Long Pitch on Paycom Software (NYSE: PAYC)

The Pitch

Paycom Software (NYSE: PAYC) is a subscription-based human capital management (HCM) provider that targets 100-249 employee SMB. Paycom’s integrated solution covers all HR processes from recruitment to retirement, eliminating the need for multiple vendors. Paycom’s latest innovation Beti streamlines and consolidates payroll by requiring employees to review paychecks prior to processing.

The HCM industry is both highly competitive and fragmented, with no single dominant player in the market. Driven by constant regulatory change and evolving employment models (remote/hybrid work), the sector will grow at a 10.9% CAGR, primarily in North America. I recommend longing PAYC, currently at $169.54 after falling ~40% last year following management’s lowered revenue guidance (11.30%) because investors fear Beti over-cannibalizes revenue. I believe the market underappreciates Paycom’s superior, differentiated product, its strong operating leverage, and leadership in innovation.

Paycom’s integrated, closed-loop system creates a strong switching-cost moat that minimizes churn in the volatile SMB space (94% CRR and 98% recurring revenue). Unlike competitors that rely on unintegrated acquisitions, Paycom’s in-house, single-platform solution allows it to maintain industry-leading LTM EBIT/DA margins of 32.87% and 36.59%, respectively. While Beti does cannibalize near-term revenue from legacy services and billable items, it is highly margin accretive through significant SG&A reduction (down 30% YTD). Thus, despite just 14.17% LTM revenue growth, EBITDA and earnings surged 34.72% and 49.45%, respectively.

Management’s near-term focus has been maintaining margins and integrating Beti with existing clients. As Beti continues to take market share, a pivot back to sales with the ability to exercise pricing power will reignite top-line growth and bolster investor confidence. With a 3-year DOL of 2.94, 14.17% LTM sales growth, and 26.55% profit margin (satisfying the “40% rule”), management is proven in its ability to scale sustainably. Furthermore, Paycom only penetrates 5% of its US TAM, implying strong potential for top-line growth.

Paycom has consistently proven itself an industry leader in R&D, consistently investing 10-12% in revenue. Management has established itself as a trailblazer in the HCM industry through its early adoption of cloud-based (2015) and AI/ML (2018) systems and award-winning products like Beti and GONE. Paycom's commitment to innovation allows it to consistently enjoy a “first-mover” advantage, and further R&D investment, particularly if backed by debt, creates strong potential for growth. Because Paycom is currently debt-free, it foregoes interest-tax shield benefits. A 1.31% reduction in WACC increases implied share price by 16.12%. Thus, a debt-backed investment into a new product creates strong potential for value creation.

The risk of post-COVID SMB benefits drying up threatens its core client base. However, Paycom’s recent international expansion and strong switching-cost moat mitigate this risk, helping secure its customer base and continue growth despite potential market challenges. Furthermore, differentiation from Beti and its integrated product mitigates pricing pressures from the commoditization of the HCM industry.
Base-case DCF analysis implies undervaluation of 25-38%, aligning with a CCA (Forward P/E and TEV/EBITDA) that suggests 20-40% undervaluation.

Post-Mortem & Reflection

Given this was my first pitch ever, and considering that I knew little to no accounting or corporate finance fundamentals, I'm not terribly upset with this looking back. I think this pitch served its purpose as a good excuse to learn basic Excel and challenge myself (it also did its job of getting me into WITG and WUFC).

If I were to look back though: I think my bullish sentiment was misguided. If I remember correctly, I think my friend Thomas and I quite literally screened on CapIQ and saw Paycom, then proceeded to look at its financials on Yahoo Finance and decide it was a long. It also seems like my idea of a good pitch is one that cites as many metrics as possible, hence the abundance of percentages and ratios. However, pitching Paycom showed me that there are levels to this game, and conversations with mentors helped me realize how applicable the Dunning-Kruger effect is in investing.