ESMT - EngageSmart: Defensive Business Growing At 20% Is An Attractive Buy

2023-08-14 22:36:46 ET

Summary

• I recommend a buy due to the attractive growth profile, defensive business nature, and strong performance so far in this weak macro climate.
• ESMT provides customer engagement SaaS platforms and has shown strong growth in both the SMB and enterprise segments.
• The recent acquisition of Luminello assets is expected to boost ESMT's growth and profitability by expanding its capabilities and market reach.

Investment action

Based on my outlook and analysis of EngageSmart Inc. ( ESMT ), I recommend a buy rating. I expect ESMT to continue growing at >20% given the defensive nature of the business and its strong performance so far. This strong growth justifies a premium in valuation relative to peers. Moreover, ESMT is on track to continue expanding EBITDA margins, a favorable attribute that it has over peers.

Basic Info

ESMT provides customer engagement SaaS platforms. ESMT offers an application that simplifies tasks like paying a bill, going paper-less, making a donation, setting up an appointment, and viewing customer history.

Review

Revenue for ESMT in 2Q23 was $94.4 million, which was above both the $93 million consensus estimate and the $93.5 million high end of management's guidance, thanks to strong growth in both the SMB and enterprise segments. Customer base increased by 22% year-over-year to 113.2k, while total transactions increased by 21% to 44 million. I think it's remarkable that ESMT has managed to keep its annual growth rate at over 20% despite the current economic climate. In my opinion, the continuous strong growth in payment volume is a key indicator of underlying demand and future growth. The robust operating metrics also demonstrated the defensive character of InvoiceCloud payments. I would point out the strength of enterprise in particular. In many other industries, the common theme is that enterprises are delaying project implementation and scrutinizing budgets; however, the ESMT enterprise segment continues to grow robustly. Moreover, ESMT is also somewhat insulated from inflationary pressures given its variable rate structure.

“The inflation for us InvoiceCloud being the primary driver for the enterprise. We have a lot of pricing that's based on a variable rate, I mean in other words like it could be 2.95% for tax payments, could be a flat fee for certain utilities, what happens is we offset one with another, so we think that in an inflationary environment, in other words, if there is a tax bill that goes up -- if you have property assessments that drive higher prices on homes.” 2Q23 earnings

In addition to the company's organic performance, I anticipate growth and profitability to be boosted by the corporate action discussed during the call. Management has announced a strategic agreement to acquire Luminello assets . Luminello is an EHR and practice management system used by thousands of independent and small-group psychiatrists, psychiatric nurse practitioners, psychologists, and other prescribers. Since ESMT and SimplePractice complement each other, I think this purchase will improve the company's value proposition. First, psychiatry's market share and growth potential for ESMT should increase with the addition of Luminello. Since Luminello's clientele overlaps with that of SimplePractice, I don't foresee any serious problems in generating synergies in this area of the business. As management mentioned:

“the deal would unlock greater possibilities for serving multidisciplinary group practices. To solve more complex and acute mental health diagnoses, a growing number of group practices include both prescribers and non-prescribers, and Luminello's strong background in serving prescribers adds to SimplePractice's deep expertise in mental health.” 2Q23 earnings

Second, Luminello is in a unique position in the market and provides useful, innovative features like e-prescription. The addition of Luminello and SimplePractice will expand the capabilities of ESMT and increase its value to clinicians.

Overall, I find the 2Q23 results very positive and the new acquisition to be a growth catalyst for the future. Contrary to expectations, the stock took a dive, which I see as a buy opportunity. I believe the weak share price action was largely due to weak guidance. The way I view it, this has nothing to do with ESMT fundamentals; it is the market expecting too much. Note that this is a business that is growing at 20+%, resilient to macroeconomic weakness, and has growth catalysts up ahead.

Valuation

I see no issues with ESMT continuing to grow at >20% for the foreseeable future given its performance so far and the defensive nature of its business. I note here that growth could possibly accelerate if the macro recovers, but I think it pays to be conservative. The tricky question is finding the right valuation multiple for ESMT. I did this by comparing ESMT against peers that are offering similar solutions, and I think ESMT should continue to trade at a premium to peers. ESMT is growing much faster than the median of its peers and is arguably more sustainable given its defensive nature. Also, ESMT is on track to continue expanding profitability, which is an attractive attribute in today’s market.

Risk and final thoughts

While the business is defensive, it does not mean there is no risk. Providers like Bill.com and Paymentus offer solutions in the InvoiceCloud market. Shares of ESMT could underperform if the company's growth slows because of increased competition in its target market and/or a decline in pricing power.

In conclusion, ESMT presents a compelling investment opportunity. Its defensive nature, demonstrated by consistent >20% growth and resilient performance, positions it favorably in the market. The recent strategic acquisition of Luminello assets adds value and growth potential by expanding its capabilities and market reach. Despite a recent stock decline driven by market expectations, ESMT's fundamentals remain strong, making the dip an attractive buying opportunity. While competition and pricing pressure are potential risks, ESMT's growth trajectory, robust operating metrics, and favorable valuation relative to peers make it a recommended buy.

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