INTUIT INC INTU
March 21, 2014 - 6:11pm EST by
go2bl93
2014 2015
Price: 80.00 EPS $2.92 $3.87
Shares Out. (in M): 284 P/E 27.0x 21.0x
Market Cap (in $M): 23,000 P/FCF 0.0x 0.0x
Net Debt (in $M): -1,000 EBIT 1,100 1,440
TEV ($): 22,000 TEV/EBIT 20.0x 15.0x

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  • GARP
  • margin expansion
  • Competitive Advantage
  • Revenue Growth

Description

I don't expect this write-up to get amazing marks as INTU is more of a “GARP” name than a traditional value name and given the stock chart, it doesn’t appear completely out of consensus.  However, I believe that there is definitely some controversy around this name (INTU was just touted as SZ’s top short write-up of the week) that causes disconnects from time-to-time, especially during tax season, which generally creates buying opportunities, though I’m happy to own it in size at its current valuation. 

At a high-level, I believe the company is an earnings compounder than can be owned through the cycle.  It has solid growth prospects, a very strong and shareholder-friendly management team, difficult to dislodge products, attractive margin characteristics/trends and trades at a reasonable valuation both on an absolute and relative basis.  For the tech-minded, this is a cheap way to play the shift from on-premise to SaaS which is not disruptive in the near-term and will drive upside in the long-term.  Finally, I believe this company is on the verge of accelerating revenues that will lead to multiple expansion.  There are a lot of nuances to this story and this write-up is meant to be more high-level…please feel free to ask any questions for those who would like to drill down further. 

Overview:

Intuit sells business/financial management software that handles such functions as accounting, tax preparation, payroll and payments to a wide breadth of SMB customers and consumers throughout the US.  Its brands/products include TurboTax, QuickBooks, DemandForce, GoPayment, Quicken, Mint.com and a number of others.  The company serves over 5M SMB customers and over 62M tax filers.  Earnings are highly seasonal as tax preparation is 45%/55% of revenues/operating income, so tax season (Jan-Apr) is generally a fairly volatile period and most of their revs/earnings occur in their fiscal Q3 (1/31-4/30).

INTU is a very innovative company with an excellent competitive moat, but its multiple has been generally compressed relative to history (used to trade at 25x+ with a similar growth profile as I expect going forward) for a few reasons:  half of the company’s revenue is exposed to the SMB segment of the economy, which has been fairly stagnant macro exposure for the last several years, software as a category has become more penetrated within the tax preparation world and hence revenue has slowed and competitive concerns, which I will address later.

Ultimately, I think that despite these issues, this is a low double-digit top-line growth business with operating leverage and strong capital returns in the form of share repurchases and dividends, which will drive the bottom-line total returns by 15-20%+.  This is ahead of what the Street expects and represents an acceleration going forward.  This type of setup with this type of business should result in multiple expansion (even from here), which provides plenty of upside into the triple-digits from here.  Growth drivers include:

  • Introduction of new Quickbooks online allows for an accelerated shift to higher-value SaaS subscribers as well as a renewed focus on adding new subscribers
  • Acceleration in tax growth off of a weak FY13 and what’s shaping up to be a moderately better FY14
  • Cross-selling new products into their existing base as SMBs continue to become more technologically sophisticated
  • Rebound in SMB growth in the US as the economy continues to recover

Recently the stock has been strong on the back of solid results within their tax business, which I believe validates their strategy and also sets them up to outperform not only this year, but next year as well.   Despite the fact that I couldn’t get around to completing the write-up after the stock sold off on their preannouncement in mid-February, I think this it is timely as tax season generally creates a lot of noise for this name, and I believe one should add on any tax-related weakness.  I believe the TurboTax brand will continue to be strong for years to come and any tax-related sell-off provides a cheaper point to buy what I view as the real asset, which is their cyclically depressed SMB segment right after a significant product launch that should drive increased customer uptake and an acceleration in growth.

