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Vertex, Inc. (NASDAQ:VERX) recently delivered EPS better than expected, and with investment banks upgrading their expectations, there seems to exist a lot of optimism in the market. In my view, new partnerships with existing vendors of ERPs and CRMs as well as professional services firms could be the fuel for net sales growth. However, with services offered in the cloud, VERX could experience net sales growth thanks to the cloud computing market growth. There are obvious risks from new alternative software vendors, changes in demand in the sector, or changes in the tax jurisdictions. However, VERX does not trade expensively.
Vertex Operates In A Large Market
Vertex offers enterprise tax technology solutions to companies that need to report and pay taxes in jurisdictions all over the world. With experience accumulated in the last 40 years and currently reporting 4,300 customers in over 190 countries, I believe that there is significant geographic diversification.
Furthermore, with access to close to 900 million of data-driven tax rules in about 20k jurisdictions, I believe that new entrants in the industry may have issues in competing with the company's established know-how and scalability potential.
Our software is fueled by over 900 million data-driven effective tax rules and supports indirect tax compliance in more than 20,000 jurisdictions worldwide. Source: 10-k
With software offering different capabilities depending on the jurisdiction as well as different services addressing growing complex tax requirements, Vertex offers a necessary tool for most businesses. With this in mind, I believe that the market opportunity is quite large. According to experts, the Global Tax Software Market is expected to grow at close to 10% CAGR from 2024 to 2030.
The Global Tax Software Market size was valued at around USD 18.5 billion in 2023 and is estimated to grow at a CAGR of about 10% during the forecast period, i.e., 2024-30. Source: Marknteladvisors
Considering the most recent earnings released, I think that it is a great time for reviewing the company's business model. EPS GAAP was better than expected. Moreover, quarterly net sales were $8.4 million more than anticipated. In addition, I believe that the recent EPS revision increases that took place in the last 90 days could bring the attention of market participants soon.
Source: Seeking Alpha
I also think that the expected earnings consensus may benefit the demand for the stock. Earnings are expected to increase in Q2 2024, Q3 2024, and Q4 2024.
Source: Seeking Alpha
Solid Balance Sheet
I believe that Vertex reports a significant amount of liquidity, sufficient to acquire other competitors or launch marketing campaigns. The current ratio is under 1x, however the total amount of cash in hand and receivables appear significant. In addition, the largest current assets are represented by deferred revenue, which means that clients are financing the operations of Vertex. More in particular, as of December 31, 2023, the company reported cash and cash equivalents worth $68 million, with funds held for customers of about $20 million and accounts receivable worth $141 million.
In addition, with goodwill and other intangible assets worth $260 million and total assets of about $759 million, I think that Vertex does appear to have a significant amount of expertise in acquiring other business models.
Source: 10-k
The current portion of long-term debt stands at about $2 million, and debt, net of current portion stands at $44 million. It means that net debt appears to be negative. With this in mind, I am really not concerned about the total amount of financial debt. The debt/EBITDA is about 0.8x.
Source: Seeking Alpha
The largest liability is represented by deferred revenue worth $290 million. Total current liabilities stand at about $440 million, and total liabilities are equal to $506 million. Hence, the asset/liability ratio is larger than 1x.
Source: 10-k
Cloud Offering, And Data Centers
Vertex appears to offer its services through data centers and cloud computing capabilities all over the world. Considering that clients do accept to upload their tax information to the cloud, I think that the lack of necessary physical infrastructure will most likely help Vertex in launching its business models in new jurisdictions.
We provide cloud services from six geographically separate data centers located on two continents: North America and Europe. The data centers are paired for failover of operations to an alternate, geographically separate production facility in case any single data center becomes unavailable. Source: 10-k
In addition, I believe that Vertex will most likely enjoy the growth of the global cloud computing market, which is expected to increase at close to 14% from 2023 to 2030.
The global cloud computing market size was valued at USD 483.98 billion in 2022 and is expected to grow at a compound annual growth rate of 14.1% from 2023 to 2030. Source: Grand View Research
Revenue-based Pricing Model, And Flexibility
I think that Vertex offers a scalable business model mainly because it offers a tiered revenue-based pricing model. It means that large and small business clients may decide to work with Vertex. If these clients grow for whatever reason, I believe that Vertex would continue to be able to offer services to the organizations. Under my DCF model, I took into account the beneficial effects of scalability. The company provided details about these facts in the last annual report.
Our flexible, tiered revenue-based pricing model also results in our customers growing their spend with us as they grow and continue to use our solutions. Source: 10-k
Annual Recurring Revenue
The existence of recurring revenue is another great reason to run DCF models about Vertex. Recurrent revenue means that net sales predictability is easy. As a result, I believe that FCF growth expectations from analysts and the financial community seem a bit more realistic.
As of December 31, 2023, we had 4,310 customers and our Annual Recurring Revenue per customer was $118,910. Source: 10-k
Integration With ERPs, CRMs, And Software From Other Partners
I think that Vertex will most likely grow thanks to technology partners, which include the capabilities of the tax software in their solutions.
