With the valuations of software companies in question, many pundits have pointed to low interest rates as a catalyst. As the thinking goes, easy money and few high-yielding alternatives force investors to take more risk to find growth. That's why many high-flying technology companies fell sharply when inflation started dominating conversations in March.
But there's a technology company that benefits from inflation. Paycom (PAYC +1.02%) actually makes more money the higher interest rates go. Below are two reasons why that's the case -- and why shareholders shouldn't worry about rising rates.
Image source: Getty Images.
1. Interest on client deposits
As a payroll-service provider, Paycom collects money from clients before paychecks are sent out or direct deposits are made. Companies also have to include the funds to cover their portion of Social Security taxes.
Those funds are typically held between one and 30 days before being disbursed. The company earns interest on those deposits while it holds them. When interest rates climb, the interest earned on the funds held for clients also increases.
Management doesn't break out the interest it earns, but it's included in recurring revenue. Charting those deposits, interest rates, and recurring revenue over the last few years paints a hazy picture.
| Year | Funds Held for Clients at Year End | Avg. 10-Year Yield | Recurring Revenue |
|---|---|---|---|
| 2020 | $1.61 billion | 0.89% | $825.9 million |
| 2019 | $1.66 billion | 2.14% | $724.4 million |
| 2018 | $1.00 billion | 2.91% | $557.3 million |
Data source: Paycom, Federal Reserve.
Headcount reductions and clients choosing to delay Social Security taxes -- which was allowed by a pandemic relief bill called the CARES Act -- caused funds held for clients to drop last year. That put a dent in recurring revenue. So did the drop in interest rates.
In May, CFO Craig Boelte estimated the lower headcount was reducing weekly recurring revenue by nearly $2 million, while the interest-rate cuts from last year amounted to a $350,000 weekly impact. Thankfully for shareholders, the unemployment rate has fallen to 5.9% and the 10-year yield is back up to 1.26%. If rates keep rising, the company will benefit. Paycom ended the first quarter with $1.7 billion in funds held for clients.
2. Increasing wages
One area of inflation that's causing concern is the rising cost of labor. Average hourly wages grew 3.6% in June, according to the U.S. Bureau of Labor Statistics. For a company like Paycom, it's irrelevant. Management doesn't even mention the word in earnings calls or filings with the Securities and Exchange Commission. There's a good reason.
As wages go up, so does the overall amount employers are paying employees. That means the funds on deposit to cover payrolls and taxes also increase. It's another way the company profits from a booming economy without having to sign up a single client. But it's growing the number of clients.
| Year | Clients* | Client Growth | Recurring-Revenue Growth |
|---|---|---|---|
| 2020 | 16,063 | 18.3% | 14% |
| 2019 | 13,581 | 6.5% | 30% |
| 2018 | 12,754 | 14.8% | 31% |
Data source: Paycom. *Clients based on parent-company grouping.
Note how recurring revenue grew faster than the number of clients until the pandemic. In addition to signing customers up for more software modules, the money made from those client deposits plays a meaningful part in Paycom's growth.
Light at the end of the tunnel
COVID has made year-over-year comparisons difficult for many companies, but we're finally seeing an end to the disruption. Paycom is no different. Management has guided for full-year revenue of $1.02 billion. That's 21% growth -- closer to what shareholders had become accustomed to.
The low-interest-rate environment has actually hindered an important part of the company's growth -- unlike so many other software providers. If the economy continues to gain steam and talk of inflation once again spooks investors, remember where to find safety in the storm. Paycom has many ways to grow its recurring revenue and several of them benefit from inflation.
