ipopba
Investment thesis
I feel Guidewire Software (NYSE:GWRE) doesn’t have a strong competitive position, as its products lack ease of learning and ease of use compared to competitors, according to user reviews. Moreover, I believe that the competition is fierce, which has seemingly led to decreasing gross margins and increasing investment expenses. In my opinion, its valuation appears to be high for a company with these challenging factors in mind. For these reasons, I rate Guidewire as a “sell.”
Introducing Guidewire Software
Guidewire Software, Inc. provides an industry platform for property and casualty (P&C) insurance carriers in the United States and throughout the world. The company was founded in 2001 and went public in 2012. It generates recurring revenue by selling term licenses. In addition, the firm provides its software as a service on a subscription basis. ClaimCenter, PolicyCenter, and BillingCenter are its three core software solutions, each of which serves as a critical component of a P&C insurance carrier. Several add-on modules are available, as well as an expanding number of value-added web services available through Guidewire Analytics and Guidewire Marketplace.
Property and casualty (P&C) insurance encompass a wide range of insurance products. Generally, it relates to insurance coverage that protects your assets, including property.
Market Outlook
Insurance is being used differently by consumers, and they have different expectations of their insurers than in the past. When P&C businesses deal with clients, they must be prepared to respond with both technology and a thorough customer strategy. Clients demand more customized products and services that fit their lifestyles.
Technology and data insight can provide an excellent chance to customize the consumer experience rather than focusing exclusively on products. Telematics, mobile applications, self-service, and other technological innovations are improving goods, pricing, claims, and services.
All of these factors present possibilities for P&C insurers to improve their member engagement and business practices. There is a tremendous opportunity to cut costs and risk while boosting connections.
As a result, I believe that the P&C software market is set to grow at a decent rate.
Intense Competition
Increased investment in software solutions by insurers, as well as the advent of new platforms ranging from core system modernization to new digital interaction and data and analytics solutions, has piqued the interest of entrepreneurs and investors. Increased capital enables market participants, or possible future market participants, such as “insurtech” businesses, to pursue more aggressive strategies, improve the existing services or products, try to introduce new services and products, develop disruptive solutions, and consolidate with other vendors. This industry is also affected by altering technological choices, changing client demands, and the growth of cloud-based solutions. I believe that these elements contribute to an intensely competitive environment. The amount of capital invested in the present and potential competitors, including insurtech startups, has expanded dramatically in recent years, so I expect the rivalry to continue to be intense in the future. Continuing fierce competition may result in increased pricing pressure, as well as increased sales and marketing expenses, as well as increased R&D investments, which could all have a detrimental influence on its profitability.
Competitors are P&C insurance software providers such as Duck Creek (DCT), EIS Group, Insurity, Majesco, Prima Solutions, RGI, and Sapiens; and horizontal software vendors such as SAP and Salesforce, which purchased Vlocity in 2020.
Competitive position
I believe that the most important competitive factors in the P&C software industry are product functionality, performance, the total cost of ownership, solution completeness, proven record of implementation, reliability, and in-depth knowledge of the P&C insurance market.
On average, users rate Guidewire on average 3.5 out of 5 on Capterra, a software review website. This is a low rating compared to the alternatives, as most score 0.8 to 1.4 out of 5 higher.
The dislikes mentioned are:
-
Higher learning curve
-
It’s so hard to find what you need
-
Application was not designed to be cloud native
Despite these dislikes, people seem to like that all the functions can be found on one platform.
The same observations can be made when looking at Gartner reviews.
Other competitors, such as Duck Creek Policy from Duck Creek, are perceived to offer a one-solution platform as well. In addition, users believe that it’s easy to learn and easy to configure.
As companies such as Duck Creek are perceived to offer the same quality of features and the one solution platform, as well as ease of learning and ease of use, I do believe that Guidewire doesn’t have a strong competitive position.
Transition to cloud and decreasing gross margins
Growth rates (Year-over-year):
|
index |
2019 |
2020 |
2021 |
Last 4 quarters |
|
Revenue |
10% |
3% |
0% |
5% |
|
Gross Profit |
10% |
2% |
-8% |
-7% |
Source: Seeking Alpha
Margins (% of revenue):
|
index |
2019 |
2020 |
2021 |
Last 4 Quarters |
|
Gross Profit |
54% |
54% |
49% |
45% |
|
Selling, General & Admin |
28% |
30% |
34% |
36% |
|
Research & Development |
26% |
27% |
29% |
31% |
|
Net Income |
2% |
-3% |
-8% |
-20% |
|
Free Cash Flow Margin |
9% |
11% |
11% |
-9% |
Source: Seeking Alpha
In accordance with the company’s most recent annual report, gross profit significantly decreased as a result of lower term license revenue attributable to multi-year term license agreements entered into and reduced professional services revenue as a result of contracts with lower average services billing rates. This could be a sign of the increasing competition that I talked about earlier.
Additionally, greater investment in cloud integration engagements increased the cost of revenue. Furthermore, its SG&A margin increased as well as the R&D margin, which is mainly to support its transformation to cloud offerings. These investment expenses are essential as the competition switches to cloud offerings. As cloud is still continuously changing and users remark on the limited cloud capabilities of Guidewire, I expect that these investment expenses will continue for a few years.
Valuation and other statistics
Basic valuation and performance-related statistics of Guidewire and Duck Creek:
|
index |
PS Ratio |
Gross Margin |
Price to Gross Profit |
3Y sales growth |
|
Guidewire Software |
7.42 |
45% |
16.49 |
2% |
|
Duck Creek |
6.52 |
57% |
11.44 |
21% |
Source: Seeking Alpha
Because Guidewire makes no profit, no PE ratio is available. The S&P 500 currently has a median PS ratio of 1.52, while having a similar gross margin on average. In other words, looking at the price to gross profit or the price to sales, Guidewire is roughly 5 times more expensive than the median S&P 500 company. Furthermore, its 3-year sales growth is very low at 2%. As I stated before, I don’t think Guidewire has a strong competitive position, so I don’t believe this growth rate to increase a lot in the future. Moreover, Guidewire is also significantly more expensive than Duck Creek.
Factors that could cause an upward move in the stock price
While I do think Guidewire does not have a strong competitive position, it has started investing more in marketing expenses and R&D expenses to support its transformation to user wishes for cloud offerings. While these expenses do pressure its income, it could improve its competitive position. This could drive revenue growth. If the expenses grow slower than the revenue, a profit might be achieved, which could drive up the price of the stock.
Final Take
The competition is quite fierce. As a result, the investment expenses of Guidewire will increase to try to satisfy the changing needs of customers. Furthermore, I believe that the prices seem to get pressed as gross margins decrease. As a result, Guidewire is a loss-making company, and I don’t see it changing in the short-term future. Furthermore, comparing product reviews leads me to believe that the competitive position of Guidewire is not strong. As a result, I don’t believe that the historically low growth rate will improve a lot.
With these challenging factors, I believe that the current valuation of the company is high compared to a competitor and the market. For these reasons, I set the recommendation for Guidewire at a “sell”.
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