Guidewire Software Inc. (GWRE, Financial) is a stock I looked at in the past but had passed over at the time because I thought it was too expensive. Recently, it popped up on my radar again because the price looks much more reasonable now. Bear markets such as what we are experiencing right now give us more value opportunities. While the bear is mauling the value of our current portfolios, it at least has the decency of presenting some wonderful bargains. This may be one of them, in my view.
Guidewire develops software for companies in the property and casualty insurance industry. Basically, it sells the "operating system" for the typical P&C insurance company. It offers mission critical systems and related professional customizations for claims management, policy management and billings.
Before Guidewire and its competitors came along, the P&C industry operated mostly with computer systems developed in house with some systems developed in the 1960s and even earlier. Guidewire helped the industry replace their aging systems with more modern software. It follows a classic land and expand strategy, getting a toehold in an insurance company with its core software offering (that is, its claims management software) and then after that is established, it upsells the company on other modules such as billings, policy management, analytics and so on.
Right now, it is working on moving its solutions to the cloud and changing to a subscription-based software-as-a-service (SAAS) model vs. the traditional license model.
The following diagram from GuruFocus explains Guidewire’s income statement breakdown. As we can see, because of heavy investment in R&D and SG&A, the company is showing a net loss on a GAAP basis.
Ron Baron (Trades, Portfolio)'s take
Well-known growth investor Ron Baron (Trades, Portfolio) recently commented on Guidewire as follows:
"Shares of P&C insurance software vendor Guidewire (GWRE, Financial) fell 13.3% and hurt performance by 33 bps. We believe this is due to continued multiple compression in high-growth cloud technology stocks. However, the company continues to accelerate its investment in its cloud computing growth opportunity. Guidewire has now crossed the mid-point of its cloud transition, which should correspond with dramatically improving financial results. We believe Guidewire has tripled its addressable market through new products and cloud delivery. We believe the company should be the critical software vendor for the global P&C insurance industry. Guidewire could ultimately capture between 30% and 50% of its $15 billion to $30 billion total annual addressable market and generate margins above 40%. This resultant strong cash flow could be used to continue to invest in new products and services for its customers. It recently instituted a $400 million share repurchase program."
Baron Funds is a long-time owner of Guidewire stock, having owned the stock since 2012. As of the firm's latest 13F filing, Baron holds over 6 million shares.
Transitioning for success
Guidewire has a large ecosystem and serves over 500 insurers worldwide. It has over 800 in-house consultants who work alongside over 18,000 outside (third party) consultants and delivery experts to implement and customize these systems with customers. This ecosystem provides a large moat around the business and it would be very difficult for a competitor to displace it. Gartner (GT), an IT consulting company, has placed Guidewire's insurance suite among the leaders of its "magic quadrant" analysis. It has it analytics solution InsuranceNow in the "challenger" quadrant.
Guidewire was a high-flying stock over the last decade, but because of the ongoing heavy investments in its cloud transition lately, it has lost profitability in recent years.
However, I believe as Baron does that this is a temporary issue due to transition from a licensing to subscription business model, and I expect this will reverse itself in the next few years.
The price-sales justified stock price indicates undervaluation. Guidewire is expected to win more than its fair share of the total addressable market (TAM) for P&C insurers, which Morningstar (MORN, Financial) estimates to be worth about $10 billion annually.
Currently, Guidewire's revenue is just over $0.8 billion annually. Therefore, the company has a long runway ahead of it if it can capture market share in the years ahead, mainly from legacy systems and vendors as well as from transitioning its current cutomers to its cloud offerings. Currently, Guidewire is selling at a price-sales ratio of about 6, which is lower than its five-year median price-sales ratio of about 10.
Recent results show that the company continues to increase revenue though profits and cash flow are negative.
Based on CIBC's compilation of analysts' 12-month forward price targets, which average bout $80, the company could be as much as 30% undervalued.
Guidewire's leading competitors in the P&C insurance area include Majesco, which is currently privately owned. Majesco was acquired by private equity firm Thoma Bravo in September 2020 at a considerable premium. The other major competitor is Duck Creek Technologies (DCT, Financial), which was spun out of Accenture (ACN, Financial) in 2020. Both sell SAAS solutions to the P&C insurance industry but are much smaller than Guidewire. The following chart compares the two competitors' stock history to that of Guidewire.
The P&C insurance industry has had a great decade after suffering during the financial crisis. In the last decade, the performance of the industry has been stellar, trouncing the stock market average, as seen from the chart below. Right now, the industry is very healthy, and players are flush with funds to upgrade their systems with the right offerings.
Guidewire is a great business in a profitable sector which has embedded itself successfully in the heart of the global property and casualty insurance industry. As it is, the P&C industry is conservative and slow to adopt new technology. Once an IT vendor like Guidewire establishes itself within the company, it's almost impossible to displace it. This gives the vendor an almost annuity-like cash flow from the customer.
Right now, Guidewire has no profits because of heavy investment in its cloud transition, but this heavy investment and development cycle is coming to an end and I expect profits to recover in the years ahead. Thus, I believe this stock could be a long-term value opportunity as multiple short-term pressures have converged to lower the stock price.