The Fund initiated a position in Guidewire Software, Inc. (GWRE) this quarter. Guidewire is a leading provider of core systems software to the global property and casualty (P&C) insurance industry. Guidewire's software forms the "technological backbone" of a P&C insurance customer. The company's software serves as the transactional system-of-record, which enables the insurer to perform many of its key business functions, including underwriting policies, administering policies, managing claims, and billing.
The majority of P&C insurers are using legacy "green screen" core operating systems that have been in use for more than 20 years, rely on outdated programming languages, and are difficult to change, upgrade, or integrate with modern technology infrastructure. These legacy systems require support by specialized IT staff, many of whom are now retiring, further compounding the problem. We believe that all of the P&C industry will ultimately move to new software, but less than 20% have yet to complete such an upgrade.
We believe that Guidewire has emerged as the "gold standard" in terms of P&C functionality, as evidenced by its near-perfect retention rates, growing installed client base, and accelerating adoption of its complete suite of offerings. We believe that the addressable market for Guidewire's core business is $2.5-$3.5 billion of annual r ecurring revenue, implying that Guidewire currently has just 3-5% penetration of its market. We believe that new products targeting mobile applications, portals, business intelligence, and data migration double the company's core
addressable market. If these endeavors are successful, the company will benefit from lucrative, ongoing annual license fees. In addition, Guidewire will reap the indirect benefits of a "network effect," thereby attracting other insurance customers to its platform. Finally, we see significant embedded leverage in Guidewire's operating model. As its business scales, we expect margins to move from the low-teens to the 35-40% range. This margin expansion should lead to significant free cash flow generation, which the company can use to make niche acquisitions or to return to shareholders. (Neal Rosenberg)
From Baron Funds' fourth quarter letter 2013 to shareholders.