SaaS for Value Investors pt. I (The Opportunity at NCNO)

A series on high-quality, mission-critical SaaS reasonably priced at “non-SaaS” multiples

Disclaimer: We currently hold positions in $NCNO. This is not investment advice

This post is part of a series on reasonably-priced, high-quality publicly-traded Software-as-a-Service (SaaS) companies we currently own.

I. Introduction (The State of SaaS Valuations and How Alpha Generation Works)

There are clear reasons behind why software remains among the most highly valued industry sub-sectors today. These include high scalability for software delivered on the cloud, business models that frequently incorporate recurring revenue, and a tendency for superior margins (GMs often of 70+, and double-digit FCF %).

Those who dub themselves “value investors” will have difficulty finding high-quality SaaS names in the public markets currently trading at the same low multiples they are used to buying. Today, the top 10 publicly-traded SaaS companies are being valued at an average of 106x NTM FCF (see table below, provided by Jamin Ball at Altimeter).

In investing, generating “alpha” typically stems from a deep understanding of an inflection point for a company, allowing investors to recognize how the market misinterprets the implications of transformative changes the company is undergoing. This misinterpretation often leads to a mispricing of the company’s securities. The most successful medium-term investments, particularly those made by most fundamental long/short hedge funds, capitalize on the eventual correction of this mispricing. As the market realigns its perception with the reality of the company’s inflection point, the gap between the misunderstood narrative and the company’s true trajectory drives significant returns.

In this series, we’ll initially cover three publicly-traded SaaS names characterized by a long growth runway (two of the three have accelerating revenue growth as a catalyst core to the investment thesis), high incremental margins, and the offering of a mission-critical solution(s). You can get all three businesses at valuations far more reasonable than the top decile of highest valued SaaS companies. Most importantly, all three businesses are in the midst of inflection points that are misunderstood by the market, which offers investors the chance to capitalize on what we perceive to be mis-pricing in their common stock.

II. The opportunity at nCino (NCNO)

The first name we are covering in this series is nCino (NCNO). You can buy it today at a reasonable price: 25x NTM EBITDA.

An investment in NCNO is a bet on successful transformation of its revenue/pricing model, significant OpEx cost reductions & additional margin expansion as it reaches scale, and a reversal of market pessimism regarding the name.

nCino is a cloud-based SaaS provider that streamlines lending, account opening, and compliance processes for financial institutions.

Below is a more in-depth description of what the company does, taken from their S-1 (for those who don’t know, these are the registration docs companies file with the SEC prior to undertaking an IPO):

nCino is a leading global provider of cloud-based software for financial institutions. We empower banks and credit unions with the technology they need to meet ever-changing client expectations and regulatory requirements, gain increased visibility into their operations and performance, replace legacy systems, and operate digitally and more competitively. Our solution, the nCino Bank Operating System, digitizes, automates and streamlines inefficient and complex processes and workflow, and utilizes data analytics and artificial intelligence and machine learning (“AI/ML”) to enable financial institutions to more effectively onboard new clients, make loans and manage the entire loan life cycle, open deposit and other accounts and manage regulatory compliance. We serve financial institution customers of all sizes and complexities, including global financial institutions, enterprise banks, regional banks, community banks, credit unions and new market entrants, such as challenger banks. Our customers deploy and utilize our digital platform, which can be accessed anytime, anywhere and from any internet-enabled device, for mission critical functions across their organizations

NCNO’s platform, built on Salesforce’s Force.com (similar to Veeva) and increasingly AWS for cross-sell products, builds mission-critical loan origination software for clients like banks, credit unions, and mortgage lenders. Loan issuance is highly complicated and regulated, but most banks use legacy technology from the 1980s or manage workflows manually using Microsoft Excel. NCNO’s end users state that the software counts as one of the most important pieces of its technology stack.