ESMT - EngageSmart Sees SMB And Enterprise Strength As It Focuses Efforts

2023-08-08 14:32:45 ET

Summary

• EngageSmart, Inc. recently reported Q2 2023 financial results, beating revenue but missing EPS estimates.
• The company provides customer engagement software solutions to enterprises globally.
• EngageSmart is executing well, focusing on higher-value markets, and the stock appears undervalued.
• My outlook is a Buy at around $17.00.

A Quick Take On EngageSmart

EngageSmart, Inc. (ESMT) recently reported Q2 2023 financial results , beating revenue but missing EPS consensus estimates.

The firm provides customer engagement software solutions to enterprises worldwide.

I previously wrote about ESMT with a Buy outlook at around $16.50 per share.

EngageSmart looks to be executing well on both its SMB and enterprise segments, management is focusing its efforts on higher-value markets, operating income is growing and the stock appears undervalued.

My outlook on ESMT remains a Buy at around $17.00.

EngageSmart Overview And Market

Braintree, Massachusetts-based EngageSmart was founded to develop a platform that improves customer engagement tailored for certain industry verticals.

Management is headed by founder and CEO Robert P. Bennett, who has been with the firm since inception and was previously president of Sage Payment Solutions.

The company’s primary offerings include:

• SimplePractice - Wellness

• InvoiceCloud - Government, Utilities and Financial Services

• HealthPay24 - Healthcare

• DonorDrive - Non-profit and Corporate Fundraising

The firm acquires customers through its direct sales and marketing teams and through partner referrals.

Management is focused on the industry verticals of health and wellness, government, utilities, non-profits and financial services.

According to a 2021 market research report by Mordor Intelligence, the global market for customer engagement solutions was an estimated $15.5 billion in 2020 and is forecast to reach $30.9 billion by 2026.

This represents a forecast CAGR of 12.65% from 2021 to 2026.

The main drivers for this expected growth are a growth in technology solutions to improve the customer journey via any device they use to connect with businesses.

Also, a desire to reduce customer churn rate results in improved revenue growth, financial results and a growing stock valuation.

Major competitive or other industry participants include:

• IBM

• Microsoft

• Nuance

• Oracle

• Salesforce

• Avaya

• Calabrio

• Aspect Software

• Genesys

• Verint Systems

• Nice Ltd.

• OpenText

• Pegasystems

• Others

ESMT’s Recent Financial Trends

• Total revenue by quarter has continued its growth trajectory; Operating income by quarter has turned up recently.

• Gross profit margin by quarter has trended slightly higher recently; Selling, G&A expenses as a percentage of total revenue by quarter have turned lower in recent quarters.

• Earnings per share (Diluted) have remained positive since 2022.

(All data in the above charts is GAAP.)

In the past 12 months, ESMT’s stock price has fallen 19.2% vs. that of the iShares Expanded Technology-Software ETF’s (IGV) rise of 11.35%, as the chart indicates below:

For the balance sheet , the firm ended the quarter with $332.8 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash flow was $50.5 million, during which capital expenditures were $8.3 million. The company paid $17.9 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure in the past eleven quarters.

Valuation And Other Metrics For EngageSmart

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

ESMT’s most recent unadjusted Rule of 40 calculation was 46.3% as of Q2 2023’s results, so the firm has performed well in this regard, although slightly lower sequentially, per the table below:

(Source - Seeking Alpha.)

Commentary On EngageSmart

In its last earnings call ( Source - Seeking Alpha ), covering Q2 2023’s results, management highlighted the acquisition announcement for Luminello, which will expand the firm’s offerings in the psychiatry market.

The company also sold its Healthpay24 patient payment platform, so the firm can focus its efforts more tightly.

ESMT’s SMB segment showed particularly strong growth of 30% due to continued high demand for mental health care and a dearth of providers.

Management hasn’t disclosed recent revenue retention rate metrics. The most recent figure was 117%, but that was in 2022.

Total revenue for Q2 2023 grew by 27.7% YoY, while gross profit margin rose 1.2%.

Selling, G&A expenses as a percentage of revenue fell 4.8% year-over-year, a positive development indicating increasing efficiency and operating income more than doubled to $8.8 million.

The company's financial position is quite strong, with plenty of liquidity, no debt and strong free cash flow generation.

ESMT’s Rule of 40 performance has been excellent, although slightly lower sequentially.

Looking ahead, management expects 2023 full-year revenue to grow at 24.2% vs. 2022.

If achieved, this would represent a drop in revenue growth versus 2022’s growth rate of 40.6% over 2021, indicating a flattening growth trajectory.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below:

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited "Challeng[es][ing]" two times and "Macro" once.

Analysts questioned company leadership about the opportunity for Revenue Cycle Management [RCM] growth. Management believes it is still early days but the firm is pursuing a number of opportunities in its SMB segment as clients face challenges dealing with insurance payments.

Regarding valuation, the market is valuing ESMT at an EV/Sales multiple of around 7.5x on TTM revenue growth rate of 27.7% against a median Meritech SaaS Index implied ARR growth rate of 21% ( Source ).

The Meritech Capital Index of publicly held SaaS application software companies showed an average forward EV/Revenue multiple of around 9.3x on July 19, 2023, as the chart shows here:

So, by comparison, ESMT is currently valued by the market at a discount to the broader Meritech Capital SaaS Index, at least as of July 19, 2023, despite a higher topline revenue growth rate.

Risks to the company’s outlook include an economic slowdown that may be underway, reduced credit availability which may affect customer/prospect spending plans and lengthening sales cycles which may reduce its revenue growth potential in the near term.

Still, EngageSmart looks to be executing well on both its SMB and enterprise segments, management is focusing its efforts on higher-value markets, operating profit is growing and the stock appears undervalued.

My outlook on ESMT remains a Buy at around $17.00.

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