BlackLine: It's Another Small Beat

Summary

• BlackLine posted another modest beat to analyst consensus, with revenue of $45.9 million exceeding consensus by $1.8 million.
• The company is dealing with the onset of revenue deceleration, with growth decelerating to 42% y/y from 46% in the prior quarter.
• BlackLine recently passed its one-year IPO anniversary and have doubled from the launch price of $17. Shares appear fully valued with little upside opportunity left, especially at ~8x EV/FTM revenues.

Well, at least this earnings quarter didn't knock BlackLine (NASDAQ: BL) completely off course. It's a strange reminder of how fickle the markets are, however: BlackLine's revenue growth accelerated to 46% y/y (up from 45%) in Q2, and the stock market responded by sending shares crashing ~20% in its first real "correction" since its red-hot IPO, as I covered in a prior article.

This quarter, BlackLine made its first foray into the realm of revenue deceleration. Revenue deceleration isn't abnormal, of course: no company can expect to keep growing at ~50% forever. With BlackLine approaching the ~$200 million revenue run rate, it really can't be considered a startup anymore (though CEO Therese Tucker does sport a hip flamingo-colored hairstyle!)

Like most software companies, BlackLine carefully manages its earnings expectations (indeed, as a provider of accounting software, it probably knows more about this topic than most tech companies) to deliver well-timed, formulaically crafted beat-and-raise quarters. The snapshot below, taken from Seeking Alpha, presents a good history of BlackLine's earnings releases since going public - a string of consecutive beats.

Figure 1. BlackLine earnings historyThis quarter was no exception, though the beat margin of $1.80 million was certainly wider than last quarter's $0.85 million. This doesn't fully explain, however, why investors chose to dump BlackLine over a ~1% beat differential last quarter.

There was virtually no reaction to BlackLine's earnings this quarter - though, this is standard fare for a small-cap company with ~200k in daily trading volume - that's about 1% of Microsoft's (NASDAQ: MSFT) average daily volume. BlackLine shares were basically flat on the day leading up to earnings and showed no change in postmarket trading.

BL data by YCharts

BlackLine's stock has recovered from its post-Q2 sell-off, rising nearly 20% in the past three months. One could be forgiven for thinking that BlackLine has built up momentum, but a bullish opinion now would be ill-advised.

Assuming BlackLine carries a ~35% growth rate into FY18, it trades at ~8x forward revenues of ~$220 million. That kind of valuation is no laughing matter. Indeed, BlackLine's rapid growth deserves some sort of a premium, but certainly not one that's double the valuation of Cloudera (NASDAQ: CLDR), which is also growing at ~40% and is trading at ~4x EV/FTM revenues, or Yext (NYSE: YEXT), which is growing at ~38% and is trading at 4.5x EV/FTM revenues. Among these recent IPO peers, BlackLine carries a massive valuation - the only ones that could match it are Mulesoft (NASDAQ: MULE) and Okta (NASDAQ: OKTA), both also trading in the ~8x range but sporting ~60% growth.

BlackLine is still too expensive for now. Though its value proposition is extremely compelling - its tagline is Continuous Accounting, meaning finance software that can help finance departments manage budgets and update the books in real-time with more reliance on automation. It faces plenty of competition in the space, though, from entrenched giants such as SAP (NYSE: SAP) and Oracle's (NYSE: ORCL) Netsuite.

There is a point at which Blackline would be a shrewd buy - and this would be in the ~6x EV/FTM revenue range, or $28. Indeed, shares almost hit that range after the Q2 fiasco. If a correction of that magnitude happens again, use it to your advantage; otherwise, stay on the sidelines.

Q3 recap

BlackLine had a good quarter, nevertheless - it's just nothing that causes undue excitement. Beat-and-raise quarters, after all, happen in the software industry with nearly 90% probability - the only disappointment in the Q3 reporting season so far is Tableau (NYSE: DATA), who also reported on the same day as BlackLine.

