Bill.Com Stock: From Sell To Hold With Many Unsolved Problems (NYSE:BILL)

Bill.com headquarters building exterior.

Michael Vi

Intro & Thesis

I initiated Bill.com Holdings, Inc. (NYSE:BILL) coverage at the end of January 2022 with a “Sell” rating. At that point, the stock had already fallen 54% from its November highs and was trading at a price-to-sales ratio of 44x, which seemed completely inappropriate to me given the continued unraveling bubble in tech stocks.

A few days after that article was published, BILL released a quarterly earnings report, after which the stock soared over 40% in one trading session – the reason being a huge increase in sales. However, I did not roll back my thesis – on the contrary, the stock became even more expensive for me after such strong growth, and I decided to wait until the dust settles and the market finally realizes that revenues and their growth are far from being the most important criteria even for high-growth stocks in 2022.

My expectation was finally justified – the market really started to overestimate its “criteria for choosing the winner,” and the BILL stock lost all its power and fell 21% below the price at which I initiated my coverage:

My article on BILL [January 25, 2022], Seeking Alpha

My article on BILL [January 25, 2022], Seeking Alpha

Today, I want to update my thesis and see how Bill.com has changed its approach to business growth, how the company’s valuation has changed, and what investors can expect in 2023. Let us dive in.

Assessing my previous take – what has changed?

My latest thesis can be summarized in a quick elevator pitch – BILL grew well in 2021, but ended up quickly losing everything it had built up. Its valuation remained quite high and, being justified by just high revenue growth, started to burst. BILL’s revenue was the only component that justified its valuation. The few mergers and acquisitions the company made, while guaranteeing that growth, required further inflation of operating costs, so the bottom line continued to suffer into the future.

Let us take a look at last quarter’s income statement and see if this thesis is still relevant today:

BILL's 10-Q, author's calculations

BILL’s 10-Q, author’s calculations

Bill can successfully pass on the growth in the direct cost of its product (subscription and transaction fees for its automation software) to small and medium-sized businesses (“SMBs” – end customers), as evidenced by the growth in gross profit exceeding revenue growth by 14.52%. It seems that BILL should use the created operational leverage to its advantage and turn it into profit and become self-sufficient by optimizing OPEX (reducing its share of sales).

However, as we can see going down the P&L, the company is still spending way too much on sales and marketing expenses (over 72% of total sales). In absolute terms, this is the fastest growing line item in the report – so EBIT continued to decline in Q1 FY2023 (loss increased 18.2% year-over-year), as it did when I first became aware of this company.

Moreover, the company continues to save on “here and now” expenses, preferring that current shareholders pay for the work of management, marketing campaigns, and part of COGS later – I am talking about stock-based compensation (“SBC”) expenses, which are embedded in the vast majority of the company’s expenses:

BILL's 10-Q, author's notes

BILL’s 10-Q, author’s notes

This is a big problem for all tech companies with a similar level of growth as BILL. However, in this particular case, we see SBCs continuing to grow as fast as revenue grows – this eats up all the bottom line growth, and ultimately investors are paying for growth that I believe is not high quality and increases risk of further dilution of share capital.

Chart
Data by YCharts

The amount of free cash flow (“FCF”) and cash flow from operations generated by BILL is definitely not enough to justify the current valuation of the company of $13 billion – if we clean up the FCF and CFO of SBC, we will understand that the problem of dilution of Bill’s shareholders remains relevant to this day, because, without options, management will not be able to ensure the smooth operation of the company, despite the huge cash cushion on the balance sheet (>20% of the market cap).

Chart
Data by YCharts

A few words about BILL’s valuation and prospects

Since the beginning of the year, the share price of BILL has fallen by 48%, and at the same time the forward P/S ratio has corrected by 67% – so the multiple contraction was the reason for the stock correction. Now that the market is laying down the Fed’s less stringent policy, is it worth buying shares in the expectation that the opposite – a multiple expansion – will occur in 2023? Let me explain my point of view.

1-year forward price-to-sales ratio, despite correcting significantly YTD, is still above the industry’s [Application Software] average 2.61x:

Chart
Data by YCharts

But that’s not how we should look at multiples, is it? We need to match them with the future operational growth rates that our object of study is showing compared to those of its peers.

I uploaded data from Seeking Alpha for 210 companies in the industry in which Bill.com operates, and after creating a scatter plot, I saw how the company stands out qualitatively from the rest of its peers:

Author's work, based on SA data

Author’s work, based on SA data

I suggest reducing the sample – 210 seems too large. I left only the companies with enterprise value between $3 billion and $50 billion, and this is the result:

Author's work, based on SA data

Author’s work, based on SA data

Based on these calculations, BILL appears trading fairly – investors pay about the same amount of dollar for 1% of BILL’s future revenue growth than for comparable growth of an average company in the sample.

But does that mean BILL is ready? I do not think so.

  • First, the projected growth we have for other companies could be underestimated, while on the contrary it may be overestimated for BILL.
  • Second, what if the whole sector is overvalued? Then BILL will be the best of the worst despite all its growth prospects.
  • Third, we consider only revenue-related indicators (both valuation and growth) for a single reason: BILL has not bothered to break into actual, unadjusted GAAP earnings.

The projected EPS numbers we are seeing look quite optimistic, in my opinion, given the increasingly difficult conditions for SME owners in the U.S. and around the world. According to the National Federation of Independent Business (NFIB), the Small Business Optimism Index in the United States fell to a three-month low of 91.3 in October 2022, down from 92.1 in September, Reuters reports.

TradingView, author's notes

TradingView, author’s notes

Based on historical data, this index still has room to fall – BILL is likely to have a harder time attracting new clients throughout 2023, leading to a review of its prospective earnings numbers by the Street. A high valuation will no longer be supported by high business growth.

Bottom Line

The 10x price-to-earnings forward ratio is no joke – if revenue growth suddenly slows to the industry average, then BILL will fall to the general “cloud” in the chart below, representing a further 40-50% decline in share price.

As in the case of Palantir Technologies Inc. (PLTR), which I write about often, Bill.com is growing only in revenue and is not approaching the unadjusted breakeven point as quickly as I would like if I were the company’s main shareholder.

The reason I am raising my rating today is the company’s qualitative customer growth rate – 131% of dollar net retention rate, with 82% of core sales from existing customers, shows how good the product BILL sells is. It’s all about the Street’s high expectations, still high valuation, and unstoppable SBC – combined, these 3 reasons keep me from being a bull.

Thank you for reading!

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