2023-11-02 08:11:06 ET
Summary
- BILL has developed an industry leading financial operations software platform for SMBs.
- The company's performance remains strong, attracting new users and improving margins.
- The stock market volatility and interest rate concerns have impacted Bill.com's share price, but its long-term growth potential remains intact.
- The company has a significant generative AI capability that dramatically automates repetitive financial operations tasks.
- The market opportunity for financial operations is huge and minimally penetrated at this point.
Bill.com: The dichotomy between its business and its share price
BILL ( BILL ) is scheduled to report its results for its 1st fiscal quarter on November 2 nd , 2023. The company has a relatively lengthy record of exceeding expectations. I wrote about Bill and its prospects in January of this year. It seems an eon ago with all the water under the proverbial bridge. Since that time, the shares initially rallied significantly, and then have lately fallen to about 11% below the price at which the article was written. Needless to say, since that point, the company has exceeded its estimates in the times it has reported, and continued to increase its forecast. It is a fairly typical story for the first 10 months of 2023: operational performance is improving and share valuation is compressing.
While Bill is no longer growing at hyper levels, in the current environment, its performance is relatively strong. It is almost impossible for the company to control or influence the average spend of its customers on its platform; it continues to attract new users to its platform at a consistent rate and its indirect channel has the possibility of significantly increasing the cadence of acquisition of new customers. The continued and substantial improvement in margins coupled with decent growth enable me to reiterate my buy recommendation on the shares at the current price of about $92/share.
This is not an article suggesting anyone go out and buy Bill shares anticipating extraordinary results or improved guidance when they report their quarter in a couple of days. No tech company is doing that, and Bill is facing similar macro headwinds that are impacting most growth stories to one degree or the other. While it is always difficult to play quarters, and I have always strongly advised against the attempt, this earnings season has been unusually perilous. Shares of Google ( GOOG ) imploded, perhaps reasonably at least to some cohort of traders, not because the company’s operational performance was weak overall-it certainly wasn't, but because its cloud growth rate decelerated more than anticipated. Facebook/Meta ( META ) reported a particularly strong quarter-but conference call commentary which suggested elements of uncertainty in the environment at the start of the Israeli-Hamas war, was judged as some kind of red flag for investors and the shares reversed and are now down 4% since the earnings release. .
That said, it is worth noting that the Wells Fargo analyst who covers this space initiated coverage with an overweight rating and a price target of $115 Thus far the recommendation hasn’t had a significant impact on the price of the shares which are up just more than 2% this Tuesday afternoon.
Earnings season is perhaps half done as I write this. Overall, it appears that earnings for most tech companies have been above average despite concerns that had been previously expressed. The earnings season for tech hasn't been great, but better than some might have feared. One quantitative analyst maintains that 92% of tech companies have beaten estimates. Of course, for most tech companies it is guidance rather than historical performance that is most significant and it can be very difficult to assemble an accurate consensus on historical projections. That said, even a laggard in the software space such as SAP ( SAP ) had decent earnings. And the first signs of AI monetization coming from the AI pioneer Microsoft ( MSFT ), have been seen although it will probably be another quarter or two before the signs become universal and substantial.
Much of what has happened to stocks over the past couple of months is a product of interest rate angst. Rates on the 10 year Treasury bond have risen by more than 65 basis points in a couple of months. By historical standards, that is a huge move in a very short time. Some economic metrics are quite strong, and in turn this has led investors to accept the "higher for longer" thesis. Some economists and prominent investors believe that interest rates have reached a peak; others are less sure. It is not a debate that I can solve, although, of course, the trajectory for rates will inevitably place guard rails on the performance of Bill shares along with the shares of most other high growth IT companies.
But this is not an article about the economy, interest rates or macro expectations. Bill.com shares have fallen sharply along with almost all other high growth IT shares. From a recent high post earnings of $135 set in July, the shares have fallen about 32% to current levels. The shares are now down almost 16% so far this year.
For many years Bill.com was a very highly valued-high growth IT vendor that lost money. It is still growing quite rapidly despite dealing with some macro headwinds. What has really changed, and quite dramatically is profitability. Last quarter the company had a free cash flow margin of 30%. For the full year the company’s free cashflow margin was 17%. The company’s non GAAP operating margin went from a loss of 2% to a positive margin of 14%. The company generates a significant level of what it calls float revenue and when it reports, it includes float revenue in operating income. Overall, the company’s net margin for the full year was 18% and it projects a similar net margin level in this current fiscal year. I have projected a free cash flow margin of 20% over for the next 4 quarters. At this point the company has a real non-GAAP P/E, which based on management’s forecast for non-GAAP EPS over the coming fiscal year is about 47X.
