock as buy and keep an end-of-year price target of $30 on the stock.

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