An investment thesis is a buyer’s rationale for making an investment, ideally backed by substantial analysis and in-depth understanding.
An investment thesis may incorporate known aspects of the business and industry, such as detailed financial models, assessment of the team’s abilities, secular trends, macro indicators, technical indicators, and so on.
An investment thesis is also likely to incorporate expectations of the future, which is inherently uncertain and results in unique perspectives.
As a long-term investor focused on compounders, I strive to keep my investment theses simple, easy to understand and digest.
Before diving into Paycom’s investment thesis, here is a brief overview of the company.
Business Overview
Paycom is a cloud-native provider of human capital management solutions delivered as software-as-a-service.
“We provide functionality and data analytics that businesses need to manage the complete employment lifecycle from recruitment to retirement. Our solution requires virtually no customization and is based on a core system of record maintained in a single database for all HCM functions, including talent acquisition, time and labor management, payroll, talent management and human resources (“HR”) management applications.”
- Paycom, 10-K filed February 2021
Paycom has approximately 31,000 clients across various industries. They have primarily focused on small-to-medium businesses and have recently looked to expand into larger clients, with their stated target client size range now being 50 to 5,000 employees. As of December 31, 2020, Paycom stored data for over 5 million people employed by their clients.
Their primary sources of revenue are recurring and composed of the following:
Recurring license fees for the software. Software licensing fees include a fixed fee component as well as a per-employee component for certain offerings.
Recurring usage fees. Paycom charges a fee for certain actions such as form filings and delivery of payroll checks and reports.
Interest earned on funds held for clients. Paycom manages payroll and therefore acts as an intermediary for those, as well as other, transactions. Collecting funds in advance of payments, Paycom invests the float for a short period.
Investment Thesis
Paycom is founder-led. Chad Richison founded the company in 1998 after working for a large national payroll company. He identified an opportunity for improvement and executed on it. Founder CEOs have historically been able to take larger bets focused on the long-term. They are driven by more than the immediate business metrics and look to make step-function changes. Chad Richison is more than incentivized to generate results for shareholders, with half of his equity package contingent on Paycom’s stock price reaching $1,000 within six years and the other half contingent on Paycom’s share price reaching $1,750 by late 2030. The stock currently trades near $365.
Paycom has proven to be a winner, with a successful track record of compounding capital. Paycom has demonstrated high return on invested capital ranging 15-45% coupled with strong annual revenue growth ranging from 30-49% pre-COVID. Even throughout COVID, Paycom has sustained strong double digit ROIC and revenue growth. They have proven their ability to reinvest efficiently for growth across new clients and new product offerings.
Paycom’s revenue is a function of clients, their client’s employees, and interest rates -- all of which appear to be supported by tailwinds going forward. As the economy continues to reopen, new businesses will emerge, creating an opportune time to adopt new solutions. As mentioned in a recent article on employment metrics, there are roughly 10 million unemployed people looking for jobs. The generous fiscal and monetary policy has led to concerns about inflation, which would drive up interest rates. (Note, that while Paycom’s revenue may benefit from higher interest rates, it serves as a partial counter-balance to the valuation-multiple pressure that would be inflicted on high growth companies that rely on future cash flows.)
And finally, Paycom’s business is predictable and durable. The subscription-based business model provides predictability into the future. Their offerings are sticky: HR and payroll are not optional functions. Because every business needs these functions, the addressable market is naturally large and expanding. Paycom has less than 5% market share, providing a lot of room to run. Beyond being necessary and broadly applicable today, these services are likely to be even more relevant and critical over the next 10, 20, or 30 years. Human capital management is becoming increasingly important for the success of an organization and investing in better technological solutions is a logical extension to the trend.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
https://torrefinancial.substack.com
Disclaimer: This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, neither the author nor any of his employers or their affiliates have independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author and all employers and their affiliated persons assume no liability for this information and no obligation to update the information or analysis contained herein in the future.