With a sagging stock price coupled with rising margins and continued revenue growth, Bill shares, for probably the first time since the company’s IPO 4 years ago, have a below average valuation considering the combination of free cash flow margin and revenue growth. The company has just now crossed the border of becoming valued based on the Rule of 40.
Can Bill.com withstand a recession?
Valuations can look attractive based on current operational performance but what about during a recession? Of course a recession is not yet on our doorstep. The extraordinary growth in GDP reported for last quarter was pretty far removed from a recession although most investors-at least when they are trading stocks-seem to realize that last quarter’s growth number was an outlier and almost certainly will not be repeated in the near future.
Bill has been battling macro headwinds for some time now. The CFO, as part of his script last quarter talked about where macro headwinds have been seen so far.
Our strong financial performance in Q4 was achieved despite macro headwinds as SMBs continue to moderate their spend during the quarter. In Q4, our TPV results exceeded our expectations, but also showed a continuation of our customer base scaling back spend compared to a year ago. TPV per customer, excluding financial institution channel customers or FIs, increased 4% quarter-over-quarter. However, it declined 5% year-over-year, demonstrating that SMBs are still facing macro pressures.
SMBs use our platform as the center of their financial operations and engagement with our platform remains strong. For example, on our BILL stand-alone platform, excluding FIs, the average number of transactions per customer was 76 in fiscal Q4, up from 74 in the prior quarter. Our annual BILL stand-alone customer retention rate, which excludes FIs, remained consistent compared to a year ago and is at a very healthy level of 86%.
But the company has multiple levers in terms of its ability to continue to grow revenues despite the decline in average spend on the part of its customer base. I will consider some of those levers in the next segment of this analysis.
Bill.Com-How does it keep growing when spending trends are negative?
Bill.com is perhaps the leading financial operations platform for the SMB space. It facilitates both bill payments, and invoice creation for its clients. The company offers a Spend and Expense service that used to be called Divvy. It offers a variety of integrations including QuickBooks, Oracle ( ORCL ) NetSuite and Microsoft. It offers a variety of management and analytical tools.
At the end of the last quarter, the company had 461k customers using its different solutions. The company has several channels with regards to customer acquisition. A bit less than half of its clients have come to it through the direct channel, about 62K customers have come to the company through its Financial Institution channel, it has 29K unique customers using the Divvy product and seven thousand accountant/partners use Bill to provide services to their clients. The number of net adds is a KPI that can drive the shares significantly. The company offers an instant transfer service for its clients and this is an exceptionally lucrative revenue source and demand driver. The company has a mobile billing solution, Invoice2Go that is geared to invoicing and expense tracking for micro businesses.
Over the years, the company has evolved a number of partnerships that are in various stages of their lifecycle, and these partnerships often drive the net add metric. The company at one time had a sales partnership with Intuit; this partnership accounted for more than 12k customers -most of them micro businesses. The partnership has come to an end; some of the larger customers from this partnership will probably migrate to Bill direct, and most of the rest will churn.
The company has developed and recently announced a significantly enhanced offering that is branded by B of A and is offered by that bank. Relative to the size of Bill, this is a very substantial, and probably underappreciated opportunity. The company has been willing to use promotional pricing with B of A to acquire new accounts and this will actually be a revenue headwind at the start of this current fiscal year. The company has several other significant banking relationships of which the most significant are with JPMorgan (JPM), PNC (PNC) and Wells Fargo (WFC). The banking partnerships probably offer the most significant marketing opportunity for Bill. The company expects to continue to expand its direct user count by 4000/qtr. in the near future.
Bill derives revenue from 3 primary sources. It charges users a monthly fee for the use of its software, it charges a fee based on volume for the transactions across its platform, and it generates what it calls float revenue from the customer balances that are in transit. It reports subscription revenue which includes its monthly subscription fee, and float revenue which is shown in other income.
Overall, the company has forecast Q1 growth of about 30%. Much of the growth is coming from float revenue which are expected to increase from $6 million to $38 million. For the full year, the company had forecast revenue growth of 22%-23%. This is a product of mid-single digit growth in total subscription revenue coupled with float revenue rising from about $113 million to $137 million. Based on the relatively strong economic macros that have been seen thus far, I think that the estimate for a decline in TPV from Bill.com direct customers that is part of the overall forecast has likely been exceeded. It has been 3 quarters since the first signs of a moderation in spend across the bill platform showed up; it appears that the trend may have reached it maximum extent in the June quarter simply based on overall consumer spend reported for the September quarter.
