- Blackbaud has strong switching costs in a niche industry.
- Its past acquisitions have increased the debt burden for the company.
- Valuation appears cheap, but it comes with worse operating fundamentals and a risky outlook.
Blackbaud (NASDAQ:BLKB) has underperformed the S&P over the past 10 years, with returns at 115% compared to S&P's 140%. This is mainly due to the company's deteriorating sales growth and margins. Blackbaud's acquisitive nature and large debt load also increase the risk for the company in the future. The company's valuation is cheap compared to its peers, but it also has worse operating fundamentals.
(Source: Seeking Alpha Data)
Growth has been fueled by product development but mostly acquisitions
Blackbaud is the leading company powering the social good community. It has millions of users across over 100 countries, and 80% of influential nonprofits use its platform. By providing multiple software solutions like relationship management, payment services, and financial management, it has penetrated deeply into the niche fundraising and nonprofit market.
Revenue has grown from $320 million in 2010 to 900 million in 2019, representing an 11% compounded revenue growth rate. This growth has been driven by the company's shift towards cloud solutions and acquisitions. Blackbaud has migrated its on-premises software to the Sky Platform, which provides more flexibility in scaling its business in this niche.
(Source: Investor Presentation)
Blackbaud has also been acquiring companies like Just Giving in 2017 and Alternative.ly in 2016. This has allowed the company to grow its total addressable market by roughly $4 billion. Since its revenue is $900 million in the latest fiscal year, penetration is less than 10%. As such, the company still has a long runway for growth. To further penetrate the market, Blackbaud would likely acquire and consolidate smaller companies, while strengthening its sales team.
(Source: Investor Presentation)
Switching costs are high for the company
Having attracted nearly 80% of influential nonprofits, Blackbaud is likely to possess some form of switching costs. Being the leader in this space helps it create worth of mouth around its brand, which attracts more nonprofits that want to follow the leading standards.
As these nonprofit customers integrate their systems of record with Blackbaud's platform, it creates stronger inertia when it comes to switching platforms. These companies generally do not want to risk lost data and productivity, which leads to service disruption. An imperfect data migration could lead to huge amounts of frustration and business risk that would cause any company to think twice about switching from Blackbaud. Nonprofit organizations are also sensitive to change, which might require budgetary reviews. Hence, switching from Blackbaud to a potential competitor with better features is unlikely.
Large horizontal software companies like Salesforce (NYSE:CRM) would also find it difficult to penetrate this market due to the relatively smaller deals. As such, they would not have the same focus and resources dedicated to meet the needs of this market. The strength of Blackbaud's switching costs is also evident in its retention rates, at 92% with a large customer base.
But future prospects look uncertain
Despite its developments and many acquisitions, revenue growth has been slow in the single digits for the past three years. Furthermore, gross margins have declined from 60% in 2010 to 53% in 2019. Operating margins have also dropped from 8% to 4% from 2018 to 2019. These thin margins make inorganic growth risky going forward.
Due to past acquisitions, Blackbaud has $7.5 million of short-term debt and $460 million of long-term debt. With only $31 million of cash and about $20 million of free cash flow in fiscal 2019, it creates pressure on the company to settle these obligations in the future.
One of the key strategies of Blackbaud is to increase its total addressable market. However, it might be better to focus on improving efficiencies in its existing operations to optimize cost savings to expand free cash flow. Once Blackbaud has de-risked the company, it might then make sense to strive for growth.
Our TAM now stands at over $10 billion, and we remain active in the evaluation of opportunities to further expand our addressable market through acquisitions and internal product development.
(Source: Company's latest 10-K)
(Source: Company's latest 10-K)
Peer analysis shows that Blackbaud appears cheaper than the median EV/Revenue, EV/EBITDA and P/E ratios. This is mainly due to its weaker consensus EBITDA margins at 18.1% compared to the median of 31%, and the smaller consensus revenue growth of 1.8% compared to the median of 5.4%. As such, the cheaper ratios are justified with weaker operating fundamentals.
(Source: Atom Finance)
In an economic downturn, the discretionary nature of donations might result in the shutdown of some nonprofit organizations, which could increase customer churn rate for Blackbaud in the future. Hence, it is important that it manages its cash flow carefully and reduces its acquisitive nature to ensure that a recession does not put the company at risk.
According to TrustRadius, Blackbaud also faces competitors in this space that may lead to slower customer adoption on its platform. Some of these competitors like Salesforce have large resources to challenge Blackbaud directly. Although Salesforce is unlikely to challenge in a large way, it might steal some market share from Blackbaud's platform.
By targeting a niche category, Blackbaud has fueled its growth to become the leader in social software services. It exhibits strong switching costs from the company's high retention rates and will likely continue to generate cash flow from its loyal customer base.
However, Blackbaud's acquisitive nature to grow the company has increased its debt burden. This might be risky for the company in the future if a longer recession takes place, as higher customer churn reduces its debt-paying capabilities. The valuation appears cheap compared to its peers, but Blackbaud also has worse operating fundamentals.
Considering all the factors above, I would give this a miss at this point in time.
This article was written by
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