Thesis:

  • Intuit is a very innovative company
    • SaaS - the company moved much of its delivery capability to the cloud before SaaS became a popular mechanism for software delivery.  This has made their incremental delivery costs minimal
      • INTU is actually the 2nd largest public SaaS company by revenue with over $2B in SaaS revenues
    • Big data - They have used their significant data assets and 16-17% of revenues for annual R&D spend to constantly develop innovative products for their SMB customers
      • Product evolution -  Accounting -> Payroll -> Payments (C2B, B2B, mobile) -> Marketing automation (DemandForce) -> Inventory mgt (?) -> (???)
      • Data set = 2B invoices, 1.5B bills paid, 1.6B vendors, 30M employees, $2T in commerce
  • This is a very defensible business that is characterized by strong financial returns and is run by a solid management team that has a history of execution and returning cash to shareholders
    • Defensibility/execution - this management team knows how to grow under almost any circumstances and did not comp negatively in either the 2000 or 2007 recessions
 
  2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Revenue Growth 16.3% 0.2% 19.7% 25.8% 13.1% 9.1% 12.5% 16.6% 14.9% 1.2% 0.5% 10.4% 6.0% 7.1%
GDP Growth 4.2% 1.1% 1.8% 2.6% 3.5% 3.1% 2.7% 1.9% -0.3% -3.1% 2.4% 1.8% 2.8% 1.9%
Outperformance 12.2% -0.9% 17.9% 23.2% 9.7% 6.0% 9.9% 14.7% 15.2% 4.3% -1.9% 8.6% 3.2% 5.2%
Note: 2012 excludes the divestiture of the healthcare business
    • Strong financial metrics
      • Revs/EPS have compounded 10/15% for the last 5+ years
      • >80% GMs that continue to trend up…operating margins have increased every year since 2003 (except 2008)
      • ROIC = 24%, 25% FCF margin, >50% EBITDA to FCF conversion
    • Management has returned ~$5.5B to shareholders since the beginning of FY09
      • $5B was through share repurchases
    • The reality is when you’re buying a business, you’re buying the management teamTheir director of IR is one of the best that I’ve come across…he is very knowledgeable and helpful in understanding the business
      • My view is that after knowing the management team for a few years and given their history of execution and handle on the business, this is not a management team I would want to bet against
      • Hence, I believe their narrative around having been through this type of SaaS transition before in tax while maintaining share, margins and good revenue growth has legitimacy
  • Intuit has a significant asset in its 5M+ SMB customers that currently use their software as the backbone to their business
    • Intuit has identified a $1B-$5B+ incremental cross-selling opportunity over the next several years within their current customer base and product offerings
      • They have been talking about this for some time and it hasn’t really been a huge growth driver; I think the recent release of the updated version of Quickbooks online will help to accelerate this opportunity
      • While not completely apples-to-apples b/c SaaS Quickbooks customers have higher attach rates of add-on products, but the company believes the LTV of a SaaS subscriber is 40% higher than a desktop customer
    • This business should experience low-teens growth or more over the foreseeable future and should come on at very high incremental margins (80%+) as additional costs are minimal
  • Given their strong competitive moat, Intuit has exhibited pricing power in recent years
    • TurboTax - Total revenue per filing has increased by 1-5% each year since 2009
    • Small Business segment - The company put through a $20 ASP increase in FY13 for Quickbooks
    • I will note that this year INTU is moderating pricing with the intention of aggressively expanding their customer base on the back of their recent Quickbooks online re-launch
      • They are shooting for 10M+ SMB customers over the next several years and have a goal of solidifying their competitive position from start-ups, particularly Xero (see Risks)
      • I agree with this strategy and do not view it as a sign of weakness
  • Growth in Intuit’s tax business is not permanently impaired; the underperformance in FY13 was driven more by an aberration in the overall market and I expect growth to sustain in the mid-to-high-single-digit range
    • While I acknowledge that much of the shift to digital has taken place within the DIY space (Software+DIY = ~40% of all returns….85-90% is software, 10-15% is DIY), while assisted (tax stores/accountants), I believe that INTU’s growth rate will still outpace the market for several years as there is still some share to be gained relative to the market overall
    2010 2011 2012 2013 2014
YoY Growth            
TurboTax Units   11.9% 13.6% 6.6% 4.1% 7.0%
Total Federal Filings   (1.3%) 2.1% 2.1% (1.0%) 2.0%
Outperformance   13.2% 11.5% 4.5% 5.1% 5.0%
    • Continued share gain will come from:INTU also has 33% market share in tax professionals, which is a $400M business with 60% operating margins that has and should continue to grow in the MSD
      • Paper – this shift will continue, although likely at a more measured pace than previously
      • Freefile/low value digital options - As returns become more complex, TurboTax’s ease of use may become more attractive for those currently using freefile
      • Assisted - while HRB claims there is no share shift from assisted to digital, recent data out of HRB suggests that assisted lost share in 2013 (-200 bps underperformance relative to the market)
  • Some of the cat is already out of the bag on FY14, but Tax growth in FY14/15 should reaccelerate as a result of three tailwinds:
    • Normalization of the overall tax filing market as 2013 was impacted by lawmakers’ late implementation of the fiscal cliff resolution and increased EITC regulation (200-400 bps headwind)
      • Results thus far suggest this is the first normal tax season since 2011
    • Healthcare regulation went into effect on 1/1/14, which will introduce new taxpayers, complicate tax returns even further and could create an opportunity for the introduction of new products
    • Tax experienced a 200 bps drag on growth in FY13 due to the outsourcing of its prepaid product, which will no longer be an issue in FY14
      • This will likely impact FY15 to a greater degree and could provide a tailwind for years to come
  • Possible SMB rebound and no EM exposure are tailwinds
    • Intuit’s revenues are derived almost entirely from the US (95%) which will help shelter revenues/earnings from any sort of macro issues in other geographies
    • 55% of revs are exposed to the SMB segment, where growth has been fairly stagnant
      • Should growth in the SMB segment rebound as the economy continues to recover, the company is likely to experience acceleration in over half of its revenues vs. the current contemplation of deceleration
    • Optionality on international growth going forward (currently <5% of revs)

