Description

Executive Summary

nCino is mid-teens compounder, with excellent mission-criticality and customer captivity, that’s in the early innings of a steep path of margin expansion. nCino serves an attractive TAM in global banking and has the best product in its core market (commercial and small business lending) by far. This has resulted in strong unit economics, with 98% gross retention, 112% ACV-based NDRs (5yr avg), and 75% subscription gross margins. I expect nCino to compound revenue at ~15% CAGR due to 1) further seat penetration within existing customers, 2) new customer wins and international expansion, and 3) new module upsell. There is also upside in pricing optimization (management has yet to use the price lever) and plenty of room for opex efficiency.

nCino trades at 5x NTM Revenue and 8.1x NTM Gross Profit, multiples that are down 75% from 2021 highs and at significant discounts to vertical software comps. The stock delivers 20% five-year IRRs with a strong margin of safety due to: 1) highly sticky recurring revenues (98% gross retention), 2) untapped margin potential, and 3) low multiple with take-private optionality. For example, an LBO at a 30% premium to today’s price (7x NTM Revenue, 11x NTM Gross Profit) is a 3-4x deal, even putting aside numerous other levers for value creation. Note: Vista Equity took Duck Creek Technologies private in March 2023 at 10.7x NTM Gross Profit, and nCino has the better business.

Business Overview

nCino is a market-leading vertical saas company serving financial institutions, such as commercial banks, credit unions, and independent mortgage banks. Customers include Bank of America, Wells Fargo, TD Bank, Santander, Truist Financial, KeyBank, etc. nCino’s product is a system of record that helps banks digitize, automate, and streamline inefficient and complex workflows relating to a bank’s customer-related operations. These workflows are foundational to a bank’s business, including loan origination, account opening, and client onboarding.

Middle and back-office employees at commercial banks use nCino daily to do their jobs. Loan officers, portfolio managers, underwriters, credit analysts, and risk & compliance professionals work within nCino to more effectively onboard new clients, make loans, open accounts, manage the loan lifecycle, and address regulatory and compliance risks. Traditionally, these tasks were cumbersome, and employees found it difficult to collaborate. Banks still use a combination of internal custom-built software, legacy point solutions, and manual paper/email/excel-based processes for loan origination and account operations.

nCino has a unique delayed seat-activation business model. Small banks take 6 months to ramp while enterprise banks can take 2-3 years. For example, an enterprise customer that lands with a large upfront ACV contract for 1,000 seats is contracted to pay at a pre-determined schedule e.g. 300 seats activate in month 6, 700 in month 12, and the full 1,000 in month 24. While ACV is contracted on day 1, revenue recognition for large contracts occurs on a lag. This results in high revenue visibility as 2023 revenue grows based on 2022 bookings (management has 95% revenue visibility into 2023). However, net revenue retention can be misleading, as it is inflated due to seat activation growth. Instead, ACV-based NDR is a cleaner metric that tracks growth in run-rate revenue. This metric has slowed down significantly from covid highs of ~120% to my estimate of 106% today.

