NCNO - nCino Should Be In Your Radar For Its Developing Moat

Summary

• nCino is a provider of cloud-based software for financial institutions and its value addition is making the banks take notice.
• nCino's core product allows banks to more effectively take on new clients for loans and helps manage the entire loan lifecycle.
• Once a product or technology is adopted by a bank, banks are notoriously hesitant to any change which provides nCino its moat.
• nCino's financial performance needs improvement and therefore I am rating it as a Hold.

What do they do?

In simple words, nCino's (NCNO) original product is a software that helps banks automate and improve their processes with the aid of data analytics and machine learning. Their product, the nCino Bank Operating System was originally started within a bank and eventually spun out as the problems being addressed by the system were applicable to many categories of financial institutions. By connecting employees, clients, and third parties its system breaks down silos and increases coordination and transparency across the entire organization. It provides all the necessary tools for key workflows like client onboarding, loan origination, deposit account opening, analytics, and compliance. The whole platform was built using Salesforce (CRM) which helped nCino to leverage its reliability and scalability. They have no real competition for their product in this segment. Most banks perform these functions with in house developed tools or custom solutions developed by vendors and nCino demonstrates that there is a superior alternative to what is being used by these institutions.

Their acquired product SimpleNexus , offers an end-to-end digital platform that simplifies the process of buying a home by connecting people, systems, and stages of the mortgage process. Nexus Engagement, Origination, Closing, and Vision are four tools offered by the company that helps financial institutions collaborate with borrowers and real estate partners from pre-application to closing, while also streamlining processes and providing business intelligence to improve visibility and productivity in lending operations. Nexus Engagement offers relationship-building tools, Nexus Origination is a mobile-first toolset that enables loan officers to manage pipelines, run pricing, and review automated underwriting system findings, Nexus Closing streamlines the closing process, and Nexus Vision provides visual dashboards and other analytics to forecast revenue, and evaluate performance.

Existing coverage and Expansion opportunity

Along with serving multiple regional and community banks, nCino's current base includes a lot of well recognizable names such as Bank of America, Barclays and TD Bank. Across all of its products, it counts close to 1800 customers. But there is a lot more ground to cover. Globally, there are an estimated 28000 financial institutions and banks are not known for being technology-forward companies. However, there are many reasons for banks to get their digital transformations. From BCG's report on digital banking, scalable tech-operations on cloud are an important piece of digital transformation puzzle and a key ingredient of success. BCG believes its best clients have leveraged cloud technologies and advanced-technology architecture to power customer journeys.

A report from Cornerstone Advisors in 2021 also revealed that loan volume, productivity, and deposit account volume all saw significant improvements as a result of a targeted digital transformation which in turn translated to increased profits. The same report also mentioned about the problem of legacy systems in US banks.

Many banks in the US rely on core systems that were created in the 1980s or 1990s. 72% of surveyed banking institutions stated they would not replace their core system as part of their digital transformation strategy. However, almost half of them reported that their core system vendor was not helping in their digitization efforts. This dichotomy clearly provides great expansion opportunities for nCino. With no direct competitors, it will be interesting to see how nCino can leverage its existing partnerships and make foray into new places.

Where does nCino get its moat?

To answer this question we have dig into the operational challenges as a bank. Banks are highly regulated and must comply with strict rules and regulations. If they are adopting a new technology, they must ensure that new technologies comply with these regulations and also meet their risk management requirements. Additionally, there are security requirements, as banks handle sensitive customer information and financial transactions. They must ensure that new technologies are secure and protect against data breaches and cyber attacks.

So, once a technology passes these barriers and a bank adopts them, they start getting baked into the bank's processes and switching to an alternative becomes prohibitively expensive.

During my last experience with a financial advisor, I remember seeing a system that was used by the advisor to check and enter investments. I remember seeing a MS DOS style type of operating system and the advisor mentioned that it was a bank wide used system and had been in place for decades. This led me to believe that banks have a lot of legacy systems with a lot of data and processes built around them.

Changing to new technology can be time-consuming and disruptive, and banks may be hesitant to invest in new systems for the same reason. As banks are large organizations operational changes are hard. All of this gives nCino its moat. nCino seeks less to replace an existing system/processes and posits itself as more of a value addition that incorporates these processes. Once nCino lands a client and the adoption grows throughout the financial institution, it would become harder and harder to replace the system.

Why am I rating this as a Hold?

There are a few reasons that is keeping me away from this stock for now. Although it has been putting stellar sales numbers, its losses have been expanding as well. These are two extremely diverging points of information.

Now one could justify this as normal for growth stocks. But I see another concerning indicator for a shareholder. SBC has been extremely dilutive and above a 10% threshold when compared to revenue.

Its current valuation does not help either. Its Enterprise value trades at 8 times its sales and it's the same story when its price is compared to sales. Although this is a far cry from its valuation when it initially came public, its current valuation suggests that there is still more pain to come for investors buying at these levels.

Going forward, I will be looking for signs to see if all the above metrics have improved. I understand these may develop slowly but if the management can at least give a concrete plan towards profitability, it will check one of the boxes and pique my interest. Until then it would be hard for me to reevaluate my position.

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