Duck Creek Technologies (DCT) has seen a very successful public offering, no wonder, as this company is a SaaS play which these days seems enough of a reason to guarantee a successful offering. I am not that impressed with the performance of the company, as even if sales growth has seen a meaningful acceleration as of recent. The growth numbers, in combination with margin profile, as well as current 23 times sales multiple makes this a very easy avoid for me.
SaaS For P&C Insurance
Duck Creek is a SaaS provider of core systems for the property and casualty insurance industry. Over the past two decades, the company has developed great expertise in this market and has developed a low-code SaaS configurability technology platform. This works together with core processes of its clients for policy administration, management of claims and billings, working in conjunction with the core operating systems of its customers.
Greater user expectations, stiff competition and new risks create the need for agile and innovative software, as many P&C customer rely heavily on legacy systems which not only are inefficient, they are further costly to maintain and upgrade, while they lack flexibility.
Clients of the company include blue chip names such as Progressive, AIG, Berkshire Hathaway, Geico, Munich Re, and many others. This is a bit of a concern as these clients are typically quite large, resulting in some dependency risks. Furthermore, many incumbents such as Lemonade (LMND) aim to disrupt the market, and given their innovative practices, they perhaps circumvent the services of Duck Creek altogether.
IPO & Valuation Thoughts
Duck Creek and underwriters sold 15 million shares at $27 apiece, with pricing taking place far above the initial midpoint of the pricing range at $20, which thereafter was raised to a range of $23-$25 per share. The company will generate gross proceeds of $405 million with the offering.
With 128.3 million shares outstanding, now valued at $27 per share, the company supports a $3.46 billion equity valuation. Factoring in the gross proceeds of the offering and a small net cash position ahead of the public offering, I peg net cash holdings around $400 million, for a $3.06 billion valuation of operating assets. Note that shares now trade around $40, during the first day of trading. At these levels operating asset valuations come in around $4.7 billion.
If we look at the actual numbers the growth rates do not look that impressive, nor the margin numbers. The company grew sales just 2% in 2018 to nearly $160 million on which an operating loss of $6 million was reported. For 2019 trends look a lot better with sales up 7% to little over $171 million, yet operating losses widened to $14 million. Note that the business was a traditional software play so growth is held back by the conversion from a traditional business model to SaaS model. SaaS subscription revenues rose 31% in 2019 to $56 million, making up a third of total revenues.
For the first nine months of 2020 (note that the fiscal year ends in August) the company has seen real growth acceleration with revenues up 24% to $153 million, making the company comfortably on track to generate about $200 million in sales this year. Problematic remain the margins are gross margins are not as high as other software plays, as the company reported an operating loss of $7 million for the quarter.
With revenues trending at around $200 million a year, expectations are high at 15 times sales at the IPO price and roughly 23 times sales at $40 per share. After all, these sales are not growing at a very impressive rate, although recent momentum has been solid, yet the company continues to lose money.
I must say that I do not believe that this is a great investment opportunity. My biggest concern is that of the valuation, furthermore the losses, yet also a stiff competitive field as growth has been underwhelming a bit. Truth be said, the company has seen a big acceleration in growth and given that the company is transitioning into a SaaS model, it could very well be that sales and earnings have been ”understated” for some time as a result of this transition. After all, subscription based revenues are growing 50% year to date, yet given that they already make up nearly 40% of sales, the headwind becomes smaller by the quarter.
All of this, including the fact that the company has large clients and the industry is ripe for disruption, are additional concerns for me as I furthermore take note that Roper (ROP) just announced a $5.3 billion acquisition in this very same field. I actually covered that deal a bit in this article as Roper paid a 9 times sales multiple for a related company who reported revenues of $590 million, and reports EBITDA margins of basically 50?, while growing sales at double-digit growth rates. At the same time, Duck Creek basically reported flattish adjusted EBITDA numbers over the past year.
Hence, I approach the company and investment thesis with great caution, as I do consider the possibility that the SaaS transformation is weighing on the sales growth results and current margins. Hence, I am happy to keep a close eye on the shares and company in the coming quarters, yet here and now I see absolutely no compelling bull argument here.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.