Bottomline Technologies: Transitioning Business Model Is A Temporary Pain

Summary

Well positioned to monetize the changing digital payment processing space.

Transition to the SaaS-based revenue model has negatively impacted the growth, margins and stock, but the impact seems short term in nature.

Post correction, expectations and valuation look reasonable, whether the business stands alone or gets acquired.

Bottomline Technologies (NASDAQ:EPAY) seems to be suffering from the problems usually associated with any business model in transition, but it should be comforting that once the transition is complete, the changing business model should offer high growth with visibility, something that usually commands a better trading multiple from investors.

Since my previous note on the name, the stock is down almost 15% compared to a flattish market, failing to deliver on the promise offered by this B-to-B electronic payment network and digital banking solutions provider. The stock is bearing the negative impact of the revenue model changing from selling licenses to SaaS based, which in turn led to a negative impact on the profitability that is expected to last till 2017. The difficult market conditions did not allow investors to appreciate the long-term potential for the business to create value for the shareholders from this transition. But the pessimism surrounding the name is ignoring the fundamentals that are pointing towards good market demand and strong visibility, as evident from strong annual recurring revenue (ARR) trends and growing subscription and transactions.

A business model in transition

Investors of all hues may be happy of the eventual destination - the SaaS-based revenue model - but the concern is the transition period. At the beginning of the fiscal year, the company announced moving all digital banking products that are sold to the banks of all sizes to the subscription-based revenue model as part of a strategic plan to focus on and drive subscription and transaction revenues that constitute almost 57% of the total revenue right now. The new model coincided with the launch of the new digital banking 3.0 product set, which is driving strong interest from customers.

Because the revenues are deferred until the customer goes live, while the expenses of services are recorded when they are provided, there is a short-term negative impact on the P&L, more so if the shift is combined with strong demand. The company, during the latest quarterly results, reduced guidance due to the business model transition and the three large new business wins in the digital banking business. As the expenses associated with the new business awards increased, margins also took a hit since a SaaS sale compared to a license sale has a negative impact on the margins on the first two years. Because a multi-million-dollar revenue stream, post implementation, is highly profitable, predictable and may last more than a decade, forsaking the first few years of profitability still makes sense.

The long thesis intact

The fragmented payment processing and transaction banking industry is changing, and Bottomline with its cloud-based digital banking, fraud prevention, payment, financial document, insurance and healthcare solutions is one of the better-positioned players to monetize it.

Excluding the digital banking business, which is undergoing a transition, the revenues are growing at a decent double-digit rate, 14% on a constant-currency basis during the most recent quarter. Even below the top line, subscription and transaction revenues grew 15% and ARR year-to-date was up 73%, with total bookings for the quarter up 39%. There were 24 new wins for Paymode­-X while the legal spend management business saw nine new wins.

In the meantime, EPAY has probably the cleanest balance sheet in the space, with net debt of around $20 million versus much larger debt for peers like ACI Worldwide (NASDAQ:ACIW), Fiserv (NASDAQ:FISV) and Fidelity National (NYSE:FIS), which should work in favor of the company, in case consolidation heats up in the space.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.