Description

I recommend shorting Blackbaud on its excessive valuation, low LTV/CAC, and increasing competition. By my estimates, BLKB has 60% downside to fair value.

Background:

Blackbaud provides enterprise software for non-profit organizations (NPOs). Their software helps NPOs with customer relationship management (CRM), fundraising, analytics, payment processing, and accounting. The company has about 35,000 customers in 60 countries, but nearly 90% of sales are generated in the US.

Blackbaud is the largest software provider focused on the highly fragmented NPO industry. The company estimates their TAM is worth $7 bn, growing at a 7% cagr, and is 15% penetrated.

The company has been going through a transition over the past decade from a license-based model to a subscription model. Currently, 65% of sales are from subscriptions to cloud-based services, up from 28% five years prior, and if one includes maintenance revenues, recurring revenue represents over 80% of total revenues. This transition has been led by a new CEO from Fiserv, who took over 3 years ago, making a strong push to move the company to the cloud. In addition to the cloud transition, the company has been aggressively acquiring adjacent companies to expand its portfolio of products serving the NPO market, with 6 acquisitions over the past 3 years.

Why is BLKB a short?

The "turnaround" that has driven low teens eps growth over the last few years and dramatic multiple expansion has come from declining net present value customer acquisitions. Over the past three years, customers have grown at ~7%, and organic revenues at ~8% a year, but sales and marketing costs have grown at 18% per year, pushing customer lifetime values near to their acquisition costs -- see historical chart below (assumes 93% retention rate and 10% discount rate):

A recent Credit Suisse report on SaaS unit economics shows how poorly BLKB compares against its peers in this metric -- it’s 6th worst:

In other words, as BLKB has shown dramatic growth, it has added limited, and progressively declining economic value while its forward P/E has expanded from 22x to 40x.

As BLKB has spent more and more on sales and marketing per customer acquired, it has also spent more and more on acquiring other companies to add incremental tools (analytics, online checkout, etc.), adding leverage. Over the past 5 years, the company has spent 1.4x its cash flow from operations on acquisitions -- 760 mm vs. 550 mm. These tools have not had an apparent impact on growth, and have driven net debt/ebitda to 2.7x as of the last quarter.

In addition, competition is sharply increasing. Salesforce offers the first 10 licenses to NPOs for free, and provides sharply discounted rates for additional licenses. Salesforce has already donated licenses to over 30,000 NPOs (vs. BLKB’s 35,000 customers), and reported a 60% growth in subscription revenues to NPOs last fiscal year (growth in number of organizations would be even higher since the first 10 licenses do not generate revenues).

Over time, with Salesforce’s massive scale advantage (its R&D budget is 13x that of BLKB) and open source platform where third party developers can build apps, it should be able to outcompete Blackbaud’s closed system.

In addition to the threat from Salesforce, there are numerous other, small, niche entrants providing cheaper alternatives. One non-profit technology expert we spoke with said that BLKB software was “pretty bad (old-looking) and there are a lot of new, cheaper tools coming on the market,” like Classy, Kindful, Neon CRM, Crowdrise, DonorPerfect Mobile Cause, Pledgeling, Givelocity, and more.

Hence, competition appears to be significantly increasing both from large and small players, making it difficult for BLKB to alter the downward trend in lifetime customer value/acquisition cost.

Valuation:

Even with fairly optimistic assumptions, BLKB appears overvalued. I assume the company continues growing sales with its TAM, at ~7% per year, for the next 6 years. This compares with the company’s long-term targets of 6-10% organic revenue growth. I also assume it is able to expand operating margins to 24% -- above the company’s high end target of 300-600 bps of growth from its 2014 baseline of 17.5%, and its guidance of 20.5% for 2017. With these assumptions, I arrive at a 6-year forward, normalized earnings power estimate of ~$4.18. Beyond 6 years I assume the company continues growing at market rates, and hence, I apply a terminal, discounted market multiple (~9x) to this value to arrive at an estimate of fair value of ~$34 per share, or 60% downside to fair value, today.

Catalyst

Increasing competition impacts growth and multiple re-rates to an appropriate level.