Good Morning!

Happy Happy New Year, and I am so pumped to be back with the first issue of 2023, but first lets kick things off with a nice little New Years joke:

"I always skip the gym the first week of the new year. I can’t deal with the crowds. I also skip weeks 2 - 52 of the New Year but still looking for an excuse for those."

Too funny and too real. 

Also, before we get into all of the finance fun, make sure to check out one of my favorite Instagram Reels from the past week. Now we just need this legend to make a cover of the whole song! And yes: Reels > TikTok

Showtime!

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DEEP DIVE

Introduction

Every once in a while I think back to the day that Adam Ryan, CEO of Workweek Media, came up to me with the idea of The Crossover. The second he started talking to me about the idea, the biggest metaphorical (thankfully) light bulb I have ever seen went off in my head. 

I love the public markets and private markets. Why not find a way to leverage the knowledge of one into the other and see if there are some interesting insights and takeaways to be had. 

There most definitely are and now that I am about 6 months into shifting my schema to thinking about the intersection between the two, the connections are   becoming second nature. 

I am therefore excited to kick off the new year with a two part newsletter on an industry that you most likely haven’t spent much time researching, analyzing, or reading about because I sure as heck didn’t before this. 

What is the industry? 

Payroll and HR Software. 

Sounds exciting right? Yes. That was sarcasm. 

I can actually guarantee you that this space is much more interesting than it might initially sound.

In the private markets, there is the $11B+ Rippling that is growing at an unprecedented rate and then there are several publicly traded competitors that have high margins, generating strong cash flows, paying dividends, undercovered, and could be great opportunities if the market were to see a dip.

Some of these companies include ADP, Paychex, and the one we will be focusing on today, Paylocity.

Paylocity

As technology has become more advanced and our world has become smaller, companies find themselves with more complex HR needs than ever.

Some employees are remote while some work in person. Some are in the US and some overseas. Some full-time, some part time. Some that should have access to this information, but not that information. It is a mess. 

Thankfully for HR professionals, Paylocity is a company that has identified all of these pain points  and has created a suite of products to help make their lives a whole lot easier. The products are in areas that include (but not limited to): 

• Payroll – Payroll and Tax Services, Global Payroll,  Expense Management
• Human Capital Management – Core HR, Employee Self-Service, Document Library, Compliance Dashboard
• Workforce Management – Time and Attendance, Scheduling, Time Collection
• Talent – Recruiting, Onboarding, Learning Management 

At the end of 2022, Paylocity had 33,000 clients with the average company size of 100 employees per company. This client list represents 16% growth from that of 2021 and the company still feels that they are at just a percentage of their TAM of 1.3M companies (between 10-5,000 employees). 

Alright. Now time for the fun stuff! The financials.

Financials

Over the past several years, Paylocity has achieved nice top line growth, growing revenues from $468M in 2019 to $853M in 2022 representing a 22% CAGR. The company has achieved revenue growth not only through adding new customers, but also expanding relationships with existing customers and cross selling them on additional products while keeping R&D spend consistent. 

• Paylocity grew from 24,450 in 2020 to 33,300 in 2022
• R&D spend as percent of revenue between 13%-15% since 2017

As you can see from the chart below, (good work Paylocity IR team), almost all of the company’s rapidly growing revenue is on a recurring basis giving significant foresight into their future revenues.

What is also intriguing to me about Paylocity is they are big fans of three of my favorite words, which at this point you can probably guess, Free Cash Flow. Here are Paylocity’s Free Cash Flow figures from the past several years: 

• 2019 – $76M (16.3% margin)
• 2020 – $70M (12.5% margin)
• 2021 –$87M (13.7% margin)
• 2022 – $103M (12% margin)

With a market cap of over $10.7B, Paylocity is trading at around 100x trailing FCF. If the company can maintain a 12% margin on their $1.1B in revenue (32% revenue growth), this would give them 2023 FCF of $132M which would represent an 80x FCF multiple. 

Paylocity also projects into the long run that they expect to have 20% revenue growth annually and a 15%-20% FCF target. 

This type of top line growth with serious FCF conversion makes this a stock on my radar, but the multiple of cash flows just seems way too expensive. 

I also want to point something out regarding their Annual Revenue Retention Rate which sits at 92%.

In some ways, this figure is incredible, but there is another way to look at it that 8% of total revenue from last year goes away – which sounds like a solid amount of churn. I checked out ADP and Paychex who seem to have around a 90% and 83% retention rate. 

Therefore, Paylocity does look pretty good, but I am concerned that if the economy continues to go south, layoffs continue, and SMBs start going out of business, the 92% number would look pretty different and not in a good way.

