2023-12-14 05:02:20 ET
Summary
- Reiterate the buy rating for VERX as it has strong growth momentum and pricing growth in FY24.
- Recent results show revenue growth, improved margins, and strong operating metrics.
- Vertex is well-positioned to navigate the current macro environment, with the potential for increased pricing and customer base through migration and acquisition.
Overview
My recommendation for Vertex ( VERX ) is a buy rating, as I believe the current growth momentum can continue in the near term, supported by the strong pricing growth in FY24 and the upcoming migration of ECC customers. Strong growth momentum should continue to support VERX's current above-historical-average valuation multiple. Note that I previously gave a buy rating for VERX because I believed the share price contraction was another great buying opportunity given that the competitive threat was not as impactful as it seems. The share price action so far proved that my recommendation was the right call, as the share price increased to my target price of $28 from $18, representing a 52% gain.
Recent results & updates
3Q23 was a great quarter for VERX. Total revenues grew 14.9% to $145 million, with subscription revenues growing 14%. Blended gross margin also improved on a y/y basis, with Subscription gross margin improving by 180 bps to 78.3%. An improved gross margin profile drove improvements in non-GAAP EBIT margins to 18.6%. Other key operating metrics also point to strong growth traction, which led me to think that VERX can continue its growth momentum. For instance, VERX reported ARR growth of 17.8% Y/Y as trends remained solid. Average ARR per customer also increased 16% to $112,690, marking the fourth time VERX has had an average ARR per customer of over $100k. This clearly indicates that VERX is making a lot of successful cross-sells. Total direct and indirect customer counts were also up sequentially to 4,303. Churn metrics also remained very healthy, with gross churn at 4% and the net dollar retention rate at 111%.
I believe VERX can continue its growth momentum and that its business model well positions itself to navigate the current macro environment. The current macro environment has forced many businesses to scrutinize budgets and cut costs to improve their balance sheet strength so that they do not get hit by any liquidity crisis. In other words, these businesses are finding ways to save costs. This plays right into the hands of VERX, as their solution is to help businesses be more productive, thereby leading to cost reduction. By automating many of the compliance tasks associated with VERX software, customers can reallocate labor to higher-value tasks. Here is where VERX's pricing structure shines, which I expect to be a growth tailwind in the near term. The current environment effectively forces businesses to drive more automation, leading to more usage of the VERX solution. This could happen through companies expanding VERX use cases to other divisions or geographies. As this happens, customer subscription tier pricing will go up, but the increased pricing will not be permanent yet. Management terms this as entitlements. In short, this leads to an increase in ARPU, or ARR per customer. However, this increased usage gives VERX the opportunity to increase the annual pricing charged to customers during re-contracts. I expect this to continue to be an ARPU growth driver in FY24. Also, remember that VERX typically raises prices by 5% a year. As customers typically have contracts that range from 1 to 3 years or longer, they are likely to refresh their contracts at a higher annual price to fit their current expanded needs before the 5% increment kicks in. Altogether, these drivers should be a big boost to pricing growth in FY24.
then equally balancing that out is the price increases on an annual basis, we offer price -- we have price increases on our software. It averages around 5 or so percent per year. So that is something that's important to keep in mind. from: 2Q2020 earnings call
In terms of new customer addition potential, I don't see much of a concern either. According to management comments last quarter, there are about 1000 customers still on ECC, which will be a major growth driver for VERX as these customers must migrate by 2027. Remember that ECC is a platform that SAP will stop supporting as they force migration to S/4HANA. There is really no other way out but to migrate. As many of these customers have a mix of homegrown and custom solutions, they will very likely need a third-party firm (e.g., a consulting firm) to help them with the entire migration process. Using channel partners is a key strategy to the VERX one-to-many strategy; as such, I believe they have built up good creditability with the big consulting firms. I expect VERX to be able to capture a good amount of market share through this migration.
Aside from these organic growth drivers, I also thought that the recently announced acquisition could open up more growth opportunities. On December 13, 2023, Vertex announced an offer to acquire Pagero Group AB for $555 million in cash. If this deal goes through, it is going to significantly expand the VERX addressable market, as VERX can benefit from the continuous transaction control [CTC] demand tailwind and other e-invoicing regulations internationally. Even though Pagero isn't making any profits right now, I think there are significant cost-synergy opportunities to boost profits, especially considering that Pagero has a gross margin in the high 80s. Additionally, Vertex has the opportunity to enhance Pagero's overall go-to-market strategy by leveraging its partner channel and recent investments in customer success., thereby extracting revenue synergies. Overall, I think the acquisition is a great move by VERX to strengthen its product offerings and position itself to take advantage of the increasing opportunities in electronic invoicing that are being driven by stricter regulations. Moreover, as a result of the merger, VERX will be able to offer Pagero's solutions to its existing customer base, which will boost wallet share and give customers a better overall solution.
Valuation and risk
According to my model, my revised target price for VERX is $34 in FY24, representing a 27% increase. This target price is based on my expectation that growth will accelerate to 18% over the next 2 years, as I expect the current growth momentum to continue. The pricing growth driver in FY24 and the upcoming surge of migration accounts are strong catalysts that support my assumption of growth acceleration. As the near-term growth visibility is high, I expect the valuation multiple to continue staying at the current level of 6.7x forward revenue.
Risk
A key part of VERX's sales strategy is to rely on its channel partners so that it can reach a wide range of customers efficiently. Hence, relationships with these partners are extremely important. If VERX is unable to fulfill the requirements of these partners (likely commission rates), it could hinder VERX's ability to grow the business.
Summary
In summary, I reiterate my buy recommendation for VERX. The recent quarterly results showcased robust revenue growth, improved margins, and promising operating metrics. I expect VERX to continue benefiting from the current macro environment. In FY24, VERX should see strong pricing growth, and alongside the impending migration of ECC customers, it bodes well for revenue acceleration. Additionally, the proposed acquisition of Pagero Group AB promises to broaden VERX's market reach and revenue potential.
For further details see:
Vertex: Growth Momentum Can Continue In The Near Term