Valuation:

While the valuation isn’t overly cheap (21x FY14 Non-GAAP EPS, 21x FY 14 FCF, 12x FY14 EV/EBITDA), it is trading well within its historical ranges and given my view that overall growth should be similar to recent years going forward (and could actually accelerate), I believe that this a good entry point.

  • Bear
    • 16x CY14 Street EPS of $3.73 = $60 (25% downside)
      • Current S&P multiple…INTU has only traded below this in depths of the recession
      • This would require a much more moderated view of growth going forward than I believe will occur
  • Base
    • 20x CY15 Non-GAAP EPS (~FCF) of $4.60 = $92 (15% upside)
      • Assumes modest share repurchase of 10M per year
  • Bull
    • 25x CY15 Upside Non-GAAP EPS (~FCF) of $4.85 = $120 (50% upside)
      • Assumes accelerating growth in SMB as cross-selling and uptake of the new Quickbooks online increases
      • Assumes 200 bps of acceleration in tax due to share gains and ACA tailwinds
      • Assumes incremental revenues drive strong margin expansion
      • Assumes all cash is used to repurchase shares

Key Risks:

  • Competition in Quickbooks – primarily Xero – is this the next WDAY/CRM vs. SAP/ORCL?
    • A lot has been made of Xero (of NZ) as a competitor as they launched a SaaS product out of New Zealand in 2006 and took the entire NZ market and also took a bunch of share away from MYOB in Australia…they also have significant backers that have capitalized the company for the next year or two
    • Most of the bear case that I’ve seen outlined has been around Xero inevitably repeating the success that they had in Australia in the US, without much mention of the fact that:
      • This isn’t the first attempt at disintermediating INTU in SMB by a significant competitor
      • INTU is taking this challenge head-on (which is what they’ve done in the past to solidify their competitive position) vs. MYOB, which was caught effectively sleeping at the switch
      • INTU has already been through the SaaS migration which lowered barriers to entry in Tax
      • I’m not really sure what problem Xero is trying to solve…these aren’t massive multi-million dollar license agreements with sizable implementation costs…this is attempting to unseat a competitively priced competitor with what is at best only a slightly better solution
    • Previously attempted disintermediation- Microsoft has attempted to disintermediate Quickbooks on several occasions, the most serious being back in 2004-05…they failed miserably and quit trying despite accounting software for SMB seeming like an obvious extension to their success in Windows
      • This was obviously a different time and world, but another example of how this management team has proven themselves against very worthy competitors in the past
    • Taking the challenge head-on- while I view Xero as a legitimate competitor abroad, I think their work is cut out for them in the US as INTU has been hard at work developing…I believe their release of the new Quickbooks online is partially (if not wholly) in response to Xero’s successes abroad
      • I think the knowledge base of those that know how to use/have familiarity with Quickbooks, the data integration companies have with Quickbooks, the familiarity that accountants have with Quickbooks (these are effectively INTU’s channel partners), the integration INTU is now driving with their new products (partnerships with Square, Ehealth as well as adding inventory management systems, payments, etc.) and that most users are happy with the product (high net promoter scores) will be significant barriers for any competitor
      • Unseating an incumbent is fairly difficult unless the product is significantly better or significantly cheaper, neither of which seem necessarily true in this case
    • Tax online transition- As mentioned above, TurboTax has managed a transition from desktop to online that started in the early 2000s…just by way of reference:
      • TaxAct was founded in 1998
      • TaxSlayer.com was also founded in 1998
      • TurboTax growth/margin metrics since FY07:
    2007 2008 2009 2010 2011 2012 2013
Pricing Growth   8.4% (2.8%) (6.5%) 2.7% (0.2%) 7.4% 0.2%
Unit Growth   6.2% 17.7% 14.7% 11.9% 13.6% 6.6% 4.1%
