Description

Introduction

Bottomline Technologies (ticker: EPAY) is a misunderstood, value-oriented, catalyst driven name where the public market value of this FinTech roll-up is significantly below its comps and private market value.

EPAY provides software and manages payment hubs to enable electronic payments, invoicing, digital banking, fraud prevention and document management to both banks and corporates globally.

My price target for EPAY is $40-45/sh (33%-50% upside) over the next one year for the following reasons:

1)      Several industry trends driving increased demand and adoption from banks and corporate customers.

2)      Strategic players from adjacent industries are focused on partnering with and acquiring B2B Payment providers to participate in this high growth opportunity.

3)      The Company’s recent business model transition has led to 80%+ recurring revenue, and a double-digit revenue growth and expanding margin opportunity.

4)      Management has recently signaled that they are willing to shift from a strategy of growth thru acquisitions to one focused on better execution and disclosures that should help remove the valuation gap that currently exists relative to its publicly traded comps.

5)      Rapid industry consolidation sets up the Company to be acquired at a premium valuation or the board to sell parts of the business to maximize shareholder value.

Industry Trends

Bottomline competes in the business-to-business electronic payments (“B2B Payments”) market globally.  The product offerings in this market consist of software products to streamline accounts receivable collections, accounts payable bill payment, and global cash management as well as industry specific payment hubs for vendor sourcing, procurement, contracting, invoicing, ACH bill payment and settlement.

Goldman Sachs in a recent in-depth payments industry report estimated that the B2B Payments market generates $12B in fees across $23T in payment volumes globally. The market is expected to nearly double to $21B in fees and $41T in volumes over the next decade as corporates upgrade their back-end infrastructure to adopt more efficient and lower cost payment processes.  As a result, this large and mature market is expected grow at an above GDP rate of 6% annually for the next decade.

The B2B Payments market has been shifting to electronic form for several decades but the automation trend has recently accelerated due to 1) increased cost transparency and lower cost alternatives, 2) need for fraud prevention and 3) requirement for faster settlement times.  Today, B2B Payments are made mainly by paper checks (50% of all transactions), Automated Clearing House (ACH) transfers (32%), credit cards (10%) and wires (8%).   A Payments Costs Benchmarking Report published in 2015 estimated that the average cost (direct and indirect) of processing checks was $2-$4/payment, 2-3%/transaction for credit cards, $8-10/transaction for wires, and $.26-$.50/transaction for ACH.  The meaningfully lower cost, lower error rate, faster settlement time and ease of use of ACH transfers has led to its volumes growing by 50% in the past 3 years while check volumes are down by 20% over this period. ACH is expected to be the primary driver of the conversion from paper-based checks in the B2B market over the next decade.

B2B Payment products are either sold to banks who provide the products to their customers or directly to corporates who use it as means to lower the cost of paying and managing their vendors.  Given their broad and sticky customer base, recurring revenue model and high margins, B2B Payment products have become valuable to players in various adjacent sectors such as core banking, credit card processing and ERP software.

The core banking software industry provides back-end systems to banks that enable automated processing of customer transactions (e.g. account opening, deposit, loan and credit issuance).  As the number of commercial banks in the US has shrunk from 7,500 to below 5,000 over the last decade following the financial crisis, the core banking software industry has consolidated to five major vendors (FIS, FISV, JKHY, Misys Group plc, and QTWO) who have been actively looking for new products to offer their large, mid-size and regional banking customer base in the US.  As a result of the rapidly shrinking customer base, the core banking software players have expanded into B2B Payment products to grow their wallet share and drive revenue growth within their existing bank customer base.  These players initially entered the B2B Payments segment thru acquisitions of online bill payments software vendors.  More recently, they have acquired cross-border cash management and treasury solutions providers and payment hubs, many of which compete with EPAY.  For example, Fundtech, one of EPAY’s direct competitors, was bought by the private equity firm GTCR in 2011. It was then later sold in 2015 for a large gain to D+H Corp, a core banking software vendor.  D&H Corp was recently bought by Misys Group plc, a Vista Equity Partners portfolio company, to become the number four core banking vendor globally.  Fundtech’s cash and treasury management solutions along with its financial messaging products enables Misys to cross-sell more products into its existing client base.  FIS, the number one core banking software vendor globally, recently acquired Clear2Pay, a European payments technology provider with a bank service payment hub.