Bill’s Competition and product strategy.
Bill was one of the pioneers in perceiving the need for a financial operations platform for the SMB space. But over the years, many competitors have emerged. Some competitors focus on different market segments and different payment types. For example, Tipalti, which is the payment engine used by Seeking Alpha, is designed to automated mass payments. Coupa is probably the company best known as a competitor, at least in some ways, although its category is better known as spend management, and it gets much of its revenue from supply chain design and planning, and from strategic sourcing software as opposed to paying bills. But broadly defined, Coupa’s software is designed to pay invoices and to invoice customers, and it has a travel expense management offering. Its focus has been on selling its platform to the enterprise where it more nearly competes with SAP Arriba.
Coupa was recently acquired by P/E firm Thoma Brava. Thoma Brava paid $8 billion for the acquisition which closed at the end of February 2023. At the time of the transaction, Coupa’s revenue run rate was about $800 million, and its growth rate had declined to 17%. It was generating some cash but margins were going backward.
A few years before, SAP bought Concur a few years ago. The valuation paid for Concur was exceptional-those were the days in which stack vendors wanted to bulk up SaaS revenues and were willing to pay almost any price to do so. Concur is an expense, travel payment system. It probably is the standard amongst enterprises for keeping track of and paying travel expenses. It has had its share of ups and downs mostly due to the past travel issues during and in the aftermath of the Covid pandemic. Concur revenues are significantly greater than those of Bill.com. but are apparently growing much more slowly, and growing more slowly than Divvy the most comparable component of the Bill platform. In 2022 Concur revenues were around 2 billion Euros and have likely grown modestly this year. Of course Concur really only competes with Bill in a small portion of the space.
Bill has introduced an AI features into its payment processing functionality. It is a step function forward in terms of automation. Earlier this year, it extended its AI functionality by introducing an Intelligent Virtual Assistant that its customers can use. The capability is built into some of the levels of functionality that the company offers. Obviously the new functionality improves the payback for adopting Bill in an organization. That said, there was no explicit discussion in the last conference call with regards to the potential for AI to increase the growth of Bill’s user base. I believe that Bill’s Intelligent Virtual Assistant is a competitive differentiator and its importance will grow over time.
The overall market for SMB software is large , but its CAGR is just moderate. Bill competes in just a portion of the total market. The latest market survey I found was the one linked above, but just how useful it might be in terms of evaluating the growth potential for Bill is questionable. All of the stack vendors have ERP solutions for the SMB space, and that is what makes up the lion's share of the TAM reported here. The specialty that Bill addresses in terms of bill payment and invoice creation has a significantly greater CAGR, and within the space, Bill has continued to gain share as best as can be determined.
Bill’s current forecast is deliberately conservative to account for macro headwinds. Trying to forecast average spend per customer is a bootless undertaking, although that won’t prevent many from attempting it. In the long run, average customer spending on the Bill platform will increase and add to the company’s growth rate; that is obviously not the case at this point, although spend per customer metrics are extremely variable on a quarterly basis. Not all of the company’s customers take advantage of all of the functionality that is offered by the platform. But most of the growth for Bill will be its ability to sell more users, and in that regards, partnerships will be vital
The Bill partnerships with Bank of America and JPMC and accountants
There are literally millions of SMBs who could use the Bill.com solution. The total count of SMBs was most recently a bit over 33 million. Of that number, about 5 million have employees. The SMB headcount has risen rather consistently over the last several years. Essentially all SMBs have to pay bills, send invoices and account for expenses. But the question for Bill and its competitors is how to reach potential customers economically. When Bill was much smaller, and less established it developed a partnership with Intuit. The basic problem with that partnership was that users were too small, and weren’t generating enough average revenue to be profitable or to move the growth needle for Bill.
Bill has two substantial partnerships these days with banks, and it is also being used by a significant percentage of the largest accounting firms. JPMC was an early stage investor in Bill and the Bill technology is embedded into Cashflow 360 , that company’s back office solution for its SMB clients. The service allows for digital connection to suppliers, vendors and Bill network members.
The company recently announced an expansion of its relationship with Bank of America to serve the entirety of the bank’s SMB customer base. The initial launch of the expanded relationship helped Bill add 700 BofA users to its platform last quarter as they migrated to the company’s direct channel. Most recently, Bill has been adding about 4k new users quarterly, net of the Intuit churn. The company has essentially initiated its BofA partnership with the equivalent of promotional pricing. The promotional pricing is through the reduction of contractual minimums which will push out revenue and profits from this customer cohort for several months.
