2023-05-08 14:23:57 ET
Summary
- PowerSchool’s net revenue retention rate is holding strong at 109.1%, while ARR has increased to $612M.
- The company recently landed its largest Ed-Tech software deal ever at $11M and management believes more deals in this size range could be coming soon.
- Given the future growth and cross-selling opportunities, PWSC’s shares are now reasonably priced and downside risks appear limited.
Company Overview
PowerSchool Holdings ( PWSC ) is a software technology corporation that provides K-12 schools and districts with educational management solutions. The company's headquarters are located in Folsom, California; it was founded in 2000. PWSC offers products and services designed to streamline administrative tasks, enhance communication between educators, parents, and students, and promote student success. Student information systems, assessment and analytics, and learning management systems are some of the solutions provided by PowerSchool. The company is committed to enhancing the educational experience for students, instructors, and administrators through the use of technology. State education departments, public school districts, charter schools, independent schools, and virtual schools are served by the corporation.
Updated Strategic Investment Case
For a full overview of the PWSC investment thesis and discussion of competitive advantages, please see our previous article “ PowerSchool: Steadily Building A Wide Moat In The Ed-Tech Market ”. This section will focus on the progress PWSC has made year-to-date.
In our previous analysis, we highlighted PWSC’s strong market presence with over 50 million users worldwide and 15,000 customers in the government / educational space as a source of moat for the company. It appears that PWSC is continuing to build this moat and further strengthen its grip on these markets. During the Q1 earnings call, management highlighted PWSC’s successful landing of the company’s largest deal ever.
“One of our exciting wins was our largest ever deal, an $11 million plus bookings from Puerto Rico Department of Education for digitizing their entire K-12 infrastructure, leveraging our science and enrollment solutions across the territory, supporting over 250,000 plus students. We continue to see strong demand for our core student information system product, further expanding our clear market leadership.” Source: Q1 Earnings Call
The company also continues to build out its education-focused innovative software portfolio. Management noted that PWSC is the process of developing a number of AI focused solutions that will provide further efficiencies to school administrators and teachers. From the Q1 earnings call –
“We are also embedding generative AI models to support educators across our solutions. For example, we are launching automated content creation based on individualized student needs later this year. Other use cases like supporting administrators in curriculum planning and the launch of our PowerSchool Personalized Homework Solution next year will be further supported by generative AI.” Source: Source: Q1 Earnings Call
Evidence also continues to mount the PWSC’s products are very “sticky” and resonating well with customers over the long-run. Annual recurring revenue has now increased to $612M, up from $596M previously and PWSC’s net revenue retention rate remained strong at 109.1%.
PWSC continues to execute on its geographic expansion plans and cross-selling opportunities as well. This summer, the company is set to open its first sales and support office outside of North America in Dubai and has already announced a new channel partner to assist with reselling the platform in the region. On the cross-selling front, PWSC had several wins in its Connected Intelligence segment with Des Moines Public Schools, Fairfax County Public Schools, Epic Charter Schools and the Challenger School Foundation all selecting the platform.
Overall, the progress landing new customers, including increasing ARR, continuing product innovation and expanding globally shows that PWSC is executing on the strategic investment thesis and building a moat.
Financial Update
On the top line, PWSC continues to show strong quarterly revenue. Note that PWSC’s revenue growth is generally impacted by both the sales cycle and timing of implementations. Growth can thus be lumpy. In Q1 2023, revenues were up $10M YoY vs. Q1 2022. Additionally, management provided guidance that Q2 revenues could be up $10-$15M sequentially for a total of $169M - $174M.
The longer-term revenue growth thesis also appears to be intact as management noted on the Q1 earnings call that several larger deals are in the pipeline, but that the impacts of those probably would not be felt until Q1/Q2 of 2024 given the proposed implementation timelines.
PWSC’s gross margins also continue to remain very stable. GM% has not fallen below 64.4% over the last 12 quarters and came in at 66.5% in Q1.
If there’s a knock on Q1’s performance it’s likely that SG&A expenses increased by $4M to $49.5M in the quarter. Management noted that this increase is due to increased in-person sales activities, and continued investments in their sales and go-to-market functions which are necessary to fuel future growth. As a result, Q1 operating margin was -0.5% down from 4.1% in the prior quarter. This is definitely a watch area and potential investors should look to see if the sales and marketing investments are paying off in the next few quarters.
Turning to the Balance Sheet, the company’s cash and equivalents balance slipped by $70M to $64M in Q1. Management noted that this is largely due to the timing of renewals and annual bonus payouts. The first quarters of 2021 and 2022 also showed similar cash impacts, so there does not appear to be any concerning activity tied to the lower cash balance. On the liability side, the long-term debt balance remained stable at $727M.
Looking ahead to the rest of the year, management reiterated its full year sales guidance of $688-$694M and adjusted EBITDA of $222-$227M, a 32.7% margin at the midpoint. The sales growth guidance represents 10% YoY growth. Wall Street Analysts appear to be right in line with management for 2023, expecting $691M of sales and $225M of EBITDA. For 2024, analyst estimates increase to $762M and EBITDA of $255M. Given management’s commentary that additional larger customer wins could be coming, there appears to be a reasonable chance that PWSC may outperform these estimates.
Valuation, Risks & Outlook
In our February 2023 coverage of PWSC, we noted that although PWSC has strong market positioning, a solid growth outlook and products that are creating value for its customers, the overall valuation appeared stretched. At the time, PWSC was trading at 25.0x forward earnings. With PWSC’s stock price having declined to $16.49 on little to no apparent bad news, the valuation now appears to be much more reasonable at 16.5x next year’s earnings. With management’s confidence in the company’s overall customer pipeline and expectations that larger client wins are coming, PWSC’s shares are a buy at the current valuation. Another potential driver of outperformance are the cross-selling opportunities and expansion of wallet share with existing customers that leadership has also referenced.
The core risk to the buy thesis is likely a recession where schools, governments and educational institutions pull back on spending. In this scenario, given the stickiness of the company’s products and the efficiencies these products provide, major hits to existing revenue don’t seem likely. Instead, it’s likely that PWSC would experience delays in additional orders, landing new customers and cross-selling opportunities. While the valuation may contract some, ultimately, there would appear to be limited downside if the company can maintain its NRR and ARR near current levels. Longer-term the company must continue to fend off larger potential competitors from entering the space. As long as PWSC can maintain its current strong value proposition with customers, then it will likely remain more than competitive in the market.
One final consideration worth highlighting is that PWSC will hold its first-ever investor day on July 11 th this year. This is noteworthy, as we do not believe PWSC would be holding the event if management was not confident in the future outlook and growth story. For potential investors with a 3+ year time horizon, PWSC is a buy at current levels. In the event of a recession, if the price falls to the $10 - $14 range, this would likely be a strong buy opportunity and a chance for potential investors to load up.
For further details see:
PowerSchool: Rising Demand, A Reasonable Valuation, And Strong Customer Retention