A Takeover Target in the Cloud

09/17/2012 11:45 am EST


Rob DeFrancesco

Founder, Tech-Stock Prospector

Cloud-based storage is the new hot ticket, and this niche player is doing well on its own but could be a takeover target to boot, writes Rob DeFrancesco of Tech Stock Prospector.

Shares of Guidewire Software (GWRE), a provider of solutions for the property & casualty (P&C) insurance industry, have cooled a bit over the past few months. But the company’s long-term outlook remains promising, with management maintaining its annual revenue growth target of at least 20%.

Guidewire went public in January at $13 a share (above the expected range of $10 to $12), opened for trading at $16.75, and closed the first day at $17.12. The stock ran up to a high of $38.13 in late March before pulling back with the overall market, trading down to $22.40 in early June.

The company’s software—featuring a Web-based interface that is accessed either on-premises or via the cloud—is used for underwriting, policy administration, claims management, and billing. Customers generally implement Guidewire’s solutions as a replacement for legacy systems because the company’s offerings are more cost effective, efficient and easily configurable when it comes to workflows, rules and user interfaces.

According to IT research firm Gartner, the P&C insurance industry spends nearly $15 billion a year on software and IT services. There are approximately 7,000 P&C insurance carriers worldwide, with roughly 2,300 in the US. Guidewire CEO Marcus Ryu estimates that the company, which has more than 110 customers worldwide, has penetrated its target market by just 10%.

Guidewire’s ClaimCenter claim-management system is well regarded in the P&C sector, because it allows both large and small insurers to proactively manage claims in order to improve the speed and accuracy of the overall process.

In addition to ClaimCenter, Guidewire’s first product, the company offers PolicyCenter and BillingCenter applications, giving it the ability to cross-sell into its installed customer base. Up to a third of Guidewire’s revenue in any given quarter is generated by existing customers.

Co-founded by Ryu in 2001, Guidewire has a steady stream of recurring revenue (roughly 70% of its license revenue comes from term contracts that are billed annually), and its average initial contract length is rather long at five years; full software implementations generally take anywhere from 12 to 24 months.

For the fiscal third quarter (April), Guidewire reported EPS of 10 cents, 13 cents better than an expected loss of three cents a share, on revenue of $57 million (+28.1% year over year), vs. a consensus estimate of $52.2 million.

Rolling four-quarter recurring revenue showed growth of 30%. Gross margin came in at 60% and operating margin at 16%. Adjusted EBITDA rose 43% to $9.9 million, resulting in an adjusted EBITDA margin of 17%. Guidewire’s long-term EBITDA margin target range is 20% to 24%.

The company continues to add new customers at a healthy pace, recently bringing on Penn National Insurance, which is using Guidewire’s Billing-Center as its new billing-management system. Penn National went with this solution because it allows the insurer to provide real-time billing information on the Web and offers the flexibility needed to support new products and billing plans.

With BillingCenter, Penn National will improve customer support by giving policyholders self-service options, increase new business and retention rates by introducing new payment methods, and boost operating efficiencies by automating certain processes to speed up the resolution of agent/policyholder inquiries.

Guidewire’s recent market cap of $1.42 billion is 5.2 times the fiscal 2013 (July) consensus revenue estimate of $270 million. This valuation is not unreasonable given Guidewire’s strong top-line growth and the fact that its healthy renewal rates on term contracts provide good visibility at the start of each fiscal year. The company has $201.9 million in cash & investments on its balance sheet.

While Guidewire should do fine on its own, it is the type of niche, cloud-based software provider that could eventually get scooped up by a much larger vendor such as Oracle (ORCL) or SAP (SAP).

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