PAYC – Paycom: A Valuation Story Written by SaaS Metrics

This is the first in an ongoing series of research pieces examining Paycom (PAYC-NYSE) business and share price. We believe both an absolute and peer enterprise SaaS valuation in relation to Paycom’s growth is the best way to determine whether the stock is a buy or sell. Paycom is an enterprise SaaS company primarily offering payroll software services. It is seeing revenue growth similar to a newer SaaS company, but has revenue churn and profitability closer to more established companies.

We also believe tracking the timing of the ramp up of its sales offices and sales teams is important to identifying when the sales (and potentially the share price) will surprise. We will expand on this point in future reports.

Exhibit 1. How the Stock has Traded

Source: Yahoo Finance, Perspectec

In order to help determine whether Paycom’s share price is more likely to increase or decrease relative to the NASDAQ, we have completed a SaaS comparative table and graph comparing Paycom with enterprise service companies including Salesforce, WorkDay and Cornerstone on Demand among others.

Exhibit 2. How Paycom Compares With Others On A SaaS Metrics and EV/EBITDA Basis  

Source: Perspectec, Yahoo Finance

Sales Growth Steady and Predictable: Dollar sales growth has increased from $73M in 2015 to $105M in 2016 and is expected to reach $105M in 2017. Sales growth is driven by new and maturing sales teams and the opening of new sales offices, of which management has provided guidance. Based on forecasts from the further opening of sales offices, we expect 2018 dollar sales growth to be $87 million. In terms of the lifetime value of its customer base, the company has seen revenue churn of 9%, generally in-line with established enterprise SaaS companies such as Salesforce.

Steady and Predictable Profitability : Paycom has managed to increase revenue and gross margin dollars at a rate faster than costs. EBITDA Margin % have increased from 17.9% in 2014 to 21.4% in 2015 to 28.7% in 2016. We are expecting EBITDA margins to be at 25.7% in Q3/17 and 25% in Q4/17 and to hover around 28% on an annual basis from 2017 to 2019.

EPS has outpaced revenue growth  Revenue grew at a CAGR of 44% from 2012 to 2016 with stable gross margins between 82% and 84%. However as company sw its sales offices grow revenue, EPS growth was 114% from 2014 to 2015 and 116% from 2015 to 2016.

Looking at a graph of historical and future net margins, we may be conseravtive on our EBITDA and net margin forecast.

Exhibit 3. How Paycom Compares With Others On A SaaS Metrics and EV/EBITDA Basis  

Source: Perspectec

Guidance consistently Beats on Sales and Adjusted EBITDA: Paycom’s reported revenue that exceeded guidance by 3% for both Q1 and Q2 of 2017. Adjusted EBITDA results beat guidance by 9% and 21% in Q1 and Q2 of 2017 respectively. There is no reason to believe this trend won’t continue. We have forecasted EBITDA slightly above company guidance.

SaaS Valuation: Based on its comparable SaaS valuation, we believe Paycom should trade at $87/share. We believe Paycom should trade at an EV of 45x its trailing 12-month EBITDA. The multiple is based on Paycom’s relative SaaS metrics. See our valuation section for more details.

Exhibit 4. Relative SaaS Valuation Leading To Target Price

Source: Perspectec, Yahoo Finance

Analysis of Downside Risk: The Affordable Care Act (Obamacare) is expected to account for 5% of PAycom’s revenue in 2017 through filings to the IRS that medium and large sized businesses have to provide. Trump signed two executive orders that will affect government subsidies to insurance companies and small businesses’ ability to buy coverage. We do not think these changes will affect the filings based on our analysis. Clients have a right to cancel agreements by giving 30 days’ notice, but the excellent retention rate and growing revenue indicate this risk will pose no harm.

What is Paycom? – Paycom is an end-to-end SaaS human capital (HCM) management solution that offers HR departments to manage their processes from recruitment to retirement. It was established in 1998 and went public in April 2014. It has roughly 2,000 employees. The software, developed in-house, is a single platform that integrates functions such as talent acquisition, time and labour management, payroll, talent management, and human resources management applications all in one application. Currently, most businesses use a variety of software to administer different HR functions, costing time and money. The software is user friendly, and according to the Q2/17 earnings transcript, its employee self-service app is one of the top trending ones on the iOS Apple Store.

