This week’s report for Steady Compounding Insider Stocks members features an in-depth analysis of Paycom, a SaaS company providing Human Capital Management (HCM) software that has been profitable since its IPO. Paycom has historically achieved a remarkable 30% revenue growth for over a decade. However, recent slowdowns in revenue growth and customer acquisition have driven its stock down to its lowest valuation ever.

In this report, I delve into whether the challenges Paycom is facing presents an opportunity for long-term investors or indicative of more permanent issues, and outline my strategy moving forward. Below, you'll find snippets from my comprehensive Paycom Deep-Dive.

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Invest wisely and stay informed,

Thomas

Paycom: An opportunity or value trap?

Paycom is a leading provider of cloud-based human capital management (HCM) software. Its comprehensive solution enables businesses to manage the entire employee lifecycle, from hiring to retirement. Designed for user-friendliness and employee self-service, Paycom’s software reduces administrative burdens on employers.

Paycom’s business model revolves around recurring revenue from software subscriptions, charging clients a fixed fee plus a per-employee or per-transaction amount.

Despite facing recent challenges such as the impact of Beti on revenue growth and slower client acquisition, Paycom remains a high-quality software business with significant long-term potential. The market’s current pricing suggests that its best days are behind it. In this report, we will thoroughly examine the company's challenges and whether it represents a good buying opportunity.

Evolution and Expansion

Paycom has evolved significantly, expanding from payroll processing to a comprehensive HCM provider. Its suite of applications now encompasses talent acquisition, time and labor management, payroll, talent management, and HR management.

Solving Key Business Challenges

Paycom addresses numerous pain points businesses face:

• Talent Acquisition: Streamlines job postings, resume screening, and applicant tracking, saving time and minimizing errors.
• Time and Labor Management: Automates employee time tracking, scheduling, and time-off requests, simplifying complex processes.
• Payroll: Introduces the innovative Beti platform, empowering employees to manage their payroll and reduce errors.
• Talent Management: Provides a platform for performance reviews, goal setting, and online training to enhance employee performance.
• HR Management: Automates document management, onboarding/offboarding processes, and ensures compliance with labor laws.

Paycom’s comprehensive approach simplifies HR and payroll processes, improves employee engagement, and ensures legal compliance. By automating many of the tedious and time-consuming tasks associated with HCM, Paycom helps businesses save time and resources, allowing them to focus on growth.

Rapid Growth Achieved Profitably

Over the past 10 years, Paycom has grown revenue at a remarkable 30% CAGR. This growth has been driven by several factors, including the addition of new clients, increased sales productivity in mature sales offices, the sale of additional applications to existing clients, and the strong performance of its tax form filing business.

The company has also benefited from growth in its clients’ employee headcounts, positively impacting its recurring revenues. As of the latest quarter, its last twelve months recurring revenue has reached US$1.7 billion. There is a noticeable boost every first quarter ending March due to the seasonality of payroll tax form processing and, in some years, Affordable Care Act (ACA) form filings.

A Profitable SaaS Company

Unlike many SaaS peers, Paycom has consistently pursued profitable growth since 2011. Its high operating margins of 33.1% are driven by its high gross margins of 86.6%, operational efficiency, and economies of scale.

Focus on Employee Usage and Innovation

Paycom prioritizes employee usage of its software and develops innovative products. The Beti platform, enabling employee-driven payroll, exemplifies this approach. The company also invests heavily in its mobile app for convenient employee access to HR information and tasks. These efforts differentiate Paycom and fuel ongoing growth.

Why Is the Stock Down So Much?

Two main reasons stand out: revenue growth slowdown and a decline in client growth. Let’s tackle these challenges individually.

Beti: Improving customers experience but reducing revenue growth

Paycom’s innovative employee-driven payroll solution, Beti, while revolutionary, has presented a unique challenge. Designed to empower employees to handle their payroll, Beti has effectively reduced errors and minimized the need for manual intervention by HR. However, this very strength has inadvertently impacted Paycom’s revenue generation.

Why?

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Client growth has slowed down

Paycom has been targeting the mid-market segment and management has repeatedly emphasized that they have only reached 5% of the total addressable market (TAM), leaving them significant room to run if they were to succeed in bringing in new customers.

The problem I see here is that even though management claims there’s still a long runway, client growth has slowed down, growing only by 0.7% to 36,820 clients in 2023.

Management cited two main reasons why client growth slowed down in 2023:

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Growth Drivers

While Beti has impacted revenue growth, Paycom isn’t just waiting for the impact to subside. Here are some strategies the management has implemented for growth:

1. International Expansion: In early 2024, Paycom released its global HCM product, attracting U.S.-based companies with an international presence looking for a global provider. This expansion allows them to increase revenue from existing customers and land larger clients. In their Q1 2024 report, they noted, “We recently won a large international sports organization, thanks to our multi-country payroll and HCM offering.”
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2. Integrated System: At KeyBanc’s Technology Leadership Forum 2023, Chad Richison discussed how large companies use different software for various HR functions, which can complicate processes. Paycom aims to roll out a single integrated system, streamlining operations and increasing automation and productivity gains for enterprises.

When Will Growth Return?

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Management

Let’s talk about the bad first, Paycom promoted Chris Thomas, Chief Operating Officer, to co-CEO on February 7, 2024, only to have him resign less than four months into the job due to “personal reasons.” When asked about Thomas’s resignation at the Baird 2024 conference, Chad Richison, CEO, offered this: “Chris had been with us for 6 years. Chris, I consider a friend. And certain situations develop where sometimes some people’s situations don’t allow them to continue on that journey.”

Paycom’s shares slipped further as the market dislikes uncertainty. Despite resigning, Chris Thomas still praises Beti on LinkedIn, indicating an amicable end to his term at Paycom.

Now let’s talk about Chad Richison, the founder and CEO of Paycom, currently owns 11.6% of the company, ensuring significant skin in the game. He started Paycom with an SBA loan and 13 credit cards, shaping the company’s culture around frugality and cost-consciousness. When asked about the company’s profitability, Chad replied, “Old habits don’t die hard from that perspective. We don’t have a lot of waste in our model. There’s a reason why we’ve had high margins. We don’t like to be dependent upon banks and other things to run our company. And that’s not going to change from us from that perspective.”

Paycom has zero debt, contributing to its early profitability and placing the company in a strong position to navigate out of its current challenges and invest for the future. Unlike other SaaS companies reliant on capital markets and forced to scale back on investments as capital became expensive, Paycom remains resilient.

Risks

Every investment will come with risks, but the key to investing well isn’t to avoid risks, but to be paid well for assuming them.

Competition: Paycom faces stiff competition from numerous players vying for the same customers. The company risks losing market share if it cannot compete effectively on pricing, product innovation, and customer service.

International expansion risks: Expanding internationally poses significant challenges, particularly in navigating different legal and regulatory environments. These complexities may stall Paycom’s growth efforts and impact its overall performance.

Prolonged economic slowdown: With a substantial base of small to medium-sized businesses, Paycom enjoys diversification but also faces heightened vulnerability during economic downturns, which could result in increased churn.

Valuation

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See you inside,

Thomas

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