At this point, Bill has about 7000 accounting partners who use their platform in conjunction with their own clients. The company has steadily grown its base of accounting clients and this has been one of the most productive channels for Bill in terms of acquiring new users.
Typically, Bill customers who work with banks and accountants have a higher level of TPV when compared to Bill direct channel, and their spend has proven to be less susceptible to macro headwinds. While the company is anticipating Bill direct users will have an average spend decrease of about 5% on its platform, overall including customers in the indirect channel, the company is estimating a mid-high single digit growth in spend over the next few quarters.
The consensus for Bill’s revenue growth next year is a bit above 23%. That is a combination of growth in TPV, growth in the number of subscribers, and stability in float revenue. The best chance for the company to exceed those consensus expectations is by improving its subscriber additions, and that more or less has to come through ramping sales through its accounting and banking partners. It is a key component of the positive investment thesis. I think the odds favor the company being able to ramp its subscriber count, especially with the addition of its AI based Intelligent Virtual Assistant to its stack. The most significant risk to the forecast, at least to this writer, is that of a further decline in average spend, a possible consequence of recession, if one eventually arrives.
Bill: The business model transformed-still additional opportunities to grow non-GAAP EPS margins along with improving free cash generation
There are many components of the investment case for Bill: a key in my estimation is that it is now generating cash and management has figured out that in the current environment investors require consistent positive cash generation. In some ways, Bill’s path to non-GAAP profitability has been materially eased by rising rates which have caused float revenue to grow rapidly. Last quarter float revenue grew by about 7X compared to the same quarter in the prior fiscal year. On the other hand, rising interest rates have gone hand in hand with macro headwinds that have impacted TPV growth substantially. While float revenue grew 7X, TPV per direct Bill.com user fell by 5% year over year. The net is certainly no better than a wash; I think the cost ratios are a reasonable indication of where the company currently is in terms of profitability.
Last quarter non-GAAP gross margin about 83% compared to 79% in the year earlier period. Some of the improvement is scale, some is mix, and some, of course is a higher proportion of float revenue in the total. Non-GAAP gross margin had been 79% in the prior sequential quarter. The company has forecast a moderation in gross margins over time, but that is not part of the forecast for the current year-its forecast is based on non-GAAP gross margin in the low-mid 80 percent range.
The research and development expense ratio is now around 20% compared to 25% in the year earlier period. On a sequential basis, research and development spend grew by less than 2%.
The other expense ratios have been showing similar trends. Bill’s largest expense category is sales and marketing. Non-GAAP sales and marketing expense last quarter was 35% down from almost 40% in the year earlier period. On a sequential basis, sales and marketing expense actually fell notably, although this was more an impact of a decline in the allocation of SBC expense last quarter. But even on a GAAP basis, sales and marketing expense fell.
Non-GAAP general and administrative costs are still quite elevated at 18.5% of revenues, although at least that is better than the 21.5% ratio in the prior year period. Sequentially, general and administrative costs increased about 15% last quarter, although on a GAAP basis, the increase the increase was 2%. In other words, the main driver of the changes in the expense ratios were a reclassification of SBC expense. Overall, the company is exercising expense discipline in all areas. Non-GAAP operating margin was 14% last quarter, reversing the non-GAAP operating loss in the prior year. Sequentially, the non-GAAP operating profit rose by 23% while revenues rose by 8%
The company’s forecast for operating margins for the current year is for little change. a function, perhaps, of the costs associated with deferring revenues from the extended BofA partnership but also of accelerating investments in opex from the levels of the last couple of quarters. Overall, the company has forecast that EPS will increase by about 18%, or below the 23% revenue increase expected. At the top of the range its forecast profit margin is expected to match this year's levels. In the past several quarters, operating expenses have lagged the company forecast, and I wouldn’t be too surprised to see a similar trend going forward.
Bill’s free cash flow margin for the year was 17%, compared to a cash burn last year. It was a swift improvement; the company was still burning cash a year ago. Deferred revenue is not a major factor in cash flow for this company. Much of the improvement related to balance sheet items and the biggest factor was the sharp decrease in the GAAP loss. Some of that was offset by the amortization of the premium in marketable debt securities. The company doesn’t forecast cash flow or cash flow margins. Just looking at the puts and takes in the full year cashflow, if full year operating margins are essentially flat, than the odds are that the free cash flow margin won’t change significantly either.
