2023-05-26 06:42:22 ET
Summary
- PAYC has some of the best S&M efficiency among SaaS companies.
- The company has solid growth ahead, led by its new Beti product.
- While not in the bargain bin, the stock is attractively priced.
With some of the most attractive sales and marketing efficiency in the SaaS space and strong growth, Paycom (PAYC) is a solid option for growth investors.
Company Profile
PAYC is a provider of cloud-based human capital software ((HCM)). Its solution keeps a core system of record that contains payroll and human resource ((HR)) information in one centralized database. Its offering is used for such HR functions as payroll, talent acquisition, onboarding, time and labor management, and other HR applications.
The company's solution also offers self-serve options to its customers' employees. Its product allows employees to view pay stubs, W-2s and benefits information. They can also schedule vacation time and update their W-4 information. PAYC also provides a management solution that allows supervisors to approve time off and expense reimbursements.
PAYC serves clients of various sizes across industries. It typically targets clients with between 50 to 10,000 employees.
PAYC generates revenue from subscription fees as well as a fee per employee or transaction processed. There is some seasonality to the business, as the company benefits in Q1 from things such as W-2, bonus paychecks, and affordable care act form filings. Q4 can also see a smaller boost from unscheduled bonus payroll runs. The company also generates interest on funds held for clients before they are disbursed to employees.
Opportunities and Risks
Most organizations use some type of payroll company, and there are many out there. Where PAYC has found its success is by displacing legacy payroll companies through its innovative HCM and payroll solution. Historically, Automatic Data Processing ( ADP ) has been one of the biggest sources of displacement. But PAYC notes today when it goes into a company, it often is not only displacing ADP, but also HCM provider Workday ( WDAY ) and expense management firm Concur, and switching them over to a single solution. This is cost effective for the customer and streamlines everything being on one system.
To displace legacy incumbents, product innovation needs to be at the forefront, and the company has been strong on that front, despite pretty moderate R&D spend. PAYC's big new solution is call Beti, which allows employees to do their own payroll with the help of automation freeing up HR's time I the process. The company notes that 80% of employers need to go back and correct employee time sheets because of errors, and that Beti lets employees manage this task, while helping identify errors and guiding them how to fix them before they are submitted.
So far the product has been a big success, with about 50% of PAYC's customers adopting the product since it was launched in the summer of 2021. PAYC says clients on BETI have a 99% retention rate versus 93% for the company as a whole. It also says it drives a higher PEPM.
Another of PAYC's big opportunities is to continue to move upstream and land larger clients. In 2014, the year the company IPO'd, the average size of its clients was about 125 employees. For 2022, it was up to 178 employees. The company has successfully been landing larger clients, but there is still room to expand to larger mid-market organizations. The company recently released a global HCM product, which will help it gain customers that have operations outside of the U.S.
Discussing the new product on its Q1 call, CEO Chad Richison said:
"We have several clients who currently use our domestic software, and they use it internationally. They rig the system a little bit so that they can store employees in other countries. And then oftentimes, they'll work with a third party for payroll. So our current clients, they don't have to do this any longer because the Paycom system now does have global HCM product that will work in 180 countries and 15 languages. And global HCM for us is everything minus the payroll side. And so we've looked at integration opportunities. We've looked at working with third parties and even potential acquisitions. But the fact is everyone else does it the old way, and payroll and HR departments send data for processing. And we're not going to be putting any development into the old way. So for us, Beti is packing her bags and will be going around the globe as we develop it out. … Absolutely, we'll be a global company. This is the first step, and that's moving our product into the different languages and getting the HCM side done. And now we're heavily focused on bringing Beti to the other countries, which it will require us to have operations in certain countries in order to do that, in order to process in those countries."
Continuing to expand its salesforce and get into other U.S. geographies is another driver for PAYC. The company estimates that it has only hit 5% of its TAM. The company has sales forces in 40 of the 50 largest markets, but in many of those markets it can still build them out.
On the risk side, PAYC does generate revenue based on the number of employees or transactions. As such, while it benefits from employee growth, it conversely sees less revenue from clients when they downsize. Many large firms have made headlines when they've reduced their workforces, SMB layoffs have followed suite.
And while the company has been moving higher up the mid-market, it still serves mainly SMB customers, who could be more vulnerable during a recession. SMBs are always more at risk of failing if the economy get bad.
That said, payroll is not something that organizations can get rid of, and with companies looking to cut costs, a cheaper single solution from the likes of PAYC could be desirable. Addressing the potential impact of a recession on its business at a Keybanc conference last year, Richison said:
"And over time, we've always been fairly recession proof. I mean if you remove out the pandemic piece, which I think impacted all of our current client base through employee attrition, if you will, and impacted our current client revenue, but it actually accelerated our go-to-market if that makes sense. And so I would have said it would have been hard for our business to be impacted by anything until the pandemic showed up. And so as we sit here today, even with unemployment, and let's say it goes up, unless it goes up very quickly, if it goes in 3.5% to 7% within a 2- or 3-week period, we're going to feel that. But if it does that over a 9-month period, 12-month period, I'm not a 100% sure that would be big reflection in our numbers or we wouldn't be able to move through that."
Valuation
SaaS companies are generally valued based on a sales multiple given their high gross margins and the companies wanting to pump money back into sales and marketing to grow.
On that front, PAYC is valued at a P/S ratio of about 9.5x based on the 2023 consensus for revenue of $1.72 billion. Based on the 2024 sales consensus of $2.07 billion, it trades at a P/S multiple of 7.8x.
In the past, the company has often traded at over 10x LTM sales. However, growth is slowing from around 30% a year to around 20-25% over the next two years.
Conclusion
When looking at SaaS companies, one of the most important metrics I like to look at is sales and marketing (S&M) efficiency. On that front, PAYC is a standout that you often don't see in companies these days, where the mantra just a few years back from many companies was growth at any cost. PAYC on the other hand has consistently had an average payback on its sales and marketing of less than a year and a half, which is outstanding.
Trading at under an under 8x multiple on 2024 sale estimates and growing revenue over 20%, PAYC's valuation while not in the bargain bin is attractive. The company continues to put up solid numbers, and while not immune for a recession, it should be somewhat recession resistant. The company also initiated a dividend and is buying back shares as well, something you don't see often from SaaS companies.
As such, I rate the stock a "Buy" with a target of $360+, which is around a 10x P/S multiple of 2023 numbers.
For further details see:
Paycom: A Highly Efficient Growth Company