Vertex: Nothing Too Special

Summary

• Vertex is a tax technology company with 40 years of experience and with more than half the Fortune 500 in its customer portfolio.
• With its strong competitive position, Vertex can easily achieve industry-like growth rates, but not higher than that due to limitations in expanding its customer base.
• The company has a low EBITDA due to large investments in R&D and marketing and sales.
• I calculated a forward EBITDA multiple by combining its current valuation with expected growth rate and expected EBITDA margin. Comparing this multiple to that of the average of the US market, I conclude that an investment now in Vertex is not worth it.

Khanchit Khirisutchalual/iStock via Getty Images

Investment thesis

Vertex, Inc. (NASDAQ: NASDAQ:VERX) deals with limitations in its growth prospects and has a low EBITDA margin. For these reasons, I don't think its value ratios are justified and believe it's currently not a buy.

Table of contents

1. Introducing Vertex
2. Market Opportunity
3. Competitive analysis
4. Growth analysis
5. Margin analysis
6. Risk analysis
7. Valuation and Conclusion

Introducing Vertex

Vertex is a tax technology company that works with companies in the retail, communication, leasing, and manufacturing industries across the world.

Several solutions are being offered by them:

• Tax determination
• Compliance,
• Reporting
• Tax data management
• Document management

Software licenses and software as service subscriptions are how the corporation sells its software. It also offers software licensing and cloud subscription implementation and training, as well as transaction tax returns outsourcing and other tax-related services.

Market opportunity

The complexity of indirect tax administration is increasing due to the fast changes in today's global business, technology, and regulatory settings. Companies' indirect tax liabilities grow when they expand their business models through eCommerce and other digital transformations, enter new territories and expand their distribution networks. Furthermore, as they broaden their core operations to include new digital products and services, new tax policies adopted by countries have a growing influence on them.

This complexity necessitates sophisticated solutions that allow firms to meet their tax responsibilities while also promoting development. Thus, I expect the tax technology market to increase at a robust rate.

In line with my expectations, the tax management software is expected to grow at a CAGR (compounded annual growth rate) of 10.4% by 2026, according to a Fortune Business Insights report.

Competitive analysis

Vertex has pioneered tax technology for over 40 years. Over these years, Vertex has become the trusted leader in the (indirect) tax technology market. This position has led to a customer base of 4,200 companies, including over half of the Fortune 500. Furthermore, its software is fueled by over 500 million data-driven effective tax rules and supports indirect tax compliance in more than 19,000 jurisdictions worldwide.

As it’s extremely difficult to replicate the depth of its platform and its strong position in the industry, I conclude that the competitive advantages of Vertex are sustainable and that it has a strong competitive position in the market.

Vertex is part of the tax technology market. Throughout this article, I will use Avalara in order to benchmark Vertex's statistics. Avalara provides cloud-based solutions for transaction tax compliance worldwide.

Company name	Symbol	Market Cap
Avalara, Inc.	(NYSE: AVLR)	9.07B

Click to enlarge

Avalara is a disruptor in that it focused on the mid-market with a simpler, cloud-based solution while leaving the more demanding enterprises to Vertex. As I will get deeper into Vertex's growth strategy in the next section, it will be clear that Vertex invests in cloud as well. However, as we will also see, Avalara and its innovations do seem to form a risk for Vertex.

Growth analysis

Growth performance of Vertex and its competitors in the last few years:

Stock	Revenue Growth (Quarterly YoY)	Revenue Growth (TTM YoY)	Revenue Growth Rate (3Y)
Vertex	12.17	13.58	16.03
Avalara, Inc.	34.8	39.64	36.96

Click to enlarge

Source: Seeking Alpha, income statement and earnings

Revenues increased by $50.9million, or 13.6% in 2021, according to the latest annual report. The increase in software subscriptions revenues was primarily driven by an increase of $35.7 million in revenues derived from our existing customers and a year-over-year increase of $6.0 million in revenues derived from new customers.

Although Vertex’s growth rate is in line with industry CAGR, Avalara has grown at a much higher rate (Their organic growth rate is slightly lower, 29%, according to their latest earnings call). Filling a gap with an aggressive growth strategy and many innovative products and services awarded them with a high growth rate.

As more than half of the Fortune 500 companies are customers of Vertex, it’s difficult to find many new large enterprises to sustain any higher growth rate than its current growth rate. We also saw this with the % of new revenue that came from existing customers versus new customers.

Although Avalara thrives with its cloud solution, Vertex is taking advantage of the trend as well. They see significant traction in cloud revenue with both existing and new customers. Further new products, such as the recently launched Cloud VAT Compliance to automate and simplify value-added tax complexity.

With the focus on cloud, its strong competitive position in the enterprise market, but somewhat limited excess growth opportunities with new customers, I expect its future growth to be in line with the expected industry CAGR, so around 11%. This is fairly in line with what analysts expect:

Growth estimates by analysts in percentage:

Stock	Revenue 2022	Revenue 2023	Earnings 2022	Earnings 2023
Vertex	13.1	13.9	-18.2	29.6
Avalara, Inc.	22.6	21.9	-73.3	119.2
Industry median	22.6	21.9	-73.3	119.2

Click to enlarge

Source: Analyst estimates from Seeking Alpha

Margin analysis

I computed several key margins for Vertex and its industry. The first number in the cells in the following table refers to Vertex, while the number between the parentheses refers to the median of Avalara.

