BLACKLINE INC BL
December 08, 2022 - 8:28am EST by
cuyler1903
2022 2023
Price: 63.85 EPS 0 0
Shares Out. (in M): 61 P/E 0 0
Market Cap (in $M): 3,900 P/FCF 0 0
Net Debt (in $M): 350 EBIT 0 0
TEV (in $M): 4,250 TEV/EBIT 0 0

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Description

Category killer, mission-critical software company with strong growth, free cash flow and extremely high potential strategic value.  GS has a misplaced (at best) sell rating on the stock that has recently depressed the shares, which I believe are heavily undervalued on a stand-alone basis and a possible double in a strategic sale.  

All characteristics of a highly attractive M&A target exist here:

  • Mission-critical, sticky, loved platform that demonstrably saves customers substantial money, generates tangible ROI

  • Extremely high gross margin business with pricing power

  • High free cash flow dynamics resulting from prepayment for services

  • Easily reduced/eliminated sales, marketing, general & admin expenses

  • Semi-retired founder Therese Tucker is a proven winner, holds a 4.4mm share ($275mm+) ownership stake, and already is a veteran of the private equity process via BlackLine's 2013 sale of a majority stake to Silver Lake (since realized)

  • CEO with experience in cashing from a strategic sale to Oracle

  • Investor Day in November got updated projections disseminated into the public realm

  • Single class of stock

  • This morning, the company issued an 8-K indicating a 95 person RIF that likely will add $20mm+ to the company's run-rate profitability, so I decided to go ahead and post my write-up now as I believe it's timely.


Based in Woodland Hills (Los Angeles), California, BlackLine is a subscription software company whose cloud-based financial operations platform manages and automates financial close, accounts receivable and intercompany accounting processes for over 4,000 large enterprise and midsize companies globally.  The company is recognized as the leader by end-user review sites including Gartner, G2 and TrustRadius.  BlackLine was founded by Therese Tucker in 2001 after leaving SunGard, where she served as chief technology officer.  Having graduated from the University of Illinois with degrees in computer science and mathematics, she built the initial BlackLine product offering and engineered its transition to the cloud in 2007.  Tucker continues to serve as Executive Chair and owns over 4.3 million BlackLine shares worth $250+ million.  In early 2021, Tucker promoted Marc Huffman to CEO.  He had joined the company as COO in 2018 from NetSuite, where he served as president of worldwide sales and grew the company from $3 million to $1 billion in annual revenue, when in 2016 it was acquired by Oracle for over $9 billion.

As an investor, I am attracted to mission-critical software companies that provide cost-effective services with a strong value proposition, whereby process automation saves customers substantial costs.  A software company’s ability to demonstrate an inarguably high ROI for customers not only facilitates the sales process, but also drives high internal gross margins and substantial long-term pricing power.  Further, as adoption continues to grow, network effects build as key employees consider such software deployments as table stakes for an efficient work environment.  Notably, my latest search of LinkedIn jobs for the term “BlackLine” returned well over 1,000 results.  In BlackLine’s case, the typical cost is usually equivalent to about 1 employee for SMEs and somewhat higher for larger enterprises with multiple divisions and complex organizational structures.

BlackLine, in my estimation, is a compelling case study in the enterprise software industry in that it is the truly indispensable platform for the office of the corporate controller, who oversees accounts receivable, contracts/billings, payables, purchasing, travel & entertainment expenses, general ledger accounting, SEC reporting and audit/tax.  Controllers typically oversee large teams across departments, which have historically relied on manual processes with inefficient/fragmented information sharing via network drives, emails and physical binders.  Controllers and CFOs have dealt with limited real-time data analysis, productivity inefficiencies, risks of inaccuracies/material weaknesses, cash management challenges and overworked/low morale department employees.  By automating critical functions, BlackLine provides clear visibility, accuracy and consistency in financial closings and compliance, while integrating securely with virtually all global ERP systems (Oracle, NetSuite, SAP, Microsoft Dynamics, et al.).  Uniquely, the company’s platform is truly system agnostic in that it supports files from (i) any single system, (ii) multiple systems in use and (iii) third parties on customers’ behalf.  BlackLine’s highly secure, ISO 27001 platform is attractive to clients in all industries, from casinos to government defense contractors, and the company is in process of migrating customers to Google Cloud Platform.