The credit card processing industry has also entered the B2B Payments segment thru acquisitions and partnerships to diversify from their traditional B2C market.  Credit card and debit cards comprise a very small share of the online and offline B2B Payments markets due to their high processing costs (2-3% of bill) and limited use case’s related to corporate travel and entertainment.  Recently, both Visa and Mastercard launched initiatives to gain a foothold in the B2B Payments market.  Mastercard Send and Visa Direct are lower-cost push payment networks that allow corporates, banks and governments to proactively send funds to a client’s bank account tied to a debit card. Though the costs of these debit transactions are 0.5% - 1.15%, less than the cost of an average credit card transaction, they are not as low as that of ACH-based transactions.  To continue to lower its cost structure for the B2B marketplace, Mastercard recently acquired VocaLink, a faster payments infrastructure provider in the UK, to compete even more directly with existing ACH networks in Europe.

The major ERP Software vendors have also realized that to meet the needs of their enterprise customers’ vendor sourcing and payment needs, they have to offer robust B2B Payment capabilities. For example, SAP acquired Ariba with its AribaPay product that includes a supplier sourcing and payment hub that also competes with EPAY.

Company Overview

Since its founding in 1989, Bottomline evolved from an outsourced check printer to a software developer of products and solutions for facilitating the transition from paper checks to electronic funds transfer. Thru the creation of standardized electronic file formats, EPAY enabled its bank customers to automate bill payment functionality for its corporate end-customers.  The Company went public in 1999 and through a series of more than 20 acquisitions in nearly 20 years, EPAY has diversified its customer and product offerings.  As the Company’s products, revenue models and competition are not well disclosed nor well understood by the market, I have attempted to describe the Company’s three product segments and its underlying major product lines.

Cloud Solutions

1)  Legal eXchange – acquired in 2011 for $54M

• SaaS-based legal spend management software and payment hub to help P&C and healthcare insurers and enterprises source, procure, invoice and pay multiple outside legal service vendors.

• Web-based portal that integrates with claims management and time and billing systems to automate the process of invoicing, routing and claims review, and manage day-to-day legal expenses.

• This payment hub includes 13K law firms and over 200 insurance customers where the average client saves 8% of their legal expenses annually.

• Revenue model – subscription service based on invoice processing fees + success fee based on cost saving realized.

• Competition –TyMetrix/Wolters Kluwer ELM, CSC/DXC, LexisNexis/RELX, and Serengeti Law/Thomas Reuters.  EPAY is the leading payment hub in this vertical with over 50% market share.

• FY17 Revenues were $59M and grew at 24% yoy.

2)  Paymode-X – started by Fleet Bank and Clariant in 2000, this business was acquired in 2009 from Bank of America (“BofA”) for $20M and integrated with EPAY’s own Business eXchange solution

• SaaS-based B2B electronic sourcing, payment and settlement hub solution for businesses.

• Web-based, bank-neutral portal that enables the exchange of electronic payments and invoices between payors and vendors and can be integrated with various ERP systems.

• Processing $200B in annual payment volumes with 365,000 vendors and 1,000 payers on the network.

• To drive increased volumes on its network, EPAY recently changed the revenue model from payer-pay to vendor-pay with a portion of fees returned to the payor in the form of a rebate.  Even with the rebates, the new model is approximately 4-6x more profitable.

• Bank channel partners that resell this product include BofA, RBS/Citizens, Trustmark, BoNY/Mellon and Fifth Third.  BofA, in particular, has been an important partner in driving new customer growth; EPAY has had a long-term reseller and service agreement in place with BofA since 2009.

• Strategic partnerships with Visa and Mastercard to integrate with their corporate cards.

• Competition – ACIW, AribaPay/SAP, Digital Insight/NCR, Clear2Pay/FIS, Bill.com, AvidXchange, as well as home grown systems from JPM, Citi, Syncada/US Bancorp and Wells Fargo. EPAY has one of the leading B2B Payment hubs in the market.

3)  Financial Messaging  – acquired two European financial messaging companies in 2013 and combined with its own US-based product

• SaaS-based platform to connect banks and corporate customers to the SWIFT global network.

• Enables banks and corporations to exchange cross-border payment instructions to facilitate settlements.

• Revenue model – primarily subscription-based.

• Competition – Fundtech/D+H Corp/Misys and Sungard/FIS.

