Paycom: Nervously Patching Leaks?

by Sonya Colberg, Senior Editor - 12/2/2015 10:01:42 AM

Iconic investor Warren Buffett once said, "Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks."

Indeed, Paycom Software (PAYC) investors may be getting tired of patching leaks in this company that provides payroll software-as-a-service for small and medium sized businesses.

One leak will become a veritable torrent in a matter of weeks, when current investors' shares could face major dilution. That's because of the Dec. 28 release of about 18 million shares that Paycom insiders have had locked up for months.

That's right. Millions of Paycom shares will become eligible to hit the public auction block, according to the prospectus supplement.

See more information here and below:

“The date of this prospectus supplement is November 12, 2015.”

“After this offering, our officers, directors and selling stockholders will be subject to lock-up agreements with the underwriter or us that restrict their ability to sell shares of common stock until 46 days after the date of this prospectus supplement. After the lock-up agreements expire, an additional 18,441,518 shares of common stock (or 17,766,518 shares of common stock if the underwriter exercises its overallotment option in full) will be eligible for sale in the public market…”

The selling shareholders may be seen here:

Clever insiders can now more easily back out of their investment in Paycom – a company they probably realize is poised to feel the effects of a fading revenue driver - the Affordable Care Act.

In fact, a major investor, Welch, Carson, Anderson & Stowe, deserves our golden plastic wheelbarrow prize for dumping stock more rapidly than any we’ve ever before witnessed.

The private equity firm and entities have unloaded some 5 million shares. In one day.

On Nov. 24, the firm sold almost every single share of Paycom stock:

(Source: Nasdaq)

Selling seems a good idea for the multi-billion dollar portfolio holder as well as a list of other selling insiders that just goes on and on and on….

 (Source: Nasdaq, click to see more sellers)

Considering the sell signals from insiders, average shareholders likely won’t have to wait long for the stock to drop. So they may want to pack up their leak patch kits and seriously consider what to do about the hungry alligators circling Paycom.

Paycom has not responded to a request for comment but investors may find other viewpoints here. Meanwhile, let’s look around this leaking vessel.

*Bye-Bye: Revenue Poised To Fade Under Affordable Care Act Deadlines

Paycom went public as the Affordable Care Act really began heating up in 2014.

The Affordable Care Act, often called ObamaCare, handed small businesses a raging river of governmental insurance requirements and software companies like Paycom a boatload of opportunity.

Paycom and many others offer frustrated business owners a way to manage ACA requirements and associated tax forms.

With an eye on 2016 ACA deadlines, competitors like Ultimate Software (ULTI) began spending millions – in Ultimate’s case more than $15 million - through 2015 on security and compliance product features. As beautifully noted by Alecto Research, such big bucks spent in advance can help HR companies avoid security breaches and other issues that should have been protected from by their software companies.

Now, that ACA opportunity is almost over. Employers are hitting compliance deadlines in January and March 2016.

Yet, with these deadlines just around the corner, Paycom has made some mistakes.

First, it uses a non-traditional subscription-based revenue model. Rather than the traditional annual customer contract, Paycom allows customers to cancel with just 30 days prior notice. So customers who aren’t happy with Paycom are probably less likely to try to work it out than just switch to another company altogether.

Second, those killer ACA deadlines now threaten to maim Paycom’s revenue growth. At this critical moment, Paycom has committed to only a fraction of the research and development dollars spent by competitors. Top development of technology should have been a key factor in management's planning because development spending is crucial to keeping up with the competition and keeping customers happy.

Last quarter, Ultimate devoted $23 million to R&D or 15% of revenue. Paycom spent about $2 million – only 4%. Yet Paycom spends 21% of revenue on general and administrative services - about $34 million over nine months. Ultimate spends about 12% on general and administrative or $53.5 million over nine months.

Here are estimations of how some year end figures may look for Ultimate and Paycom:

(Source: From Paycom SEC filings;Ultimate Software SEC filings )

Falling so far behind peers’ efforts will ultimately come back to bite Paycom.

*Tough Competitors, New Disruptive Rival

Paycom competitors include ADP, Intuit, Salesforce, Palo Alto Software, Sage, WorkForce Software and many more.

The sleek new yacht called "Zenefits" has launched and is thought to be one of the fastest-growing Silicon Valley companies in recent history. Red-haired, unusually self-doubting founder, Parker Conrad, appeared in a New York Times write-up after he captured more than $66 million in VC funding.

Mr. Conrad had spotted the ACA opportunity and one-upped the competition with a disruptive offer: free software. If customers then decide to buy their employees’ insurance through Zenefits’ software, that company gets a payment from insurance companies. Now Zenefits is reportedly blowing everyone else out of the water.

*Overheated Sector

But that water is overheated, we believe, regularly fueled by the Affordable Care Act. TheStreetSweeper can't help but think about how much this sector looks like another one that we sounded an early warning about a couple of years ago .... the 3-D space.

That was back when it seemed that people at every party, picnic and movie theater wanted to talk about 3-D printing companies.

Much as we're alerting investors to Paycom's multiple stock offerings shortly after the IPO, we wrote that ExOne shocked investors six months after its IPO with a stock offering that meant millions for the CEO and entities - and dilution for investors. We talked about the 3-D bubble and the danger of it collapsing.

Back in 2013, The ExOne Company (XONE) fetched $71.90 per share on our publication date. It's $9.95  per share now. Here's the chart:

(Source: Yahoo Finance)

Investors can quickly see that this category, too, seems to be floating in a bubble rather similar to the 3-D companies and dot-com companies in the 1990s. Yahoo (YHOO) cost well over $100 per share back then, for example. Now it's $33 and change.

Look at Paycom and rivals' price-to-earnings, price-to-sales, and cash. Do we really want to pay 100 times earnings for stock?

(Source: Yahoo Finance)

*Conclusion

Paycom stock is screaming along with virtually no one sounding an alarm. But the historical follow-on offerings, near-term stock lockup expiration, insider selling, revenue risk amid ACA mandate deadlines, free alternatives and crazy price-to-earnings ratio are screaming, too.

Investors might want to devote their energy to changing vessels because the leaks in this boat are becoming geysers. We think $22 per share is a very fair, near-term valuation for this stock.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in PAYC and stand to profit on any future declines in the stock price.

* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to scolberg@thestreetsweeper.org.

 

 

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