Blackbaud – Investment Thesis

March 2024

All figures presented in US$ millions, except for per share data

All price data as of 3/6/24

Situation Overview:

Blackbaud, Inc (“BLKB” or the “Company”) is a vertical market software provider that primarily serves the nonprofit and education verticals.  BLKB offers fundraising, nonprofit financial management, digital giving, grantmaking, CSR, and education management solutions to 40k+ customers, including 80% of the most influential nonprofits and one out of every three Fortune 500 companies ¹.  

We believe that BLKB is an attractive target for private equity, with a market leading position in a fragmented industry, a portfolio of sticky, mission-critical subscription product offerings, and highly cash generative operations.  Our LBO math indicates that a bidder could feasibly pay a 25% premium to the current stock price and achieve a ~17% IRR over the next 5yrs.

While not the only outcome, we believe Clearlake Capital (“Clearlake”), the Company’s largest shareholder with ~18% ownership of the Company, is a logical acquirer.  In March 2023, Clearlake submitted a proposal to take BLKB private for $71/share, representing a ~26% premium to the Company’s 30-day VWAP at the time and in line with the Company’s current share price, which was rejected by BLKB due to valuation.  We anticipate an updated take-private offer in the near-to-medium term.  

We also hold the view that the market is overlooking the Company’s recent operational transformation, driven by pricing and cost cutting initiatives, which has resulted in the Company’s achievement of its “Rule of 40” target (defined as organic revenue growth + adjusted EBITDA margin) materially ahead of expectations.  With runway for further pricing growth, margin expansion, and anticipated capital deployment into accretive share repurchases and M&A, we believe BLKB represents an attractive investment opportunity at the current valuation of ~11x EV / FY25E EBITDA in either a take-out or standalone case.  

We believe the sponsor thesis for BLKB is:  1) Market leading nonprofit software company in an underpenetrated, fragmented industry.  2) Sticky, recurring product offering driving mid-to-high-single digit organic revenue growth through pricing and incremental growth opportunity from M&A.  3) Opportunity for continued margin expansion from operating leverage and cost rationalization.  4) Attractive FCF profile (adjusted unlevered FCF conversion = ~60-70% of EBITDA), significant operating leverage, and financing capacity.

We recommend BLKB as a long with a target price of $91.09 (25% upside).

Historical Financial Data ²:

LBO Math:

We believe a sponsor can comfortably pay a 25% premium to the current share price, which equates to a purchase EBITDA multiple of 13.5x.  

We have assumed a transaction date of 12/31/24 and transaction leverage of 6.0x applied to Cash EBITDA, calculated as Underwriting EBITDA (FY25E EBITDA) plus the FY24E change in deferred revenue, consistent with industry practice.  This implies equity of ~54% relative to the total consideration.  The 9% interest rate on debt assumed equates to a spread of ~370bps, estimated based on current interest rates and BLKB’s financial profile.

Our principal operating assumptions include: 

1. Revenue Growth: Equity research forecasts through FY25E.  Held constant thereafter at 5%, in line with the low-end of BLKB’s long-term organic growth target (mid-to-high single digits).

2. EBITDA Growth: Equity research forecasts through FY25E.  Held constant thereafter at 8.5%, with continued margin expansion from pricing, further operating improvements, and automation investments.  Forecast margin profile in line with management's long-term goal of Rule of 40+.

3. NWC and CapEx: Equity research forecasts through FY25E and constant margins thereafter.  

We believe a business with BLKB's financial profile at exit would transact at 15.0x+ EBITDA.  Based on the assumptions above and an assumed exit multiple of 15.0x (+1.5x compared to the entry multiple of 13.5x), we arrive at a five-year sponsor MOIC and IRR of ~2.2x and ~16.6%, respectively.  Even absent multiple expansion and any additional value creation initiatives a sponsor would underwrite to, we believe a mid-teens IRR is highly achievable.

Investment Thesis: 

1. Market leading vertical market software company in underpenetrated, fragmented industry

Nonprofits have a variety of core functions, including solicitation and collection of funds, donor relationship building, specific nonprofit accounting/tax/reporting requirements, etc.  Historically, nonprofits have utilized retrofit horizontal software or homegrown/ad hoc solutions to serve their needs, driving increased costs and inefficiencies.