BlackLine posted revenue of $45.9 million, up 42% y/y from 3Q16 revenue of $32.2 million. Analysts had penciled in a consensus estimate of $44.1 million, or +37% y/y, indicating a 5-point beat.

The 40% growth threshold is an important psychological threshold - in the 40s, BlackLine can still be considered a "high growth" software company, whereas 30% falls pretty much in-line with other mid-cap, recently-public software peers. The fact that BlackLine was able to hold on to this growth bucket for another quarter is a positive fundamental indicator, even though it is decelerating 4 points from Q2 and will likely slip below 40% in Q4 (Who knows though? A re-acceleration in Q4 could send shares spiking).

Figure 2. BlackLine revenues

BlackLine's high gross margins - 75.8% in the quarter - stayed essentially flat from a slightly-higher gross margin of 76.6% in 3Q16. Operating margin, however, took a turn for the worse, with operating losses of -$13.2 million representing a -28.8% operating margin. In the prior year quarter, BlackLine had lost $7.2 million on $32.2 million of revenue, indicating an operating margin of -22.2%.

The majority of the operating margin decline was driven by an uptick in sales and marketing expenses, always the usual suspect. The company spent 72.7% of its revenue on sales in Q3, versus just 59% in the prior year.

Sales spending can't really be viewed as a negative though - in the software world, investors should really think of sales spending like industrial investors think of capex - as an investment into the future. This quarter's uptick in sales spending was certainly responsible for keeping growth above 40%, and may pay continued dividends into the future if BlackLine can re-accelerate its growth.

Optically, however, it's not good for near-term results. The company's operating cash flow declined to $3.5 million, down from $4.1 million in the prior quarter. Even more disappointing - the company reversed back into negative free cash flow territory, posting an FCF loss of -$0.5 million in Q3. In 3Q16, BlackLine had posted positive FCF of $2.9 million.

A delta of $3.4 million, in the grand scheme of things, is no big deal and can be chalked up to quarterly lumpiness. In terms of optics and how investors view results, however, the difference between negative and positive FCF results can be night and day, especially because BlackLine's positive free cash flow was a strong differentiator versus other mid-cap software companies that are typically burning through loads of cash. Free cash flow decline was definitely one of the reasons preventing the stock from a pure-positive earnings reaction.

What's the path forward for BlackLine?

BlackLine is still a fantastic company, even though its Q3 results fail to inspire. Its customer counts continue to climb nicely - the company added 113 new customers in Q3, bringing the total base to 2,091.

BlackLine also caters to an enterprise-leaning clientele - those that have complex, bureaucratic procurement and IT organizations that will likely never move off BlackLine software once installed. For a SaaS company, this is the golden ticket to customer retention and fantastic revenue stability. The Q3 earnings call highlighted several major enterprise wins for BlackLine - a "leading provider of digital banking products" with $6 billion revenues; a public pharmaceutical company with $21 billion in revenues, and a financial services provider with $24 billion in revenues.

The fact that large, Fortune 500 companies are deploying BlackLine is a strong positive indicator of its traction in the enterprise IT community. Reviews certainly praise BlackLine's ability to bring modern features into the staid world of corporate accounting, and this trend isn't likely to reverse anytime soon.

60-second summary: it's just the valuation that's in question

The key sound bite here: good earnings, good company, good prospects - just a bad price.

BL EV to Revenues (Forward) data by YCharts

As seen in the chart above, BlackLine trades at a premium multiple (multiples can vary based on the forward growth assumption; the true revenue multiple lies somewhere in the ~8-10x range, in any case a huge premium to the average software company). 42% growth and a just-breakeven cash flow picture doesn't really support that high of a multiple.

As we saw in Q2, BlackLine isn't prone to near-term volatility, with the stock tumbling 20% last quarter. Windows like these offer a fine opportunity to buy into BlackLine and bank on its long-term potential to continue disrupting corporate accounting departments; but without a pullback, the stock already prices in its expected slew of consecutive beat-and-raise quarters.

The play is simple: buy at ~6x ($28); sell at ~8x ($34). Beyond 8x, wait out on the sidelines.

Analyst’s 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.