In many ways, Paycom Software (NYSE:PAYC) has been a perfect stock for investors -- putting up impressive top-line growth numbers while increasing margins and free cash flow over the last several years. With its all-in-one cloud-based solution that combines payroll along with multiple HR tasks, Paycom continues to make significant inroads with companies in its 50-to-2,000-employee target, primarily by stealing market share from ADP (NASDAQ:ADP).
During multiple conference appearances in November and December, Paycom CEO Chad Richison and CFO Craig Bolte provided new insights on the company's total addressable market and margin trends, its sales force, and why Paycom is staying laser-focused on its mid-market niche.
The 50-to-2,000-employee market is a gold mine
Paycom's licensing agreements generally include a per-employee fee. That fact, coupled with some new business wins in the 2,000-to-8,000-employee range, has led many (including me) to speculate that Paycom may be trying to expand its sales efforts into larger companies. Richison, however, explained at a Dec. 5 tech summit that this is not the case.
Typically what you'll see as you go way far upmarket, it's the same thing you experience in low market. They use less of a full solution. If you go to a 30,000-employee [company] using one of our competitors, they're primarily using them for payroll and tax depositing and filing. They've built the other software around it, and now they're integrating point solution providers. So if you go too far upmarket, you run into that type of decision tree. Likewise, if you're going small business, it's more referral based, and they might only need one of your products. Well, our value proposition is we have 29 modules and 1 database ... the value proposition there starts to break down if you go too high up-market or too low down-market.
At a conference the next day, Richison provided more detail around how much opportunity still exists in the smaller-size companies Paycom targets.
According to the U.S. Labor Bureau statistics, in 2009 ... there were 126 million workers in the U.S., and what we were able to identify at that time is about 50 million of them worked for companies in our sweet spot. And so as we take our total opportunity for any one employee, which is well over four-hundred dollars -- we have not updated that since our IPO, and we've released a lot of new products since then -- and so as we calculate that out, it's well over a $20 billion opportunity for us, and so that's what we're focused on is that mid-market.
With so much untapped potential remaining in the market where its value proposition is the strongest, there's simply no need at this point for Paycom to pursue larger (or smaller) companies that would result in lower win rates.
A sales force singularly focused on new business
Paycom's current client base uses, on average, about one-third of Paycom's available software modules. So there's still a significant opportunity to cross-sell existing modules to current customers. However, Richison has a simple reason why the reps in the field don't waste their time on incremental dollars from existing clients:
Landing new business -- when we represent 2% of the overall TAM [total addressable market] for us -- obviously that's the largest opportunity. Our outside sales reps don't go back into the client base after the clients have been on-boarded for longer than 30 days, so they're really focused on the hunting side.
After a big run-up, margins may still have room to expand
Paycom's adjusted EBITDA margin has risen dramatically in recent years -- from 16.7% in 2012 to 28.7% in 2016 -- and the company's latest guidance implies an adjusted EBITDA margin of around 31% for full-year 2017. CFO Craig Bolte said at a conference in November:
We continue to update our kind of medium-term margin targets. We updated it about a year ago to go up to 30 to 33%. And like you said, we're really hitting that -- the bottom end of that -- already this year. You know one thing, we're really focused on growth. So this isn't levers we're trying to pull to increase our margins, it's just we're focused on growth and when we bring on the business we bring on, it follows similar margin profiles to the business we already have. So I think we're still kind of early on to start pulling those margin levers.
Perhaps I'm over-focusing on a couple of words, but I think the fact that Bolte said "medium-term margin targets" in the above quote is telling. On previous conference calls, those adjusted EBITDA margin targets have been referred to as "long-term." To me, Bolte's comments clearly imply that there's another level Paycom believes it can achieve beyond the 30% to 33% target they've set.
The grandest of ambitions
Richison hasn't been afraid in the past to talk about big goals. He's mentioned the potential for 120 total U.S. sales offices (which currently number 45). He's discussed the company's ambitions of $1 billion in annual sales. In Paycom's most recent conference appearance, in early December, however, Richison spoke about the company's boldest objective yet -- to replace ADP as the industry leader.
The quarter-to-quarter messaging is extremely important ... but we also know what we're working on as our overall goal, and that's to be the No. 1 in this industry. You know, people laughed at that four years ago, and I'm sure there's people laughing at that right now. But our value proposition remains extremely strong, and we're focused on that.
Admittedly, that goal seems like the tallest of orders, given that ADP is more than 10 times Paycom's size by market cap, and reported $11.7 billion in revenue last year compared to Paycom's $329.1 million. But based solely on the success Paycom has had at ADP's expense over the last several years, I wouldn't want to bet against the company.