BLKB offers 17 core products to meet the needs of nonprofits, educational institutions, and corporations, with a specific focus on fundraising, nonprofit financial management, digital giving, grantmaking, corporate social responsibility, and end-to-end education management solutions.  The Company’s flagship product, Raiser’s Edge NXT, incorporates CRM capabilities to help larger, well-established nonprofits implement more complex fundraising strategies and store significant amounts of data.

The Company’s main solution areas and capabilities are summarized below ³:

BLKB estimates a TAM of ~$20bn (breakout below) ⁴, with the Company’s largest end-markets being nonprofits and education (including K-12 and higher ed) ⁵.  These verticals are highly underpenetrated largely due to customer size (nonprofits with less than $500k in revenue account for ~80% of total nonprofits ⁶), with adoption of 3rd party digital/automation solutions (excluding core ERPs) for nonprofits and K-12 education estimated to be as low as ~40% ⁷.  BLKB’s core nonprofit customers are generally mid-market and enterprise scale.

Despite only 5-10% revenue penetration in core solution areas, the Company is a market leader in the fragmented industry, serving 40k+ customers, including 80% of the most influential nonprofits, 93% of higher education institutions with billion-dollar campaigns, 30 out of the 32 largest nonprofit hospitals, and one out of every three Fortune 500 companies ⁸.  Per an expert network call speaking to the Company’s position in the K-12 industry ⁹: “It's the go-to software.  It's what everybody uses.  There really doesn't seem to be much of a competitor [that allows you to work with all the different constituencies].”

BLKB’s main competition is point solutions provided by small, niche software players and homegrown systems.  The Company also faces some competition from larger, general software vendors, namely Salesforce, however these competitors often lack nonprofit-specific feature functionality and integrations out of the box.  BLKB encounters Salesforce in <5% of deals and win-rates against Salesforce are in-line with the corporate average ¹⁰. Major competitors by solution are summarized below ¹¹:

The Company wins against competitors due to its broad product set tailored specifically for the nonprofit industry, which has been streamlined and increasingly integrated over time.  The ability to cross-sell services is a key competitive advantage, and the Company’s go-to-market approach reflects this – BLKB’s sales team is split between account executives focused on new clients and those focused on selling additional products to current customers (land-and-expand model) ¹².  Cross-sell initiatives have been successful over time, with the Company selling an average of ~2.5-3.0 products per customer today, up from ~1.5 in 2013 ¹³.

2. Provider of highly recurring, mission-critical subscription offerings, with revenue growth supported by pricing and M&A

BLKB has a highly recurring revenue base, driven by its largely subscription-based business model.  ~67% of the Company’s revenue is contractually recurring and a further ~30% is transactional and reoccurring in nature, made up of donation processing (~55%), consumer giving (~20%), tuition management (~20%), and event-based usage (~5%).  In general, donations are highly resilient, with absolute dollar contributions to U.S. nonprofits declining only three years (1987, 2008, and 2009) from 1974-2014 on an inflation-adjusted basis, according to the Giving USA foundation ¹⁴.  

The Company has strong gross dollar retention rates of ~90% (down 1% YoY driven by the recent EVERFI acquisition).  This level of retention points to BLKB’s mission-critical offerings to customers, which serve as sticky, difficult to replace, highly integrated systems of record that facilitate revenue production, financial reporting, and operational management.

In March 2023, the Company began modernizing its approach to customer contracts in terms of pricing and tenure, implementing a 3yr standard customer contract term with mid-to-high teens rate increases at renewal and mid-to-high single digit rate increases annually.  The Company also implemented pricing increases for the transactional portion of the business, albeit at more modest rates.  

Previous contract structures were a mix of annual and multi-year contracts with mid-single digit rate increases upon renewal and no embedded annual price increases.  The financial impacts are expected to drive material acceleration in revenue growth, with the Company indicating a >2x increase in revenue from the FY23 renewal cohort in FY24E as seen below ¹⁵:  

~35% of the Company’s contracts were renewed in FY23, with ~30% up for renewal in FY24E, ~25% in FY25E, and ~10% in FY26E.  This pricing-driven revenue growth tailwind should support mid-to-high single digit organic revenue growth in the coming years.  Importantly, there have been no meaningful changes in gross dollar retention as the Company has implemented updated contracts, pointing to BLKB’s pricing power ¹⁶.  

