2023-03-23 05:42:14 ET
Summary
- QTWO’s TAM is expected to grow to $23 billion by 2026 as the demand for digital banking continues to grow.
- The company is focused on driving revenue growth and expanding margins, with a goal of achieving $1.2 billion in revenue and significantly expanding margins by 2026.
- QTWO currently trades at a forward EV/FY23 revenue multiple of ~2.5x, a discount to a peer group of financial software stocks that trade at a median multiple of ~5-6x.
- I keep a buy rating on QTWO stock with an end-of-2023 price target of $39, derived from an assumed forward EV/rev multiple of 4.5x applied to the FY24 consensus revenue estimate.
Thesis
Q2 Holdings, Inc.'s ( QTWO ) 4Q22 results were weaker than expected due to a one-time contract termination, but the company still achieved its best sales quarter ever with several big client wins. The outlook for 1Q23 is for lower revenue but improved profitability, which should be positive for investors during these uncertain times. Despite the temporary setback, I believe that QTWO is still a top player in cloud-based digital banking and that its current EV/revenue multiple is attractive for investors. The management has been execution well, driving high double-digit growth, and is targeting improved margins and revenue growth of ~20% in the medium term. I keep a buy rating on the stock with an end-of-2023 price target of $39, derived from an assumed forward EV/rev multiple of 4.5x applied to the FY24 consensus revenue estimate.
QTWO stock price movement YTD (Seeking Alpha)
Post Q4 Outlook
QTWO has provided a positive outlook for 1Q23, with decent revenue growth and improved profitability. The company expects revenue of $149-$152 million, a 12% year-over-year growth at the midpoint. Adjusted EBITDA is expected to be $10-$12.5 million. For FY23, the company expects revenue of $632-$640 million, with a $4 million impact from the contract termination and EBITDA of $62-$66 million. Despite the one-time contract termination affecting 4Q22 results, I believe the business fundamentals are strong, and I remain optimistic about the margin improvement forecasted for FY23. I am also encouraged by the consistent new deal activity and cross-sell/up-sell execution from management.
QTWO Financial Outlook for 2023 (Company Presentation)
Focused on innovation to drive TAM expansion.
Since QTWO's IPO in 2014, the TAM for the company has grown from $3.5 billion to $15 billion and is expected to grow to $23 billion as the demand for digital banking grows and QTWO continues to add new products and technology partners. I believe that the value proposition for QTWO's products is mutually beneficial and should result in a healthy demand environment for the next several years, as QTWO clients have historically generated faster deposit growth and stronger operating margins compared to FIs that use solutions from competitors or legacy providers.
Large and Rapidly Growing TAM (Company Presentation)
Deepening relationships through enhanced offerings.
QTWO is prioritizing the expansion of its existing customer relationships through increased engagement and cross-selling efforts. The company has identified a potential $3 billion opportunity in cross-selling to its current customer base, and expects this opportunity to grow as it introduces new products and features like commercial lending and analytics/machine learning capabilities. The company's average net revenue retention rate of 110% in 2022 underscores the potential for cross-selling, as well as the strong customer loyalty and retention enabled by QTWO's solutions.
Break Down of Cross Sell Opportunity (Company Presentation)
Aggressive Growth and Margin Expansion Targets
QTWO is focused on driving revenue growth and expanding margins, with a goal of achieving $1.2 billion in revenue and significantly expanding margins by 2026. While there was a slight deceleration in growth in FY22, largely due to pandemic-related impacts, management expects revenue growth of around 20% per year in the medium term until 2026, consistent with historical growth rates. In terms of margins, investments in emerging businesses such as loan pricing and BaaS kept margins flat in FY22, but management expects to expand gross margins and EBITDA margins by 150-250 bps and 300-400 bps per year, respectively, from FY23 onwards. I see these targets as achievable and are conservative compared to other financial SaaS stocks. The consistency of these targets with prior financial targets presented on 2019 analyst day supports the view that the model is scaling as planned, with significant growth and margin expansion opportunities ahead.
QTWO historical revenue growth and gross margins (Ycharts)
Valuation
QTWO currently trades at a forward EV/FY23 revenue multiple of ~2.5x, a discount to a peer group of financial software stocks that trade at a median multiple of ~5-6x. I consider a modest discount reasonable given the lower LT gross margin trajectory relative to peers. However, I expect QTWO shares to re-rate higher and the valuation gap to narrow as the company executes against its MT financial targets. My end-of-2023 price target of $39 is derived from an assumed forward EV/rev multiple of 4.5x applied to the FY24 consensus revenue estimate.
QTWO valuation multiple vs. Peers (Ycharts)
Risks
QTWO’s primary customer base comprises of regional and community financial institutions (RCFIs). A consolidation or a downturn in the financial services industry could cause a reduction in spending on virtual banking solutions by RCFIs which would have consequences for QTWO. This could also result in RCFIs holding onto older legacy systems, which they have already invested in. Additionally, if RCFIs are acquired by larger institutions with their own virtual solutions, they may lose customers. Moreover, Q2 is investing heavily in sales, marketing, and research and development to achieve growth in a highly competitive market. However, this may lead to higher-than-anticipated costs to sustain this growth, which could slow down the company's path to profitability.
Final Thoughts
QTWO is a strong player in the digital banking software industry, serving banks, credit unions, and FinTechs. The COVID-19 pandemic has accelerated the trend toward cloud-based digital banking, and QTWO is consolidating its position as a market leader due to its wide range of product offerings. I expect QTWO to continue to dominate the retail-focused banking sector while also expanding its corporate banking capabilities, leading to sustained high revenue growth in the medium term. I keep a Buy rating on the stock with an end-of-2023 price target of $39 on the stock.
For further details see:
Q2 Holdings: Attractive At Current Levels