Key Investment Drivers

1. Banking is a large, attractive, and legacy vertical that’s still in the early innings of cloud adoption
2. nCino is a mission critical system-of-record for banks, with long-term sustainable differentiation and multi-decade business longevity
   1. Thousands of bank employees (e.g. relationship managers, loan officers, underwriters, credit analysts, risk/compliance) work in nCino daily to do their jobs and collaborate with colleagues. nCino can’t be turned off because it’s so critical for banks to make loans and open customer accounts
   2. When implemented, banks replace 15-25 legacy systems and standardize on nCino, replacing checklists, spreadsheets, and manual processes e.g. Bank of New Zealand, a large international enterprise customer, is refreshing their entire tech stack and replacing it with nCino wall-to-wall
3. nCino is the best product in commercial lending software and faces weak competition
   1. Competition in commercial lending systems consists primarily of old home-grown systems with custom-code and legacy point-solutions. There is no comparable competitor that’s a modern cloud-native platform in nCino’s core markets e.g. Abrigo is a good solution but primarily focuses on smaller banks and is thus small by relative market share. 14 of the top 25 US banks use nCino, while the remainder use home-grown systems
   2. While nCino dominates in commercial lending, retail lending is a more fragmented market with greater rivalry, but with primarily 20-year-old vendors e.g. Fiserv, FIS, Jack Henry, MeridianLink
4. Significant switching costs provide powerful barriers to entry
   1. Adopting nCino is a generational purchase with multi-year sales and implementation cycles. Banks require buy-in across many senior stakeholders and choose nCino as a long-term partner. When deploying nCino, banks also write custom code and staff IT teams to maintain that code, making it even harder to switch
   2. Upselling more modules has deepened platform stickiness
   3. nCino is becoming an industry standard for commercial loan systems. Employees list nCino as a skill on their resumes, and banks perceive nCino to be a safe investment
5. nCino has been successfully expanding its TAM internationally and into new product adjacencies
   1. nCino has built a ~$60mm ARR intl business (15% of total) since first moving into Canada in 2017. International subscription revenue grew 58% yoy (cc) in CY2022 and is expected to grow 40-50% yoy (cc) in CY2023. Blue-chip international logos include CIBC, Bank of New Zealand, Macquarrie, etc. nCino is only now hitting its stride in key European and APAC markets
6. Valuation: nCino trades at 5x NTM Revenue (8.1x NTM GP), which I find difficult to get much cheaper given long-term earnings power of 30%+ EBITDA margins, which has been proven out by the vertical system-of-record business model
   1. A low multiple, highly recurring revenues, and a mission critical product provide significant downside protection. nCino has excellent competitive positioning, mission criticality, and significant room to expand margins e.g. management has recently suggested price increases could be on the horizon
   2. Vertical software comps suggest nCino should generate >30% EBITDA margins at maturity. For example, Veeva, Bentley Systems, CCC Info Services, CDK Global, and Real Page have median EBITDA margins of 35%. MeridianLink (a competitor and legacy vendor) trades at 8x NTM GP with 37% EBITDA margins
   3. Comparable vertical saas serving financial institutions trade at big premiums
      1. Guidewire trades at 13.1x NTM GP with 15% growth and 1% EBITDA margins
      2. Duck Creek was acquired by Vista Equity in March ’23 for 10.7x NTM GP with 18% growth and 10% EBITDA margins

Why does this opportunity exist?

1. Fears of recession and the SVB regional bank crisis has caused RPO growth to decelerate to 0%. Investors worry about the timing of new deal acceleration and what steady-state growth will be in CY 2024
2. Banks are “out of favor” with many unknowns about the long-term structural health of regional banks. Vertical software companies often trade based on the perceived health of their end-market
3. Shift in the equity story creates investor turnover as the company goes through a “growth to profitability” business transition
   1. nCino IPO’d in 2020 as a hypergrowth saas company. Organic subscription revenue growth was 52% yoy in 2020 and 36% in 2021 with -5% EBITDA margins. Growth has decelerated massively to 20% yoy (2023), destroying buyside analyst models as numbers keep coming down. I estimate revenue growth will decelerate further to low-to-mid teens in 2024, as 2023 new bookings are expected to be weak, before accelerating in 2025
   2. At today’s valuation, there’s not enough growth to attract growth investors but not enough profits to attract GARP investors
4. Lack of investor interest in a small-cap stock down 66% from its highs and in a “bad neighborhood” of growth / unprofitable tech, facing macro headwinds and decelerating growth
   1. Public market investors lack interest, as the stock may not “work” in the near-term. In fact, numbers might get worse as new bookings for 2023 are expected to be poor, as customers pull back on investment spend. Investors are afraid to step in front of a growth story with risk of downward revisions
   2. However, market expectations are awfully depressed given the banking turmoil and negative daily headlines. We are close to or may already be behind peak fear

Risks – What could go wrong?

1. The TAM for commercial lending is smaller and more penetrated than advertised. 14 of the top 25 US Banks are already nCino customers. With 106-108% steady-state NDR, nCino needs new logo wins to sustain mid-teens revenue growth
2. Gross churn increases as banks consolidate and/or go out of business at an accelerating pace. The next few quarters will test the resiliency of the banking end-market as the economy slows
3. International execution needs to be strong and is key to the growth story
4. nCino’s Retail Lending solution fails to gain customer traction. Their retail product execution has been poor, as the Company has pulled the product back from the market multiple times
5. Poor cost structure optimization results in failed margin expansion and path to significant profitability
6. Management does another large M&A deal and loses capital allocation credibility. Management bought SimpleNexus for ~$1.2bn or 20x NTM Revenue in Nov 2021, top-ticking the market
7. Salesforce enters the market and builds a strong competing product on top of its financial services cloud

Catalyst

1. Private equity take-out
2. Price increases
3. New bookings come in better than feared
4. Macro headwinds reverse. Interest rates come down, and long-duration is back in favor. New customers revitalize technology transformation investments
5. Banking turmoil subsides and WSJ headlines of banks going the way of department stores disappear
6. nCino’s Retail Lending solution succeeds and becomes an attractive product in the market with strong customer uptake, substantially expanding nCino’s TAM and accelerating revenue growth
7. nIQ (AI product suite) becomes widely adopted and bolsters subscription growth while lifting margins
8. Management executes on profitable growth, resulting in outsized margin expansion