Pricing uplifts are already flowing through to revenue – The Company exited Q4 FY23 with organic revenue growth >7% YoY and expects continued revenue growth in the ~7% range YoY in FY24E. The majority of FY24E renewals are expected to take place during the summer and at year-end.

Revenue growth may be supplemented by inorganic opportunities focused on vertical end-markets already served by other BLKB products or near adjacencies.  There is a large opportunity for such acquisitions due to the fragmented nature of the industry, with BLKB seen as an attractive acquirer ¹⁷ due to its scale, existing portfolio (driving cross-selling opportunities), and experience (BLKB has acquired an average of at least 1 company annually since FY10 ¹⁸).

3. Opportunity for continued margin expansion

In the past year, the Company has implemented strict cost management measures, including a reduction in headcount from 3.6k in Q3 FY22 to 3k in Q4 FY23, the migration of customers from private data centers to public cloud providers and renegotiated contracts with Azure and AWS, and a reduced real estate footprint as the Company has shifted to a remote-first workforce.

These cost-cutting initiatives have been highly successful – In Q4 FY23, BLKB achieved $11m in cost reductions YoY while revenue grew by $20m YoY, driving a 46% YoY improvement in adjusted EBITDA and a ~9% expansion in adjusted EBITDA margin YoY.  This, coupled with the pricing initiative, allowed the Company to achieve the Rule of 40 in Q3 FY23, ahead of expectations.

The Company believes there is room for further elimination of excess costs.  BLKB is currently still paying duplicative costs for its two remaining data centers and still maintains the ~172k square foot global headquarters in South Carolina in addition to leased office space in Washington D.C.  BLKB also sees opportunities for margin expansion from AI and automation investments.

The Company expects to see muted EBITDA margin expansion in FY24E, guiding to an adjusted EBITDA margin of ~33% at the midpoint (representing ~100bps of margin expansion YoY), driven by headcount-related costs associated with merit/cost of living increases and heightened investments in R&D and cybersecurity ¹⁹.  Over time, the Company expects pricing initiatives and the removal of aforementioned excess costs to drive greater margin expansion.  

4. Financial Characteristics

In a normalized environment, BLKB is highly cash generative.  Both FY22 and FY23 FCF were impacted by costs related to a nonrecurring cybersecurity incident.  Excluding these costs, FY22 and FY23 FCF would have been $154m and $214m, respectively, implying ~15-20% FCF margins and ~60% FCF to EBITDA conversion in both periods.  

Total FCF should continue to grow as the Company drives revenue growth and operating margin expansion through pricing and continued operating improvements.  As the Company is near its 2x net leverage target, we expect excess FCF to be used for share buybacks and opportunistic M&A.  On 3/4/23, BLKB announced it would be repurchasing 7-10% of outstanding shares in FY24E.  In the event of a take-private, BLKB’s FCF generation along with its sticky revenue base will support substantial leverage in excess of current levels. 

Risks:

1. Macroeconomic environment

The Company is exposed to economic slowdowns, which may impact the financial health and IT demand drivers for nonprofits.  Customers may opt to delay software implementations if IT budgets shrink, impacting net new billings.  

There may also be reductions in nonprofit donations and funding in a recessionary environment.  For example, donations to private charities in the U.S. declined by 8% YoY in FY09 ²⁰.  That said, only ~30% of BLKB’s revenue is derived from transactional revenues.  

2. Competition

The industry is highly competitive.  BLKB faces competition from homegrown solutions, point solutions provided by small, niche software players, and more general offerings from larger software vendors with substantial resources.  Market share loss to these competitors could drive slowing top-line growth.  

In particular, the Company may face increasing competition from Salesforce, which offers discounted CRM software to the nonprofit community.  However, unlike BLKB, Salesforce has limited nonprofit-specific feature functionality and integration out of the box.  The Company sees Salesforce in <5% of deals annually and has win-rates against Salesforce in-line with the corporate average ²¹.