BlackLine's Disruptive Business Model On Track In Third Quarter 2018

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About: BlackLine (BL)
by: BAM Investments

Summary

BlackLine is a cloud-based accounting software company that's disrupting the way accounting departments are performing monthly closing processes, which is evident by a third-quarter revenue increase by just over 29%.

The stock has more than doubled from its late 2016 IPO, despite not turning a GAAP profit due to investments in its sales force, support, and product development.

These investments, the company's strong balance sheet, and market disrupting value proposition will allow the company to continue posting rapid revenue growth.

Investment Thesis

BlackLine (BL) offers market software which has allowed it to post significant revenue growth in the past two years while investing in the company's sales force, support, and products that will benefit long-term shareholders.

While BlackLine is a relatively new player (formed in 2001) in the financial corporate performance management solutions, it has been mentioned in the same ranks as tech behemoths Oracle (ORCL), IBM (IBM), and Workiva (WK). BlackLine is a cloud-based accounting software company that helps companies create enhanced financial controls. Instead of relying on basic general ledger applications, BlackLine's cloud-based software manages financial data, reconciles balances from sub-systems, ensures accurate and complete closings, and monitors regulatory controls. The company ended the 3rd quarter with 2,494 customers, including Fortune 500 companies Coca-Cola (KO), Costco (COST), and Kraft Heinz (KHC). The company posted a strong third quarter of 2018 with revenue growth over 29% while returning investments into R&D and Sales. With the company projected a full year growth rate of 28%, I remain bullish on BlackLine's rapid growth projections.

Financial Results

When the company debuted in the U.S. markets with an IPO price of $17 per share, it was reporting operating losses. The company is still reporting operating losses on a GAAP basis; however, the company was able to use the funds raised in the IPO to pay off its pre-public debt - approximately $67.7 million was paid off in November of 2016, versus the debt-free balance sheet the company maintains today. This is indicative of an extremely strong balance sheet, and it hasn’t been maintained at the expense of growing the company’s revenue.

As seen in the chart above, the company has been able to increase annual revenues 62%, 46%, and 44% in the past 3 years, respectively. While the company has nearly matched 2017’s revenue metric in the first 3 months of 2018, the full year guidance provided by management of $227 million will bring the company’s year-over-year annual growth rate down to 28%. As with all new companies, as revenue grows, it becomes more difficult to continue achieving the ultra-high growth rates seen in the first few years as the pie gets larger. Despite this, BlackLine is obtaining new customers or selling additional licenses/products to existing customers, or likely both in this case. After adding 92 net new customers in the third quarter of 2018, the company finished the quarter with a customer count of 2,494. This was up over 19% year over year from the 2,091 a year ago and gives an indication that most of the revenue is from adding new customers versus selling new products and increasing prices on current customers.

BlackLine is trying to change that as new customer growth is likely to slow by trying to sell new features and products to increase the transaction price on existing customers. Additional services include Transaction Matching, Smart Close, and Intercompany Hubs-all designed to help streamline a company's monthly close process. With this rapid growth despite already established accounting software incumbents, it makes you wonder: What separates BlackLine from other solutions in a very competitive marketplace with much larger players? The three biggest advantages of BlackLine include cloud-based subscription model, customer service, and innovating culture.

Being a cloud-based subscription model helps BlackLine because they don't have to support legacy on-premise solutions like other older companies in the same space. This not only helps cut support costs but also leads to higher customer satisfaction. This is an area where BlackLine has excelled as the company provides 24/365 live global support for customers. Lastly, the company is bringing innovation to a market that doesn't actively accept change, but it has succeeded with a small portion of customers who have become raving fans. The company's account reconciliation and financial solutions were ground-breaking innovations from archaic handwritten and excel solutions that accounting companies have typically relied on.

This won't be an easy task, but BlackLine is clearly on its way. With over 2,000 customers, the company believes its solutions have the ability to target 165,000 customers globally, which is an estimated $18 billion market opportunity. The plan is to expand its current cloud-based financial corporate performance management to additional add-ons including Intercompany Accounting, ERP Automation, Close & Compliance Enhancements, and Robotic Process Automation. It is certainly difficult to entice corporate executives to spend money on accounting software. However, BlackLine helps offset license costs by requiring fewer resources to perform the same job. Despite requiring fewer resources, there is a higher quality of accuracy, internal controls are enhanced, and decision-makers are presented with close results in a more timely fashion.

With these benefits, the company should continue to be able to sustain growth for the foreseeable future. However, it's important to understand what's keeping the company from achieving profitability.

There are a few takeaways from the above analysis. First, the cost of revenue has decreased drastically and has been below the revenue growth, which is how a company grows gross profit. Revenue is expected to grow 28% year-over-year in 2018 while cost of revenue has only increased 22% (Note: both metrics have a slight accounting impact). This is a promising trend as it helps the company’s gross margins and shows the company’s scalability. The important thing to understand is what the company is increasing and whether it’ll drive more revenue growth. For example, it’s important for BlackLine to invest in R&D to extend BlackLine's leadership in the broader financial software landscape by further modernizing the company's technology and investing in its platform. It's important to note that, while the company isn't profitable now, management is investing in the company's future. It's important to see a newly public company focusing on the future instead of caving to the short-termism that public companies often fall victim to.

Despite the earnings call being a predictable positive update on the company's growth plan, the company provided positive reaffirmation on executing large deals, expanding internationally, and leveraging key partnership. BlackLine relies on partnerships with accounting firms, other accounting software companies, and other consultants to make that connection with CFOs and other important accounting personnel. With approximately 209,000 professionals currently using BlackLine, these connections are only going to get stronger and stronger as long as BlackLine continues investing in R&D.

Conclusion

The company's second-quarter results reaffirm that the company's growth plan is continuing to be successful with revenue increases from upselling, rate increases, and new customers. There wasn't any big news during the report, which means the company is achieving its business plan without any major hiccups. I believe BlackLine has a market-disrupting product offering, but it's going to require patience from shareholders. While it's going to take a lot of work to grow its customer base, I believe management is making all of the right moves for the future. By investing in the sales force, research and development and support, it's going to result in subscriber growth. With the high gross margins, the company has a very scalable platform that will reward shareholders with operational profitability. Additionally, the company has a strong balance sheet with very little debt on the books. I'm bullish on BlackLine, and I expect the rapid growth to continue as customers adopt its platform, and once the company has a customer subscribed - it will be difficult to transition from its products, which makes it an attractive investment.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BL over 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.