2023-12-01 11:03:19 ET
Summary
- Guidewire Software's cloud business is showing progress and driving momentum for the company.
- The share price has increased by 37% since the last article, leading to concerns of overvaluation.
- Employee stock compensation should be included in determining non-GAAP earnings and EPS, and on this basis, the company has a way to go before generating profits.
Investment Thesis
Back on August 6, 2020, with the Guidewire Software, Inc. ( GWRE ) share price at $119.07, I published an article, " Guidewire Software: 'Leaky Equity Bucket', Time To Abandon Ship ."
One year later, on Aug. 17, 2021, with the share price down to $110.01, I decided to take another look, and published an article, " Guidewire Software: No Fix To The 'Leaky Equity Bucket '".
Around eight months on, and with the share price down by a further $17.28 to $92.73 at close on Apr. 13, 2022, I published an article, " Guidewire Software: No Safety Net For This Stock ", with a Strong Sell rating.
Almost twelve months later, with the share price down by a further $19.58 to $73.15 at Mar. 6, 2023, I published article, " Guidewire Software: Burning Cash And Unfavorable Sales Mix Trend - Avoid ", with a Strong Sell Rating.
Three months later, with the share price relatively unchanged at $72.64, I changed my stance, and on June 3, 2023, I published article, " Guidewire Software: Upgrade To Hold ".
My change in stance was predicated on continuing progress by Guidewire Software in growing its cloud related business. From the company's Q3-2023 earnings release ,
“The third quarter was highlighted by eight cloud deals and significantly better than expected subscription and support gross margins. We are raising our overall profitability expectations for the year as higher cloud margins and ongoing cost discipline outweigh lower services revenue and margin,” said Mike Rosenbaum, chief executive officer, Guidewire. “Our continued momentum is driven by the product leadership we have established with InsuranceSuite and Guidewire Cloud.”
From the company's Q4-2023 earnings call (quarter ended July 31),
We closed 17 cloud deals in the quarter, bringing our total for the year to 37. We finished the year at $763 million in ARR, up 15% and just under $900 million in fully ramped ARR, up 17%. And something that I'm particularly proud of, we finished the year at a positive operating margin, significantly ahead of our plan. Underlying these results is a growing acceptance in the industry that the cloud solution we have built, the geological next generation platform capable of supporting the P&C industry's requirements, goals, and aspirations.
That is the sort of progress I was looking for back in June when I wrote, "On balance, I believe an upgrade to Hold is likely appropriate, pending seeing progress over the next couple of quarters." But there is another factor that causes me to downgrade to Sell at this point in time, at least for a portion of holdings. This factor is the increase of over 37% in the share price, since my previous article. The truism, no matter how good a stock is, it is still possible to pay too much for the shares, holds sway here. Some additional supporting material and analysis follows below. I will plan to update this material when Guidewire Software 1st Quarter 2024 results are released post market on December 7, and again review my rating based on those results and the share price at that time.
Guidewire Software - Additional Supporting Material and Analysis
My conclusions in previous articles were that reported non-GAAP losses are significantly understated due to exclusion of employee stock compensation, and while the company is presently financially sound, this is only due to large amounts of capital raised. $317 million of the cash stockpile of $1.13 billion at July 2019 has been utilized through the end of July 2023, and debt has increased by $80 million over the same period. While the cash reduction and increased debt was used to repurchase 5.9 million shares, an additional 5.2 million shares were issued to employees as stock compensation, so there was minimal change in outstanding shares. I believe it is quite conclusive in the case of Guidewire Software that employee stock compensation is a real cash cost, and there is no justification for excluding it in determining non-GAAP earnings and EPS. On that basis, despite growing revenues quite strongly, the company has a way to go before it can even get out of loss making mode, let alone generate profits at a level to justify the current share price. With one quarter of results released since my last article, I can see there has been continuing improvement in performance, as reflected in Table 1 below.
Table 1
Table 1 shows continuing good growth emerging in the Cloud area, with annualized revenue growth of 42.0% for the July 2023 quarter over April 2023 quarter, compared to growth of 25.4% for July 2023 quarter versus July 2022 quarter. It was stated in the Q4 2023 earnings call linked above, the high margin license revenue is expected to decline due to steady progress on cloud migrations. This is a change from expectations expressed in the Q3 earnings call for license revenues to have stabilized and to show modest growth going forward. It is pleasing to see Services segment achieve a small but positive gross margin in Q4 2023. It is also pleasing to see Sales and Marketing and General and Administrative expenses beginning to show the benefit of increasing scale of operations. This is a company necessarily focused firstly on the needs of customers, and the growth that is occurring is likely causing some growing pains internally. It would appear the problems mentioned in previous articles are being addressed. But for the ~37% increase in share price since my previous article in June 2023, I would definitely continue with at least a Hold rating for the stock. At the current high share price, a Sell rating is more likely warranted, at least for a portion of holdings. It is useful to see what company insiders are doing in this regard, as shown in Table 2 below.
Table 2
Apart from the COO, sales of employee shares have been actioned by the company to cover taxes on rights issues to employees.
Summary and Conclusions
Shareholders might take a leaf out of the COO's book and sell a portion of holdings at the current elevated share price, while continuing to review quarterly earnings releases. I will plan to provide an update following release of the Q1 2024 results post market on December 7. I will be looking for continuing strong growth in cloud revenue, together with increasing margins. This growth is absolutely essential, because at this time, Guidewire Software is still a loss making enterprise, when all costs, including stock compensation, are taken into account.
For further details see:
Guidewire Software: Time To Take Some Money Off The Table