INST - Instructure Holdings: Good Q4 2022 With Double-Digit Growth And Margin Expansion

Summary

• Instructure Holdings, Inc.'s Q4 2022 results beat most consensus estimates, with revenue growing by double-digits, and margins increasing.
• Instructure Holdings' cross-sell opportunity within its base increased to $1 billion, expanding Instructure's total addressable market and giving the company a longer runway for growth.
• Management is optimistic about K-12 sales in 2023, and believes that the Elementary and Secondary School Emergency Relief Fund will benefit Instructure Holdings, Inc.

Summary

I believe the Instructure Holdings, Inc. (INST) Q4 2022 results were pretty good overall, beating most consensus estimates. Revenue continues to grow by double-digits and margins expanded. In my opinion, Instructure's Canvas is the top Learning Management System [LMS] available, primarily due to its superior win rates and dominant market share in North America's Higher Education and K-12 sectors. Additionally, there is potential for further expansion by converting schools that currently use legacy LMS systems, entering the underdeveloped paid LMS market in K-12, capitalizing on a vast global total addressable market ("TAM"), and utilizing a platform strategy to promote the sale of additional modules.

All in all, my thesis remains the same for INST, and I believe the upside is still attractive from here.

Earnings overview

There was a 12.8% increase in GAAP sales to $124.7 million, which was higher than the consensus growth estimate by about 300 basis points. Instructure's revenue forecast for 1Q23, which ranged from $126.5 million to $127.5 million, also beat expectations. Management also projected higher-than-anticipated revenue of $519.4-523.4 million for FY23, representing 9.1%-9.9% y/y growth.

Supported by optimized cloud costs and customer support efficiencies, gross margins of 77.5% increased by 40 bps year-over-year. The operating margin of 37.3% on revenue of $46.5 million represents an increase of 80bps y/y. There was also a rise in the EBITDA margin, which now stands at 39%. The 37.5% operating income and 38.4% EBITDA guidance for FY23 are ahead of consensus by about 1% in each.

Growth strategies

The number of customers is one indicator I used to determine whether INST is gaining market share; this indicator grew by 7.4% in FY22, with new logo win rates rising in 2H22 (as mentioned by management). I believe this is because of Instructure Holdings, Inc.'s platform strategy, which, in conjunction with the benefits of the reference sale, has enabled INST to attract and close new business with the help of its ever-growing army of satisfied customers. For Platform in particular, management highlighted an increase in attach rate of 6 points over last year, with 43% of its customer base in 2022 adopting two or more products. Importantly, 60% of new customers use multiple products, which is a significant increase. This is noteworthy because it significantly expands Instructure Holdings' TAM, giving the company a much longer runway for growth. In particular, Instructure's cross-sell opportunity within its base increased to $1 Billion from $750 million as a result of a larger customer base and an expanded platform. This extra $250 million is equivalent to roughly half of FY22's total revenue base.

K-12 updates

A more optimistic view of K-12 from Instructure Holdings, Inc. management was heard in 4Q22 (relative to 3Q22). In the previous quarter , management mentioned that sales cycles are expected to lengthen, because of high number of teacher retirements and labor shortages. This quarter , management was more optimistic, reporting a healthy deal flow in the K-12 sector to kick off the year 2023. While I agree that schools will continue to face difficulties, I do think that they are becoming more aware of the need to make decisions in order to remain competitive in the modern educational landscape. I also think it's only a matter of time before demand comes back online because of the efficiency brought about by technology, which can help schools with personnel challenges.

ESSER updates

Management has noticed that most of the money allocated to the Elementary and Secondary School Emergency Relief Fund has not been spent yet because districts are still debating how best to use the money. As a mission-critical solution with a high value proposition, I believe that INSTs will greatly benefit from institutions allocating funds to upgrade their systems. Therefore, INST will function adequately with or without the additional funding. Still, I anticipate that districts will begin allotting these funds before they expire in 2024, which could provide a boost to INST expansion.

RPO

Although the slowing of INST cRPO growth to the high single digits on both an annual and 4Q22 basis is not cause for alarm at this time, it is something to keep in mind. This quarterly growth rate has now fallen below 10% for the first time over the past 3 years (excluding the covid period). I should point out, however, that due to the structure of the academic year, the bulk of billings and bookings actually occur in the second and third quarters, making the fourth quarter less of a crucial period. While Instructure management was confident in the RPO trajectory over the next year thanks to seasonality of contracts and timing of renewals, I remain skeptical and will be watching for a rebound in cRPO in the coming quarters.

Conclusion

In conclusion, Instructure Holdings, Inc. 4Q22 results were impressive, surpassing most consensus estimates with double-digit revenue growth and expanding margins. I continue to believe Canvas is the leading Learning Management System due to its superior win rates and dominant market share in North America's Higher Education and K-12 sectors, as well as its potential for further expansion. However, the slowing of Instructure Holdings, Inc. cRPO growth is something to monitor, and I will be watching for a rebound in the coming quarters. Overall, I remain bullish on Instructure Holdings, Inc.'s upside potential.

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