Revenue Growth   15.1% 14.3% 7.2% 14.9% 13.4% 14.6% 4.4%
Operating Margin   62.6% 64.0% 63.1% 65.2% 65.5% 61.4% 62.7%
    • What problem is Xero solving?- Given the high net promoter scores that Quickbooks receives and the significant value-add vs. annual cost (and cost of competitors), this seems to be somewhat of an attempt to fix a problem that doesn’t really exist
      • Unlike SAP/ORCL vs. WDAY/CRM, there isn’t a sizable pricing umbrella that competitors are under-cutting here…Quickbooks online and Xero are priced competitively with each other and Quickbooks desktop solution
        • An average SMB is paying $200-$300 annually
      • I’m not really sure most SMBs feel “beholden” to INTU b/c of their dominant market position…the net promoter scores and history suggest that it’s just a product that works
        • Bears often cite examples of folks complaining about Quickbooks on social media…that’s true for every company and these can obviously be manipulated
        • INTU has made it a point not to exercise their “monopoly” position and gouge their customer in the past and instead have focused on extracting value by creating value for their customers (sorry to sound like IR, but it’s been generally true)
    • So as per the playbook from previous competitive up-risings, INTU’s mgt has again taken the simple tact of improving the quality of the product to make it more competitive (if not better) at a competitive price
    • Overall, it is my belief that while Xero may have some success in greenfield opportunities and it is inevitable that they will steal some INTU customers, the market opportunity within SMB is still so large that INTU should be able to sustain solid growth rates
      • INTU currently has 5M of an addressable market of 7M with current products and 10M with lower end products…there are 29M SMBs in the US in total
    • All this said, this is a situation that bears close monitoring
  • Competition in TurboTax
    • There have been multiple competitors to TurboTax for many years (including HRB) and also new competitors recently, however churn has stayed fairly consistent and recent data points suggest that INTU is taking share
    • I believe that the company’s installed base, brand name, easy-of-use, marketing clout and continued innovation give them a sustainable competitive advantage
  • Growth in SMB outpacing Tax might cause margin degradation
    • Despite the fact that operating margins in Tax are 60% and SMB are 40%, incremental margins are similar given the company’s shift to SaaS, which should keep margin trajectory positive even if SMB growth outpaces Tax
  • Pricing pressure in tax
    • While some think this is inevitable, INTU has demonstrated that they are able to take price despite the competitive landscape.  INTU’s subscriber base has generally been fairly price insensitive for the product, as the value-add is very high relative to the price.  Notwithstanding, I recognize that new customer acquisition (particularly younger filers) may become a bit more difficult
      • SnapTax is an example of an innovative product developed by INTU to address this market
  • Churn in tax
    • INTU’s aggregate churn rate is fairly high (25% annually), however most of this churn is related to marriages, death and tax payers falling out of the system.  Retention among continual filers is anecdotally fairly high as the incremental effort to switch (re-entering all past years’ information, re-entering personal information, etc.) is not usually worth any promised cost savings.  If anything, I expect the churn rate to get better as INTU is putting a lot of effort behind increasing retention, which should actually help accelerate revenues
  • Multiple compression
    • I think that the franchise is sustainable and revenues/EPS should continue to grow at a consistently high rate, which should be enough to sustain the multiple
  • Regulatory risk relative to the tax code
    • When has the government ever simplified the tax code?  This should generally create a tailwind
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Acceleration in Turbotax revenues
Acceleration in SMB revenues
Rebound in US SMB
International expansion
 
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