Bill has and almost certainly will continue to use stock based comp. Last quarter, stock based comp was 19% of revenue, down from 28% of revenues in the year earlier period. The company has forecast full year SBC expense of 23% of revenue, down significantly from 30% of revenues in the year earlier period.
I do prefer looking at dilution as a measure of the cost of SBC rather than reported numbers which, as can be seen in this company, as an example, jump around quite a bit. Because Bill went from a loss to a profit last year, the accounting convention calls for the recognition of dilution from outstanding convertible securities. But other than that, there has been no additional dilution. My valuation models are based on 119.5 million outstanding shares which is company guidance; that compares to 117 million fully diluted shares reported at the end of the prior fiscal year.
Wrapping Up: The case for investing in Bill.com
Bill is scheduled to report its results after the market close on November 2. I expect that quarterly results will be a beat mainly because the company has a consistent record of exceeding prior expectations.. The company will be revising estimates for the balance of the fiscal year; I expect a modest increase, mainly because the economy has remained stronger than the prior forecast had anticipated. The shares were initiated today by the analysts at Wells Fargo with an overweight rating. Given the timing of the initiation, I imagine that the analyst feel reasonably comfortable forecasting above average estimates.
There are some other trends that I expect will provide tailwinds including a greater mix of what are called ad-valorem transactions, and an increase in instant payment transactions, both of which carry very high margins. The company has a promotional pricing offering with its partner, BofA. I think it has at least fully estimated for cost. It is almost impossible to know the potential impact this quarter, or even beyond, for the company’s AI offering which it calls its Intelligent Virtual Assistant. Personally, if I were contemplating buying from Bill, or doing something else, the IVA capability, which is a significant automation, would be persuasive as a decision point. But then I really hate populating fields and comparing and copying past invoices.
At this point, Bill has 461k customers and there are 33 million SMBs. Obviously that’s minute penetration. Bill is emphasizing its indirect channel including accountants and bank partnerships-but to say there is considerable upside to the growth rate forecast is about the same as saying that the cost of living has escalated significantly.
Bill has a very conservative growth forecast with only single digit growth in the spend of average customers and modest growth in the number of users throughout the fiscal year. The actual growth will be a bit higher than what is reported, but the end of the Intuit partnership cloaks that particular metric. In the short term, an upside for Bill is most likely to come from stronger than expected uptake through its banking partnerships. Each bank has literally hundreds of thousands of small business accounts; the penetration is incredibly low, and the incentives for the banks are substantial.
While there are plenty of competitors in the space, the most significant of these, Coupa went private at an EV/S ratio of more than 10X earlier this year. And Coupa margins and growth percentage were both actually going backward at the time of the acquisition. So I have to suggest that with an EV/S of 7.5X and a projected free cash flow margin of 20%, Bill’s shares should be attractive. The company has a Rule of 40 metric in the mid 40 range.
I am not going to suggest that Bill is going to get bought, although self-evidently buying the company would be a far more attractive transaction for private equity when compared to the purchase of Coupa by Thoma Brava. The CEO of the company, Rene Lacerte, is the founder and he has run the business since 2006. Founders often are reluctant to part with their creation, and that may be the case in this situation.
It may sound like a broken record, but I do construct recommendations for the long term. I wouldn’t recommend buying Bill shares with any particular expectation for this quarter or the next quarter to be blowouts. One doesn't see a whole lot of blowouts in enterprise software these days and it would be far from credible to forecast that kind of result. To a certain extent its operational performance is going to be tied to the macro environment which continues to be more than a bit murky, at least in my judgement. But the combination of a compressed valuation and steady growth seems to be a reasonable basis for a recommendation in this environment, and when the environment improves, Bill's franchise in its space will spark a significant growth recrudescence in my opinion.
I read recently that “scary is the new normal.” Bill shares have fallen by 16% in the last month. That is scary, especially in the absence of any news or analyst downgrades. It is even more scary if you are holding the shares as I do. But to my mind, that kind of decline is simply an indication of just how strongly the risk-off tide is running.
Another set of data I recently read suggested that short positions of hedge funds were at historic highs and cash positions of institutions, at 5.5% also had reached a record percentage. Bill shares are obviously not going to climb while institutions don’t want to buy and while many hedge funds want to short.
But this kind of "spooky" sentiment comes and goes. I think over the next year, it is likely that Bill stock will be able to deliver positive alpha to investors.
For further details see:
BILL Holdings: A Speedy Transformation To Profitability, Undervalued By The Market