The company operates in a large and underpenetrated market that management estimates to exceed $28 billion, consisting of $18.5 billion financial close and $10 billion accounts receivable sub-markets.  Of course, I discount these marketing numbers heavily, and am focused on the simpler point that the company has substantial headroom to take market share, particularly from status quo manual processes, for many years to come.  In a recessionary environment, companies of all sizes are seeking efficiencies and cost savings, and independent research organization Nucleus Research released a study in 2021 calculating that BlackLine’s customers on Oracle’s ERP system generated $2.58 of cost savings for every dollar invested.

To that end, BlackLine has developed a global partner ecosystem that not only markets and sells the company’s software but also assists with implementation.  Unsurprisingly, some of the largest accounting and tax firms are on this list, as BlackLine not only makes their clients’ jobs easier, but it also makes their own audit and tax work more efficient, consistent and remote-friendly.

BlackLine has substantial pricing power, yet historically management has chosen to strike a balance between (i) maximizing pricing today and (ii) taking a longer view and growing its customer base while eliminating barriers to adoption.  Attesting to management’s success in this regard is its simultaneous realization of both higher pricing and rising dollar-based net revenue retention rates (110% in the second quarter).  In February, CFO Mark Partin commented:

“We’ve had a couple of record quarters of user expansion now also coming from global rollouts within our customer base.  And then all of that on a higher price lever.  Every year, we have annual price increases within our customer base.  And we also have a very high renewal rate, particularly in the enterprise.”

While BlackLine had been on my radar for quite some time, I became much more interested in the stock as the company’s valuation declined sharply earlier this year.  After reaching an all-time high of $150 per share in February 2021, the company’s share price has since fallen roughly 60%.

I estimate that BlackLine could end 2024 with run-rate revenue of $825-850 million and a gross margin of 80-82% (the current GCP migration is depressing GM by 3pp), implying roughly $675 million of run-rate gross profit.  With its current enterprise value of approximately $4.3 billion and based on my projections, BlackLine presently trades at roughly 6.4x year-end 2024 run-rate gross profit, the metric that I believe to be most relevant to potential strategic buyers with existing internal sales/marketing and R&D teams.  Management’s target 21-23%+ operating margin is after spending an extremely high 38-40% of revenue on sales and marketing expense and 7-9% on general and administrative expense, duplicative line items that could be largely eliminated by certain strategic buyers, or sharply reduced by financial buyers.  I believe this could quite easily be a 50-60% contribution margin business to a strategic buyer.

Should Tucker decide to exit, it is my belief that strategic bidders for BlackLine could be numerous, potentially including SAP (which has a key strategic reseller partnership today), Oracle, Microsoft, Salesforce, IBM and Workday.  The company could also be attractive to financial buyers.  To wit, BlackLine’s Los Angeles neighbor Clearlake Capital, a $70 billion Santa Monica-based private equity firm, purchased a 5.4 million share, 9%+ stake in the open market in the second quarter, an unusual transaction for a buyout firm that ordinarily operates in the private markets.  This transaction made Clearlake BlackLine’s largest shareholder.  Subsequently, during the third quarter, Clearlake took its stake up another 296k shares to 5.7 million shares, just under the 10% filing threshold.  

Further, BlackLine is no stranger to private equity.  In 2013, the company sold a majority stake to Silver Lake's middle-market fund, an investment which that firm has since realized.

On November 8th, BlackLine hosted an Investor Day, at which management indicated a clear path to a Rule of 40 company - 20-25% organic revenue growth + 21-23% operating margins.  Given subscription prepayments, free cash flow margins would likely be 1-2pp higher.  Therefore, on a continuous independent basis, I believe the equity is very attractive at current levels.  BlackLine’s balance sheet is strong, with 2024 ($1.15bn) and 2026 ($250mm) converts largely offset by $1.05bn of cash and marketable securities.  SBC has been running around $20mm/qtr, and I believe a large amount of this would be eliminated in a sale.

This morning, BlackLine issued an 8-K announcing that it was reducing its workforce by 95 people and said "The planned actions are primarily in response to cost reduction initiatives as the Company continues to focus on key growth priorities. The actions are expected to be substantially completed in the fourth quarter of fiscal year 2022, subject to local law and consultation requirements, which may extend the process in certain countries. Costs associated with the reductions are not expected to be material."  While I don't know the precise cost savings here, I suspect it is >$20 million annually.  This could be a first step in preparing the company to maximize value in a sale event.

To be clear, while BlackLine is positioned to thrive independently, this is a business that should be acquired, in my opinion.  In a sale event, the company could prove to be worth 10-15x recurring gross profit (Avalara, a business with some operational issues, recently sold to Vista for 13x gross profit), which could yield a $130+ equity value per share.

 

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's research, opinions and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Therese Tucker is a winner.  I predict it's just a matter of time until full value is realized.

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