• FY17 Revenues for Settlement Network Solutions (Paymode-X + Financial Messaging) were $96M and grew by 5% yoy.

Digital Banking

4)  Digital Banking Solutions – formed thru a series of acquisitions from 2000 to 2014 that cost over $200M

• White-label software for commercial banks to provide web-based and mobile portals to their corporate customers.

• Includes multiples solutions that enable cash and treasury management, real-time fraud monitoring, bill payment, as well as customer acquisition and new account opening tools.

• The Company’s legacy cash management business has nearly 150 customers while its recently-launched, next generation Digital Banking 3.0 (“DB 3.0”) platform has signed up over a dozen major banks and financial institutions.

• Revenue model – subscription-based that includes heavy upfront professional services for up to a 18 month integration cycle per customer; large legacy bank customers are slowly transitioning to the new product while EPAY is actively transitioning away from its small regional banks and credit unions (many of which were acquired from Intuit in 2012 for $20M) that don’t value the new platform.

• Competition – S-1/ACIW, Clear2Pay/FIS, FISV, JKHY and Fundtech/D+H Corp/Misys, Digital Insight/NCR, Oracle, and IBM.

• FY17 Revenues were $79M and are expected to grow by $5-10M in FY18 given the visibility that they have from two newly deployed customers.  Several customers are expected to go live in FY18 and FY19.

Payments, Transactional Documents & Other

5)  Cyber Fraud & Risk Management – acquired Intellinix for $85M in 2015

• Licensed based software products for financial institutions and healthcare organizations.

• Solutions that monitor, replay and analyze bank employee behavior on their terminals to flag and stop fraudulent activity and transactions.

• Revenue Model – licensed + maintenance.

• Competition – NICE, Detica/BAE Systems, and SAS.

6)  Healthcare Solutions – acquired thru a series of acquisitions for over $50M

• Document management software for hospitals and healthcare providers.

• Integrates with electronic healthcare records solutions to convert paper based documents and enable electronic document creation, capture, and storage; provides analytics to detect fraud.

• Revenue model – licensed + maintenance.

• Competition – Access, FairWarning, and FormFast.

Competition

EPAY has dozens of competitors across it various product lines but no pure play competitor that is in all the same product categories.  Many of its competitors have been smaller players that have been acquired by the core banking players, credit card processors and ERP Vendors. The B2B Payments industry remains very fragmented as there are many players that are solely focused on selling directly to banks while others that are focused on enabling enterprises to conduct electronic transactions but very few like EPAY that cross-over both types of customers sets.  As the industry matures, I expect it will continue to consolidate amongst a small set of players that will need to have the capabilities to cross-sell between both customer sets.

Financial Model

Though EPAY discloses its revenue based on standard revenue recognition accounting criteria, I have attempted to show the Company’s recent financial history based on the product segments retrieved from disclosures from footnotes in public filings and supplementary disclosures (see Table 1).  I believe re-framing the Company’s financials based on product segments provides a better understanding of the growth drivers and profit margins.

Similar to many other legacy software companies, EPAY has been undergoing a multi-phase business model and product transition over the last several years.  First, most of its “Established Products” (most products except Digital Banking) have transitioned to a recurring subscription and transactions revenue model from a traditional license plus maintenance model.  Second, it’s “Transitioning Products” (Digital Banking related products) have undergone both a revenue model change and a platform re-write as part of launching the DB 3.0 product.  This transition has been not easy as contracts are large, and require extensive professional services integration with a bank’s core banking systems.  The integration and testing of this new product has taken several quarters longer than expected where all costs were recognized upfront without any corresponding revenues.  In the last two quarters, the first two clients on DB 3.0 went live which enabled EPAY to start recognizing revenues.

Management’s recent disclosure of product segment revenue and margin details have started providing investor’s more visibility into the main drivers of growth and profitability. The Company’s Cloud Solutions product line is growing at 10-15% while EBITDA margins have doubled over the last five years to 23%.  The Payments & Transactional Documents product line has been transitioning a portion of its revenues from license to subscriptions causing revenue growth to be volatile though margins have held steady at 26%. The Digital Banking segment has underperformed the last several years as revenue growth has been inconsistent and margins have been stuck in the low teens.  Management believes that the transition to the DB 3.0 platform with live customers should enable more consistent revenue and margin growth for this product segment.