Accounting item as % of revenue: Vertex(Median Avalara):

Accounting Item	2021	2020	2019
Gross Profit	62.0 (70.7)	55.9 (71.4)	65.7 (69.8)
Operating Expense	62.6 (85.9)	83.8 (83.8)	55.8 (84.5)
Normalized EBITDA	9.8 (-11.9)	-19.4 (-7.4)	18.1 (-8.7)
Free Cash Flow	11.0 (1.5)	7.1 (6.5)	17.1 (3.2)

Click to enlarge

Source: Seeking Alpha income statement

As Vertex is more of a mature business (compared to Avalara), its investment expenses are a bit lower, resulting in a higher cash flow margin and EBITDA margin. However, its operating expense margin (largely existing of investment expenses) is high compared to its (moderate) revenue growth rate. As the company matures and investment expenses decrease, I expect that an EBITDA of at least around 20%-30% is achievable in the longer term.

Valuation

I have computed several key current valuation metrics.

Key valuation measures:

Stock	Enterprise Value / Revenue	Enterprise Value / EBITDA	Enterprise Value / Gross Profit	Forward PS	Forward PE
Vertex	5.15	52.33	8.31	4.3	45.54
Avalara, Inc.	12.27	-103.20	17.36	8.72	2031.6

Click to enlarge

Source: Seeking Alpha

I believe that the market discounts Vertex compared to Avalara due to the fact that Avalara is a disruptor and is expected to grow its earnings and revenues at a much higher rate, for a longer time. Despite its nice innovative approach, its 40% growth rate days are over and with a negative EBITDA margin, I’d say that a premium of more than 100% is exaggerated. However, this does not say that I believe Vertex is a buy, more that Avalara is too expensive.

Regarding Vertex, a 52.33 EV/EBITDA multiple is quite high for a company with a low expected growth rate and relatively low EBITDA margin. If Vertex could double its current EBITDA margin (Roughly 20%) and grow revenue by 11% for the following 5 years, that would result in a 5 year forward EV/EBITDA multiple of roughly 16. In comparison, the recent US market EV/EBITDA fluctuates around 14. In the more optimistic case, the EBITDA margin could increase to more than 20%, and its growth rates after 5 years could still outperform US market growth. However, comparing my best estimate of Vertex to that of the US market, I don’t believe investors will get compensated enough for an investment in Vertex.

I believe that the price needs to drop in order for this stock to become a more attractive buy.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[investingforcure]

I would not invest in this company. It does indeed have an extremely conservative and financially oriented leadership team who have always been very content milking its customer base with small incremental improvements to their software, and annual price increases, for slow to moderate growth. They are innovation laggards, and have consistently failed over the years with their strategies and growth initiatives. One might say that the IPO was a success to the extent that it very richly rewarded its ownership and leadership, far beyond any history of actual company performance would justify, due to the dysfunctional tech market bubble of the past few years. The current stock price is significantly below the IPO price, and will likely fall further, as it is now a more accurate reflection of the value and prospects for this company, in my opinion. There are many other more worthy and promising companies to invest in.

[thedello]

I respectfully and strongly disagree with this article which falls into the trap of comparing Avalara to Vertex when the companies report their numbers differently and have made very different strategic bets on growth.

I believe that Vertex has been consistently very conservative in its projections and is also very conservative in its accounting.

During the past year Avalara redefined customers to add thousands of new names without adding revenue. Avalara backed off its claims that it would make inroads into the larger enterprise market in the near future. Avalara also announced it would take non-related acquisitions and count them as organic growth for the coming year.
Unlike Vertex, Avalara shifts the costs of updating its tax database to R&D shifting millions out of costs of goods. In addition Avalara amortizes certain sales commissions over 6 years.

By contrast Vertex is extremely slow to recognize revenue from cloud sales. One reason for conservative accounting at Vertex is because it has such strong relationships with the 10 largest accounting firms in the world that they all consider it a conflict of interest to audit Vertex.

Vertex works closely with the IT departments of the largest firms in the world and has deep relationships with Oracle and SAP and the key vendors to the enterprise market. That market was slowed down by Covid and economic uuncertainty now there is a hidden backlog and delayed growth that will really benefit Vertex in the coming years.

Avalara does not have the capability or relationships to succeed and has a very steep investment curve ahead if it hopes to get any for any meaningful share of the enterprise market.

Meanwhile covid has initially worked to Avalara's advantage as well as the growth of the need to report and pay sales tax out of state. Vertex got some extra revenue from existing customers, but now a number of the best paying customers in Avalara's core market are graduating to Vertex. Vertex has invested in cream skimming the upper middle market and has also established new partnerships that will sell into the lower ranks of the Avalara market base.

In short, Vertex is already doing much better than casual analysis shows and will really begin to take off this year and keep going. I look for both companies to show strong first quarters, but Avalara's will be expected and Vertex will greatly exceed expectations.

My current target for VERX is $25 by mid year and steadily higher for the next few years.