Paycom Software: Not So Deep Dive
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(Ryan) What they do: Paycom provides businesses with a comprehensive human capital management solution. In other words they’re the software for the HR department.
Paycom provides a few different solutions that it often bundles together and sells as one. It groups these solutions into 5 categories.
1) Talent acquisition: Applicant tracking, onboarding, tax credits, enhanced background checks, E-verify. 2) Time and Labor Management: Tracking time and attendance, scheduling, time clocks and terminals, labor allocation. 3) Payroll: (majority of their revenue) covers a lot, but it’s basically the entire process of companies paying employees including Beti which is a mobile app for employees. 4) Talent Management: Managing workforce performance, compensation budgeting, position management (so org charts), and more. 5) HR management: A software solution for the core HR processes. Kind of a workflow tool for the HR department.
They’re somewhat discreet on pricing, so a wannabe customer has to set up a tutorial then gets quoted a price. Someone said that their 11 employee small business was quoted at ~$318/month.
(Ryan) History: Paycom was founded in 1998 by Chad Richison (still the CEO). Prior to founding the company, Chad worked in the payroll processing industry. But he eventually broke off and started Paycom as an online payroll service. Then it’s kind of a typical B2B Software story from there. They started adding customers and then thanks to feedback from customers, found new solutions to automate.
In 2011 they moved their headquarters to a 90k sq. ft office building in Oklahoma City. And the company went public in 2014. Since then the stock is up more than 2,000%.
According to 3rd-party research, the Human Capital Management market (HCM) is $17 billion worldwide and estimated to hit $24 billion by 2025
Crowded market. Competitors: Paylocity (public), UKG Pro, Ceridian Dayforce, SAP, Workday (but focused on large companies), Oracle, ADP, and many more
Paylocity has stronger reviews than Paycom on G2. 1700 reviews and 4.5 starts vs. Paycom with 816 reviews and 4.2 stars.
How much does being headquartered in Oklahoma City benefit their profit margins?
(Ian) Management and Ownership:
Chad Richison is the founder and CEO
Been around for a while (founded in 1998)
CFO has been there since 2006 so pretty solid team at the top
Insiders own about 17% of the company with Chad owning nearly 15% (largest shareholder by far
Chad was the highest paid CEO in 2020 according to the SEC due to stock grants
But they are in two tranches; half if stock hits $1000 within six years; the other half if the stock hits $1750 within 10 years (~1.5% of current shares outstanding)
Seems like he is in it for the long haul
True startup, built the first version himself (focused on simplicity)
Stock is up 25x since IPO in 2014
What do you guys think of equity grants like this?
Seem to be getting more popular
Enterprise value of $22.4 billion, ticker PAYC
Trailing EV/s of 25.7
Trailing EV/gp of 29.1
Trailing EV/FCF north of 150 (earnings have flatlined last year or so)
2.5 million in options outstanding vs. 57.8 million shares outstanding
Bought back around $100 mil of stock a year the past five years, share count fairly flat during that time
FY 2020 revenue was $841M, up 14% YoY
85% gross margins
27% OCF margins
Nearly 40% adj. EBITDA margins
Shares outstanding slightly decreased YoY
Surprisingly high SBC. 11% of revenue. Might be one-time recognition, because that doubled YoY
Annual revenue retention rate of 93%, and that includes businesses that cease operations. So pretty low churn
Client count reached 31,000, up 17% YoY
Revenue & cash flow were both lumpy last year due to covid and less form filings so better to focus on guidance.
(Ian) Balance sheet and liquidity:
$215mm in Cash
Funds held for clients, corresponding liability of client funds obligation
About $30mm in long term debt
Basically LIBOR plus 1.5% so not too high
Also untapped line of credit
Another $17mm in leases
Strong net cash position
(Ryan) No product experience, but they themselves say they only have 5% market share. So there are alternatives out there that businesses can choose from. But flip side, there’s still plenty of customers for paycom to capture.
(Brett) An online review: Pro: “The fact that everything is all together on one database, no moving between platforms for information. The same information for payroll is available for HR and vice versa. Also love the phone app” Con: “a bit costly compared to most payroll software companies.” Also, a lot of reviews seem to indicate it takes a bit of work to set-up
(Ian) Years ago my dad was working at a small organization with 50-100 employees that transitioned to Paycom and saved many hours of work each week. Helped them to be more efficient and Paycom worked with them on implementation to ensure everything was working well.
Future growth opportunities:
(Ryan) Expanding their sales operations in both new and existing markets. First 2 growth initiatives mentioned in the 10-k. Already have sales operations in 38 of the 50 largest metropolitan markets, but they believe they can increase the sales staff in those areas. For new areas, just adding more sales offices. Having in-person offices can help a ton with system implementation for surrounding customers and makes sense to be in all the metropolitan markets.
(Brett) BETI. launched this month. It is an app that lets employees do payroll themselves (approve paychecks). Value prop is to reduce steps and further simplify the process for companies, while also improving accuracy. This makes sense as employees are usually the ones to catch anything wrong with payouts, but typically after the fact.
(Ian) Already executing on this, but attacking large enterprises instead of only its traditional small and medium size businesses. Means that entire $24B TAM is available to them and makes sense. Not only do small businesses want simple solutions. Big businesses can benefit from the tools they are building as well
Highlights and lowlights:
(Ryan) Highlights: Automating and keeping up with some of the regulations is tough for businesses and Paycom makes it easy. Paycom is a great example of doing one thing really well. They continue to bolt on new solutions which make it just kind of a pain to switch. From a business side, they seem really efficient. Lowlights: I don’t know if they have a ton of pricing power. It might be annoying to switch, but it’s not impossible. Not like an Adobe or Autodesk.
(Brett) Highlights: Great margins, strong track record, and you can see the switching costs and comprehensive solution give them an advantage. Lowlights: Crowded market and heavy share dilution coming. Besides that really tough to find a lowlight, high-quality business.
(Ian) Highlights: I like the founder. I like the incentive program. Profitable since day 1. Solid business. One of every two customers is taken from ADP or Paychex. Lowlights: Crowded market, always the chance that someone new comes along. It is susceptible to economics swings because of pricing model based on employees and checks
(Ryan) Grows customer count at a double digit rate for the next 5 years or grows at high single digits with bigger enterprise contracts. Keep opex relatively low and reach 35% FCF margins. Trades at a terminal FCF multiple above 40x.
(Brett) This may seem a bit aggressive, but I think you need to expect $5 billion in annual sales within a decade to make it work at these prices. Asking the “When will this get to a 10% FCF yield” can ground you here.
(Ian) They hit the incentive target over the next 10 years and more than 4x. Continue to pick off clients from Paychex and ADP. ~20% FCF margins (approaching 40% EBITDA) and growing at +25%, recipe for success. 3 years of growth (this is at ~45x FCF which seems cheap at that point) 10-year CAGR of 23%ish gets this to $100B market cap at 40x FCF. Gets Richison his bonus, hard, but also hard to imagine he chooses that incentive plan w/o the aspiration
(Ryan) Bear case seems limited from a business standpoint. Worst case scenario seems like the market stays relatively fragmented. Paylocity and ADP Payroll or other solutions offer a good enough alternative that Paycom’s pricing power is capped. And then you see multiple compression. At worst, this lags the market for a decade.
(Brett) Valuation number-one and then competitive space starts seeing slowdowns in onboarding as transition to these cloud models matures.
(Ian) Growth does not pick up to pre-COVID levels and valuation holds this one stagnant for years, probably don’t lose capital if you hold it long enough, but definitely valuation risk.
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Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.