Source: Diginomica
Cornerstone OnDemand (CSOD) has added new capabilities to improve its growth factor. The improved growth factor will assist earnings and cash flows while reducing its debt burden. CSOD is expected to enjoy the tailwinds from the growing cloud HCM space. Baring execution challenges, we expect CSOD's momentum to improve as it meets its financial target of $1b+ in yearly revenue/ARR and uFCF margin of 30%+.
Saba Acquisition + Revamped Sales Strategy To Propel Growth
CSOD provides SaaS-based HCM solutions. Like most HCM players, CSOD provides multiple HCM modules to diversify and differentiate its platform. CSOD's differentiating factors are mostly concentrated in its learning management and talent management modules. In recent quarters, CSOD has made moves to improve its growth factor despite the impact of the pandemic on HCM players.
Cornerstone OnDemand, Inc., together with its subsidiaries, provides learning and people development solutions through a software-as-a-service model worldwide. Its enterprise people development solution comprises four product suites, such as Recruiting Suite that helps organizations to attract, hire, and onboard the right employees; Learning Suite, which provides robust, a modern learning management software to supports compliance, knowledge sharing, and employee-driven development training; Performance Suite that provides tools to manage goal setting, performance reviews, competency assessments, development plans, continuous feedback, compensation management, and succession planning; and HR Suite, which provides an aggregated view of all employee data with workforce planning, self-service management, and compliance reporting capabilities.
As we can see in the table below, growth has accelerated from low-single-digit to the double-digit range. The improved growth momentum has benefitted from the recent acquisition of Saba. Saba was acquired for approx $1.3B. The acquisition of Saba will accelerate CSOD's market expansion initiatives. It will also validate CSOD's rationale to play in the competitive HCM space.
Source: Seeking Alpha
Given the market's warm reception towards SaaS stocks delivering strong growth, CSOD's improved topline represents a big boost to its narrative, a strong contributor towards reviving its weak momentum.
Our renewals, including some strategic customers in areas, both affected and unaffected by COVID progressed well and showed some improvement in the quarter. - CSOD
Despite the headwinds to its business, CSOD highlighted the ample market opportunity and the upward trend in renewal rate during the last earnings. CSOD also noted the improved momentum in new customer wins despite the weak macro environment.
Source: Seeking Alpha
Going forward, analysts are expecting modest revenue growth in 2021 with further growth deceleration in 2022. This is a conservative outlook given CSOD's improves HCM capabilities.
Solid FCF margin lightens liquidity pressure
Due to the acquisition of Saba, CSOD has incurred a lot of debt, which cast an ugly shadow on its balance sheet. Total debt now stands at $1.32B. With cash of $171m, the net debt stands at $1.15B. This implies a net debt to total capital of more than 30%. This raises a lot of concern about CSOD's liquidity. To improve its debt profile, CSOD intends to generate more operating cash flow.
CSOD already has an attractive profitability grade. The recent growth in COGS depicted in the OPEX chart can be attributed to acquisition-related expenses. Gross margin has also been impacted by the reallocation of some R&D costs to COGS. CSOD attributed the remaining headwinds to COGS to initiatives towards shifting more professional services to partners. Since professional services carry a low margin compared to subscription revenue, this initiative will be a long term benefit to gross margin.
Readers will observe that SG&A % of revenue has improved significantly in recent quarters due to improves sales productivity and COVID-related savings. The slight uptick last quarter is due to costs related to the acquisition of Saba. If we assume the margin profile improves due to CSOD's focus on driving sales productivity and cost synergies, we can expect earnings to be increasingly accretive to OCF in the coming quarters. Earnings will also benefit from improved growth due to CSOD's robust sales network.
Source: Koyfin
As a result, CSOD can attain its unlevered FCF margin target of 30%+. The uFCF margin strips out the expense burden of interest payment. CSOD is committed to deleveraging its balance sheet, as noted by the recent payment of $50m from its Term loan B. The repayment fell under Q4, and it was announced during the last earnings, which means it doesn't reflect on the recent cash flow statement. CSOD noted that every 25m principal payment could drive savings on interest expense of approx. $1m. This implies a yearly cost of debt of 4%-5%, which is huge given the low-interest-rate environment.
Source: Koyfin
It helps that $300m out of its outstanding debt comprises the extended convertible senior note. This means CSOD can expect its leverage ratios to improve if holders convert to shares after the note's maturity date was extended from July 2021 to March 2023. The assumption is that the market will catch up to the SaaS narrative before the debt is due. If we assume CSOD attains an operating cash flow margin of 30% on revenue growth to $1B by 2023, that puts the net debt/OCF ratio under 5x when the convertible note matures.
The weak leverage explains CSOD's conservative valuation despite its improved growth profile. However, readers will observe the market cap of bigger players highlights the opportunity in the HCM space if the strategy and narrative are well received by investors. Readers will also observe the attractive EBITDA profile of top HCM players, a sign of the potential to generate healthy profits.
Conclusion
According to an International Data Corporation ("IDC") market forecast report, titled "Worldwide Human Capital Management and Payroll Applications Forecast, 2018-2022," published in June 2018, the global market for Human Capital Management and Payroll Applications in 2018 was predicted to be $21.1 billion, of which $16.0 billion is for HCM applications. According to IDC, the HCM and payroll application market is expected to grow to $30.5 billion by 2022, representing a 9.6% CAGR, and includes payroll, HR, talent acquisition, workforce management, document management, performance management, compensation management, and succession planning. - Cornerstone
The SABA acquisition has boosted CSOD's reach to approx. 7k global clients and 75m users. Going forward, I expect CSOD to ride on this strength in addition to newly added capabilities to its offerings. It also helps that CSOD's peers are valued at rich multiples given the expanding market opportunity in the HCM space. Using a forward revenue projection of $1b by 2023, if we assume multiples expansion akin to the average of its peer group, CSOD can exceed a market cap of $10B. This is contingent on significant deleveraging and margin expansion. The strategy to achieve this has already been set in motion. However, there is a lot of execution risk to contend with. In the meantime, price discovery will be slow and steady.