The Company’s business model and product transitions have led to a series of revenue and earnings guidance misses in the last two years while revenue growth slowed down from an average of 13% thru FY15 to 2% in FY17.  As a result, the stock has been range-bound between $20-30 for the last several years.  Now that nearly 85% of its revenues are recurring (in the form of subscriptions, transactions and maintenance) while DB 3.0 has begun to generate revenues, Bottomline is in a better position to re-accelerate its revenue growth (expects 7% in FY18 and 10% in FY19) and meet or exceed management’s $300M in subscription and transactions revenues and $100M in EBITDA targets by FY19.  The Company is expected to generate nearly $70M in free cash flow in FY19 as a result of positive working capital from its growing deferred revenue, low cash 5% tax rate (due to $140M in NOLs) and maintaining capex at current levels.

Balance Sheet and Use of Cash

Bottomline has a strong balance sheet and cashflow generation profile.  The Company ended its June 30th fiscal year-end with $127M of cash and plans to retire an upcoming $190M convertible bond maturity with a low-cost debt facility.  As net leverage is less than 1.0x, the Company remains significantly under-leveraged given its high recurring revenue, sticky and diversified customer base and strong margin profile.   In the past year, EPAY has spent $25M buying back 1M shares.  Management has also signaled that they are re-focusing their historical strategic priority of M&A to one focused on meeting their near-term organic growth opportunities, improving margins while using their free cash flow for stock buybacks.    

Table 1 – Current Valuation and Financial Model

Valuation Target

The Company is currently valued at 2.9x EV/Revenue and 11.7x EV/EBITDA based on its two-year forward guidance while its public comps trade at an average 2-year forward valuation of 6x EV/Revenue and 14x EBITDA (see Table 2)  The comparable M&A transactions in the sector are at 4x EV/Revenue and 22x EV/EBITDA (see Table 3).   Assuming the company uses its free cash flow for buy backs and applying a 14x EV/EBITDA forward multiple and 20x EV/EBITDA current year multiple, I believe EPAY’s stock is worth $40-45/share in one year under various scenarios.  My valuation is also supported by a sum of the parts analysis that applies a 10-12x EV/EBITDA multiple for the Digital Banking segment but a premium valuation to the rest of the business given their higher and more consistent growth and strong margin profile.

Risks

Management’s mixed history of meeting its financial targets along with making dilutive acquisitions is the primary downside risks in this stock in my view.  Another risk is the loss of a large bank channel customer such as BofA – which in fact has been a strong customer and reseller for over 8 years.  Though no customer represents more than 10% of revenues, the loss of a large bank channel customer would impact EPAY’s revenue growth.  I believe the downside in the stock is 10x EV/EBITDA which is historically the low point of where under-performing players in the sector have traded.  This implies a downside target price of $25/sh.

Catalysts

• Consistent execution that demonstrates the Company is on track to meet or exceed management’s $300M in subscription and transaction revenues target and $100M in EBITDA target for FY19.

• Increasing leverage to accelerate share buyback program.

• Activist investors or current shareholders (e.g. Vista Equity Partners) pushing the board to run a strategic review process.

• Potential separation of the Digital Banking segment to improve revenue growth, margins and multiple.

• Sale of the entire company to a strategic player focused on B2B Payments or a financial buyer that has a platform company in the space.

Given the stock is at $30/sh currently, I believe an investment in EPAY provides a very favorable risk/reward for long-term, patient investors.

Table 2 – Publicly Traded Equity Comps

Table 3 – M&A Comp Transactions

Disclaimer

My firm is currently a holder of Bottomline Technologies securities. This is not a solicitation to buy or sell securities. Please do your own individual research and thorough due diligence before transacting in any shares in Bottomline Technologies. We may buy or sell Bottomline Technologies in the future and are under no obligation to provide any update or details on our trading activities.

Catalyst

• Consistent execution that demonstrates the Company is on track to meet or exceed management’s $300M in subscription and transaction revenues target and $100M in EBITDA target for FY19.

• Increasing leverage to accelerate share buyback program.

• Activist investors or current shareholders (e.g. Vista Equity Partners) pushing the board to run a strategic review process.

• Potential separation of the Digital Banking segment to improve revenue growth, margins and multiple.

• Sale of the entire company to a strategic player focused on B2B Payments or a financial buyer that has a platform company in the space.