Market Oppurtunity – Paycom’s main driver of revenue is payroll processing for small to mid-sized U.S. companies. Paycom had 17,800 clients according to their 10-K published in February versus over 2.3 million businesses employing over 20 people in the United States. These businesses employ 103 million people according to the U.S. census bureau in 2015.

In nearly half of organizations in the U.S. with self-service technology, HR still manually enters up to 50 percent of their employees’ data. A survey of 705 market HR professionals by HR.com in June indicated that about 87% of executives thought self-service technology was the most efficient way to manage payroll and HR  data. This means the desire to move to self-service is widespread in the U.S.. Realistically Paycom has penetrated well under 2% of the U.S. market.

Recognizing Revenue – Fees primarily come from fixed amounts for each billing period, and another fee is charged per employee or transaction processed. Typically when employees are paid, Paycom receives a fee. The fees can also be a fixed amount over each period. The company’s competitive advantage is primarily due to a comprehensive software design that covers everything from hiring to retiring and consistent improvement and expansion of its product into talent management and HR functionality..

SaaS Growth versus Valuation – Customer life time value (CLTV) is an estimate of gross margin a customer will generate before they cancel their subscription. CLTV encourages companies to shift their focus from only profits to a longer term view of their client relationships, and apply a limit to their Customer Acquisition Cost (CAC) measure. CAC is the sales and marketing spent to acquire new customers, and CAC is part of Customer Growth Cost (CGC). CGC includes Sales and Marketing and Research and Development costs, which translates to total spend in developing more technology for clients and efforts to deliver the service to customers. We believe Paycom should trade at a 2018 EV/EBITDA of 45x. We based our analysis on comparable companies such as ADP, Workday, Salesforce, Cornerstone on Demand, Paylocity, and Netflix. We then combined these ratios with Paycom’s CLTV added TTM/CGC TTM and EBITDA. Our target price is $87/share over 2018. The EV/EBITDA ratio indicates that the market has undervalued Paycom and the CLTV added TTM/CGC TTM ratio indicates that the company is generating great returns from its marketing and research and development efforts. Companies to the right are a buy, and Paycom is a buy based both on trailing 12-month results and on 2017 and 2018 financial results.

Exhibit 5. Buy / Sell on a Relative SaaS Metrics Basis

Source: Perspectec, Yahoo Finance

Subscriber Growth – On an absolute basis, a CLTV/CGC above one means the company is acquiring customers a greater rate than it is spending to acquire and maintain customers. In other words its growth prospects are high. Paycom’s customer lifetime value (CLTV) divided by its trailing 12 month Customer Growth Costs (CGC) were 1.4x after its Q3 report. This is an acceleration/deceleration of growth. We believe the market under estimates this statistic, and that future growth is likely underestimated by the market.

Forecasting Revenue Growth through Sales Team quotas – While most companies will continue to increase Sales and Marketing and Research and Development costs if they can see a positive return within 12 months, the rate of increase would still be a question mark. As a result, we examine the growth and expected growth of Paycom’s sales offices and sales team and the likely impact it should have on revenue growth. (Should we put this revenue section in the Income Statement Below)

Exhibit 6. Revenue and Cash Flow from Operations ($Millions) Results and Estimates

Source: Perspectec

Exhibit 7. Q3/17, Q4/17, 2017 and 2018 Forecasts

Source: Perspectec, Yahoo Finance

Exhibit 8. Income Statement 

Source: Perspectec

Exhibit 9. Balance Sheet

Source: Perspectec

Exhibit 10. Cash Flow Statement

Source: Perspectec

Important Disclosures and Disclaimer

This publication is produced by Perspectec Inc. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure,

distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Perspectec Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, independent contractors, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof.

No publications, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments.

 This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Please refer to Persepctec Inc.’s terms of use disclosure and privacy policy https://perspectec.com/term_of_use

For the purposes of complying with NYSE, NASDAQ and all Self-Regulatory Organizations, Perspectec Inc. has assigned the following rating system BUY, HOLD/NEUTRAL, SELL for the securities which are the views expressed by an analyst, Independent contractor, and or an employee of Perspectec Inc.  The information and opinions in these reports were prepared by Perspectec Inc. or an analyst, independent contractor. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Perspectec Inc. makes no representation as to its accuracy or completeness.