2023-12-08 13:32:17 ET
Summary
- Paycom shares tanked after issuing poor Q4 guidance.
- The company's Beti product is leading to less payroll mistakes and less payroll runs, which has negatively impacted its results.
- The company's 2024 guidance was likely low-balled, and management should take steps to increase Beti's price and lower its cost structure.
Paycom ( PAYC ) shares have been on a rollercoaster ride since I first covered the stock back in May , up a quick 25% only two months after I was initially bullish on the stock, saying it has some of the best sales and marketing efficiency among SaaS names. However, after its most recent earnings report, the stock is now down over -30% from both my initial write-up and most recent write-up in August, when I thought its slide was an overreaction. Let's catch up on the name.
Company Profile
As a reminder, PAYC is a cloud-based human capital software ((HCM)) firm that targets organizations with between 50 and 10,000 employees. Its solution is used for functions such as payroll, talent acquisition, onboarding, time and labor management, and other applications.
The company generates revenue from both subscription fees as well the number of transactions it processes. It has some seasonality to its business, with Q1 being its largest quarter, as the company processes W-2, bonus paychecks, and Affordable Care Act form filings. The company also earns interest on the funds it holds for clients before they are distributed to employees.
Q3 Results
For its most recent quarter, reported at the end of October , PAYC saw a 21.6% jump in total revenue to $406.3 million from $334.2 million the prior year. Recurring revenue climbed 21.5% to $395.5 million. Revenue was basically in line with analyst expectations.
Adjusted net income was $102.4 million, an increase of 39.5% from $73.4 million a year ago. Adjusted EPS rose 39.4% to $1.77 per share, topping the consensus by 16 cents.
Adjusted EBITDA rose 31.4% to $165.6 million from $126.0 million a year ago.
Adjusted gross margin was 83.7% compared to 83.9% a year ago.
The company ended the quarter with cash of $484 million and debt of only $29 million. It also held an average daily balance of $1.9 billion for clients, which it is able to earn interest off of before it is disbursed. The company spent $76.5 million in the quarter buying back stock.
Looking ahead, PAYC guided for Q4 total revenue of between $420-425 million. That represents a growth of about 14% at the midpoint. It is looking for Q4 EBITDA of between $169-174 million. At the time, analysts were expecting revenue of $452.3 million and adjusted EBITDA of $189.0 million.
For the full year, the company forecast a total revenue of between $1.679-$1.684 billion. That's down from prior guidance of $1.715-1.717 billion. The consensus at the time was for revenue of $1.72 billion.
It projected adjusted EBITDA to be between $712-717 million. PAYC was previously looking for a full-year adjusted EBITDA of between $712-717 million.
On its Q3 earnings call discussing its outlook, CFO Craig Boelte said:
" Throughout 2023, we have been seeing moderating upside to our guidance model, which corresponded with increases in Beti usage and macro headwinds from inflation that may impact each client differently. Now that more clients are achieving the ROI that Beti has to offer, it has eliminated certain billable items, which is cannibalizing a portion of our services and unscheduled revenues. With 10 months of data from increased Beti usage, we are incorporating the impact that our clients' ROI achievement has on our model. … Combining our expected revenue growth and adjusted EBITDA margin, we're still on track to reach the Rule of 65 in 2023. As we look out to 2024, we have a number of strategic initiatives that we believe will further strengthen the value clients receive from our offering. We are making strategic performance and client value decisions that we feel are best for our long-term relationship with our clients. Our mission is to ensure and achieve client value, and that is our focus. Our guidance for the next 15 months assumes the impact from the strategic revenue decisions we are and will be making. As a result, we believe it is prudent for us to set expectations for 2024 year-over-year revenue growth of between 10% and 12%. We'll have more visibility when we provide formal guidance in early February. "
One area I like to look at with SaaS companies is their sales and marketing efficiency. PAYC historically has some of the best S&M efficiency in the SaaS, with a payback under a year and a half. Q3 is typically solid for PAYC, but it was quite terrible this most recent quarter. Based on its guidance, Q4, which is typically its 2nd strongest quarter, will be well below historical norms.
The company indicated that there were no issues with retention or adding new customers, solely blaming its Beti product for being responsible for companies running less payrolls to fix mistakes. The 10-12% growth forecast for 2024 is a deceleration from the guidance for Q4, although it could be low to reset expectations. The company could also face the impact from lower interest rates next year if the Fed reverses course, which could impact its EPS (this is found in other income and would not impact revenue).
PAYC had been performing as I expected until this most recent quarter, when the Beti cannibalization issues suddenly popped up and future growth expectations went from 20%+ to low double digits. The guidance the company issued is hugely disappointing, and what I expected to be a growth driver in Beti has turned into a major headwind. I don't think management expected the product to hurt its results as it has, but there isn't any turning back at this point.
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 an EV/S ratio of about 6.1x, based on the 2023 consensus for revenue of $1.68 billion. Based on the 2024 sales consensus of $1.87 billion, it trades at an EV/S multiple of 5.5x.
On an EV/EBITDA multiple, it trades at 14.5x the 2023 consensus of $707.9 million and 13.3x the 2024 consensus of $770.6 million.
In the past, the company has often traded at over 10x LTM sales. However, its growth has slowed significantly from over 30% to 10-12% expected next year.
On an EV/S basis, I'd value the company at about 6x 2024 estimates, which would be around $203, while on an EV/EBITDA level, I'd value it at around $208. Previously, I would have valued the company closer to a 10x EV/S multiple, but my expected growth of 20+% has been slashed to low double digits. As such, the company should trade at a much lower multiple on lower expected revenue, dropping my price target dramatically from $360 to $205.
Conclusion
Last quarter, I thought the sell-off in PAYC was overdone, but I do think its most recent sell-off is justified, as it is now projecting much slower growth and its sales and marketing efficiency suddenly has taken a turn for the worse. When growth expectations are reset so dramatically lower, the stock's valuation must follow.
Eventually, I'd like to see the company increase prices on Beti if it is dramatically helping its customers save costs at the expense of PAYC itself. The company should also look to readjust its cost structure as well. My initial thought is that PAYC likely threw in the kitchen sink when it gave its initial 2024 guidance, taking its medicine all right away to set itself up to beat and raise next year. If that proves to be the case, the stock should have an upside from my new $205 target.
I'm going to maintain my "Buy" rating for now, although I'm not nearly as bullish on the stock as previously, given the slower growth as a result of the unexpected negative impact of Beti on its results. I'll continue to monitor PAYC's S&M efficiency closely over the next few quarters to see if it can stabilize, or if it just continues to weaken, as well as commentary of cost cuts and price increases on Beti. I think both these steps could go a long way to helping improve the outlook for the stock after this bad turn of events. However, if S&M efficiency continues to weaken and no actions are discussed with regard to its sales force, I'd likely downgrade the stock.
For further details see:
Paycom: Q3 Sell-Off Was Justified