2023-07-26 10:21:34 ET
Summary
- BILL Holdings, a cloud software company, offers a one-stop financial software solution for small businesses, including payment processing, invoice generation, expense reporting, and underwritten credit and debit cards.
- Despite high churn among small businesses, BILL has maintained a healthy net revenue retention rate of 131% with over 450,000 customers and 4.7 million in-network members.
- Growth is slowing, and stock-based compensation remains higher than peers. Despite the impressive market opportunity, BILL stock is a hold for me here.
BILL Holdings ( BILL ) is an interesting cloud software company. The company earns revenue off subscriptions but also operates a transactional platform for consolidating payments and invoicing for small and medium businesses ((SMB)). Although the company's metrics have been outstanding since going public, I think there are enough outstanding questions for me with the company's slowing growth rates and continued high stock-based compensation to initiate coverage with a hold rating.
The company is primarily focused on the SMB segment, which most notably HubSpot (NYSE: HUBS ) has found a lot of success in. Despite the higher churn among smaller companies, it also sets software providers up to be a one-stop shop and allows for a generally easier integration.
Despite the churn, BILL has maintained a healthy net revenue retention rate, most recently at 131% on over 450,000 customers and 4.7M in-network members. The customer count is loosely defined here across BILL's offerings, since they count businesses across their offerings.
This is where the company is most interesting, in my view. BILL is positioned to be a one-stop financial software offering for small business. They process payments, generate invoices and expense reports, and offer underwritten credit and debit cards through banking partners to centralize money flows. The underwriting is reminiscent of companies like Toast (NYSE: TOST ) and MercadoLibre (NYSE: MELI ) who perform similar functions for loans with their smaller customers. Once a company is in the network, they can efficiently onboard vendors and suppliers to BILL and process payments through the company's infrastructure without ever having to re-enter banking information, similar to a PayPal (NYSE: PYPL ) offering.
The opportunity is immense. Obviously, small businesses are not a one-size-fits-all opportunity. Many of these companies are operating on just Quickbooks, which is integrated with BILL, or even just Microsoft (NYSE: MSFT ) Excel spreadsheets. However, HUBS has proven to me this cohort can be lucrative. At around $1.04B in sales projected for 2023, there is plenty of breathing room for growth here. However, competition will be fierce. Despite BILL's integrations with Quickbooks among many other offerings, BILL will need to maintain its edge well as larger competitors will be working to grab that take-rate. This is a concern for almost all the smaller cloud software companies, so BILL isn't alone.
One of the portions of the 10-K I found interesting, however, is how the company handles its credit underwriting. I'm not an expert in how these companies underwrite risk, but BILL ultimately has the intimate financial data for its customers it can use to much more easily quantify the risk than a simple bank application form. However, what I expected to see here was the company taking a cut on the loan origination and then offloading the risk.
That's not exactly the case. Whenever the companies pay through the credit card offered by BILL's Divvy offering, it's closed by their banking partners (they typically use one of two regional banks). BILL is then on the hook to purchase the participation interest in all of the receivables originated through the platform, secured via cash deposits. These participation rights are purchased through borrowing under credit facilities and corporate cash. They typically immediately sell these to a warehousing subsidiary which funds the purchased through loans with financing partners.
I apologize for summarizing the quoted text here, but I think this is important. Other companies I've covered are effectively increasing stickiness by offering to underwrite loans, with the risk offloaded to banking partners. Here, it appears BILL is taking a more active role in moving money around and assuming more risk, and any difficulties in maintaining adequate credit could result in problems for the company. So long as the risk is effectively controlled through the company and bank's underwriting procedures, there's unlikely to be an issue, but I was somewhat surprised to see this when reading through the 10-K.
At least as recently as the 2022 Annual Report, there don't appear to be any issues with the company's arrangements. I do think this bears monitoring for any potential investors.
Looking at the company's metrics, total payment volume grew 11% yoy this past quarter to $64.7B on a take rate of 262 bp's. TPV growth is down significantly which is to be expected as SMB's spend less in an uncertain economic environment. Revenues are projected to grow by 62% yoy, with growth tailing off into next year like the rest of cloud software to 28% (analyst projections). Gross margin is about as good as it gets at 81%, or 87% non-GAAP, and transactions on the platform and Divvy grew 52% yoy. Divvy was a relatively recent purchase in 2021, and the company also purchased Invoice2Go last year, showing management is somewhat more acquisitive than others in the space. BILL carries $2.7B in cash on the balance sheet with around $1.77B in long-term debt on 2025 and 2027 notes.
Zooming out a little to see how BILL compares across the cloud landscape, the company is in the upper echelon for revenue growth and below the median for growth-adjusted revenue multiples. The company remains unprofitable on a GAAP basis with an operating margin of -35% and stock-based compensation of 32% of revenues, which is higher than peers. Surprisingly, the company is sitting on a stock buyback authorization of $273M with 359K shares repurchased in the most recent quarter. I'm not certain that's the best choice for capital allocation, but it does somewhat offset dilution. G&A expenses are higher than I like to see, at 28% of revenues, with S&M and R&D high but relatively in-line for companies growing at this rate. Lastly, the company no longer meets the Rule of 40 on a forward basis, at 38% on slowing growth.
Based on some comments on recent articles, I will discuss that BILL does generate free cash flow. Operating margins are negative, but adjusted for SBC, the company generates cash. This removes most liquidity concerns as the company is able to self-fund. However, it is still burning shareholder value as shareholders are diluted more than the cash the company generates.
To show what I mean, here is the income statement from the most recent 10-Q. Looking at gross profit against operating expenses, the company is still operating at a loss on the order of $54M in the most recent quarter. Again, this is not uncommon among many of these younger technology companies. However, it's important to understand what non-GAAP profitable really means. That net loss per share, $0.29 per share on the quarter and $1.96 per share on the 9 month period, is real money, and it does actually matter in the long-term.
Zooming down further to the cash flow statement, and here is where the magic happens. You'll recognize that net loss figure from above for the 9 month period of around $208M. It's then adjusted for stock-based compensation by $255M in the opposite direction. After the other adjustments to reconcile the cash flows, the company generated $107M in the most recent period. But they lost money. I wanted to highlight this because of some misconceptions I've seen in comments across the site. BILL generates cash flow, so they can self-fund. However, they are doing it, as are many other unprofitable companies, by paying their employees in stock vice cash. This dilutes you, the shareholder, and in principle acts the same as selling stock into the market to fund operations.
In all, BILL is interesting, and I could see opening a starter position in the future. However, there's too many question marks for me here. The opportunity is great, but the company remains firmly unprofitable with growth slowing (which is happening across the space). Expenses remain high, and stock-based compensation is excessive despite the company buying back shares. In a vacuum, this company is likely a fine speculative investment, but it doesn't move the needle for me compared to some of the opportunities I've covered with a buy rating recently. It's a hold.
For further details see:
BILL Holdings: Big Opportunity With Small Business