We integrate with key technology partners that span enterprise resource planning, customer relationship management, procurement, billing, point of sale, and eCommerce platforms. Source: 10-k
The company appears to be well connected to an existing network of partners, some of the largest software, ERP, and CRM providers in the United States. Vertex could benefit from their business growth. I also think that other new technology patterns will accept working with the company as soon as they get to know the technologies that chose Vertex.
Other companies working with Vertex are professional services firms such as Deloitte, PwC, Ernst, Young, and KPMG, which also recommend Vertex in their tax advisory and tax technology practices.
Valuation Under My Base Case Scenario
For the assessment of my base case scenario, I took into account previous changes in accounts receivable, changes in working capital, capex, and other cash flow statement items. I believe that my figures are conservative as they are in line with previous financial statements.
Source: YCharts
Under this scenario, I included 2033 total revenues of about $1758 million, with 2033 total cost of revenues of about $437 million in addition to research and development expenses growth of $121 million.
In addition, with 2033 selling and marketing worth $275 million, general and administrative expenses of $287 million, and depreciation and amortization of about $28 million, I also assumed other operating expenses of $12 million, income from operations of about $595 million, and 2033 net income of about $446 million.
Source: My Expectations
My cash flow statement assumptions include net income of $446 million, with 2033 depreciation and amortization of about $27 million, but no amortization of cloud computing implementation costs or amortization of deferred financing costs.
In addition, with stock-based compensation expenses of close to $13 million, I also assumed deferred income tax benefit of $2 million and the following changes in operating assets and liabilities. First, accounts receivable would be close to -$73 million, with deferred commissions of -$8 million and changes in accounts payable of $11 million.
Besides, I assumed accrued expenses of $1 million as well as accrued and deferred compensation close to $30 million, which implied net cash provided by operating activities of about $475 million. Finally, with 2033 property and equipment additions of -$15 million, 2033 FCF would be close to $461 million.
Source: My Expectations
With the previous assumptions, I also used a WACC of 9.4%, which I believe is a conservative cost of capital. My number is in line with the WACC reported by many other financial advisors. Competitors also report a WACC that is closer to that of VERX.
Source: Finbox
In addition, with an exit EV/FCF of 22x, the implied total enterprise value would be $5.4 billion. Now, if we subtract net debt, the implied stock price would be $36 per share.
Source: My Expectations
Bearish Case Scenario
Under this case scenario, my figures are simply a bit worse than that in the previous case scenario. The changes are not very significant as I mainly based my figures on my own assumptions and previous financial figures. With that, the numbers are pessimistic and a bit more unlikely.
I assumed 2033 total revenues of $1318 million, with gross profit of about $992 million, 2033 research and development expenses of $75 million, and selling and marketing of $204 million.
In addition, taking into account general and administrative expenses of $215 million and depreciation and amortization of about $21 million, I also assumed other operating expenses worth $9 million. Finally, with total operating expenses of $526 million, 2033 net income would be about $349 million.
Source: My Expectations
My cash flow expectations include 2033 net income of $349 million, 2033 depreciation and amortization of -$32 million, and provision for subscription cancellations and non-renewals worth about -$1 million. I did not include amortization of deferred financing costs or write-off of deferred financing costs because I believe they are not recurrent events.
Also, including 2033 changes in operating assets and liabilities, such as accounts receivable, of $12 million, prepaid expenses and other current assets worth $2 million, and 2033 accounts payable of -$2 million, I also assumed 2033 deferred revenue of $1 million. The results would lead to CFO of $322 million and 2033 FCF of $345 million.
Source: My Expectations
If we assume a WACC of 10% and terminal EV/ 2033 FCF of 20x, the implied enterprise value would be $3.8 billion. Subtracting the net debt, the implied equity valuation would stand at $25 per share.
Source: My Expectations
Competitors, And Risks
I believe that the sector appears to be highly competitive with a significant number of players, and the market appears fragmented. In addition, I think that clients have many options to address their tax obligations. Small companies may run their own spreadsheets and static tax tables, or rate their calculator services. The company also reported in the last 10-k that certain ERPs also offer their own tax capabilities, which compete with the solutions offered by Vertex.
Vertex may suffer many risks from failed software implementation in the most commercial ERPs or failed partnerships with large professional services firms. As a result, the company may not suffer from net sales growth declines. Lack of recognition could destroy the business model in the coming years.
I also believe that many market participants are expecting significant net sales growth and FCF growth in the coming years. In my worst case scenario, lower net sales than expected or lower FCF than expected could drive the company's EV/FCF down. As a result, I think that the stock price could decline.
Finally, lack of demand from customers, alternative software vendors, emerging software solutions, and new regulatory frameworks may affect future FCF growth.
Conclusion
Vertex delivered better than expected EPS and net sales growth in the last quarter, and recent EPS expectations increases indicate optimism in the market. I think that Vertex may not only enjoy double digit growth from the tax software market, but also growth from the cloud computing market growth, which is growing very fast. Considering the existing partnerships with large vendors of ERPs and CRMs as well as other large professional services firms, I believe that Vertex could grow significantly. There are some risks from new tax regulations, changes in demand in the sector, or new alternative solutions. With that, I believe that Vertex could trade a bit more expensively.