Also, I could see a scenario where companies drop different products like hiring tools to try and cut costs. 

Co- CEO Steve Beauchamp actually sounded pretty optimistic regarding the macro environment and its impacts on Paylocity in the Q1 2023 call: 

“What I would tell you from a demand perspective, obviously, we’re really happy with the results, and we’ve got a lot of sales momentum inside our selling season right now. As you know, January is a big time for starts. So no evidence of slowdown from that perspective. And then I think the other part is looking at our clients. And as we mentioned in the prepared remarks, we did have a little bit more employees on the platform when you look at kind of a same-store sales measurement, although that has slowed pretty significantly versus prior periods. But it is still slightly positive. And so it seems like the clients that we have are pretty resilient at the moment.

A little later in the call Beauchamp also noted on the macro environment “that I think the way that I would characterize that is it would take a pretty significant downturn from a macro standpoint to materially impact our revenue results.” 

I am hoping that we do not see a pretty significant downturn from a macro standpoint, but I do think there is serious uncertainty and would not want to have many of my chips in a company that would be heavily impacted by a downturn already trading at a significant multiple. 

Competitors 

Paylocity views their two closest competitors as ADP and Paychex. 

ADP is the giant in the space with a $100B market cap. The company did ~$16.5B in revenue last year representing 10% year over year growth. Additionally, ADP did around $2.9B in FCF in 2022, almost the exact same figure as their 2021 FCF. ADP also has a 2% yield. Through complex mathematical equations (sarcasm), ADP is trading at more than 30x FCF. 

I am definitely more intrigued by Paylocity than ADP due to the size and upside.

Paychex is also a publicly traded entity and has a $42B market cap. The company did $4.6B in revenue last year representing 12% year over year growth. The company did $1.3B in FCF last year vs. $1.1B in the year prior. The company also has a 2.7% yield. Therefore, holding myself from making the same joke I did a moment ago above, Paychex is trading at ~35x FCF.

I attached a chart below from Paylocity breaking down the competitive landscape and how they see it:

Conclusion

As you can see, Paylocity operates in a crowded yet undiscovered field. There is one company that Paylocity did not and most definitely should have included in the chart above: Rippling. 

Rippling is one of the best private companies in the game and this week was more of a set up piece to talk about Rippling, comparing them to public market opportunities, and overall valuations in the space (which spoiler alert, I think are too high all around). 

Have a great weekend everybody and look forward to connecting next week. In case you wanted to learn more about Paylocity, I attached links to the most recent earnings presentation and conference call transcript below: 

1. Investor Presentation
2. Transcript

-Alan

THE CROSSOVER ARCHIVE

Missed a recent edition? That's okay! Now you can just click on these links below to catch up on what you missed!

• 12/30 - 10 Predictions for 2023
• 12/16 - Is Splunk a Slam Dunk?
• 12/09 - Public: FinTech's Next Star
• 12/02 - Core Four: Build-A-Bear, a16z, Apple, Wander

CHARTS OF THE WEEK

My Question: Is it more the negative press around Musk selling stock and events at Twitter or just the market correcting to stocks trading more closely to their fundamentals regardless of the hype/situation? 

1. Invest Early

2. Invest Often

3. Invest in Tax Deferred Accounts

PORTFOLIO

Note: The Crossover Portfolio is a mock portfolio of how I would be investing and not with real money. All trades are shared publicly @ The Crossover Twitter as they are recognized. 

• $PARA announced a partnership with Delta to give all Delta SkyMileage partners access to the full Paramount+ experience on flight and a free trial at home
• $MODG announced a partnership with Niall Horan, a former One Direction member
• We need zero moves to kick off the year! Just how we like it!

VENTURE CAPITAL

Jessica Matthews of the Term Sheet hooked us up with some great fresh data on Q4 both in the chart above and in a couple of others in yesterday's newsletter:

• Global Venture Funding in Q4 '22 was down to $77B vs. $178B in Q4 '21
• Seed Stage Funding in Q4 '22 down to $6.9B vs. $10.6B in Q4 '21
• Late Stage and Growth Funding in Q4 was down to $39.7B in Q4 '22 vs. $110.3B in Q4 '21

MEDIA MUSINGS

The Lightshed Podcast is easily my new favorite podcast, and I do not think it is close. Rich, Walter, and Brandon have a hilarious dynamic and discuss everything to do with one of my favorite industries - media. I also find myself disagreeing with them quite often and hearing their thoughts really challenges my various ideas. 

Lightshed shared their 23 Predictions for 2023, and there is one in particular that I disagree with and wanted to share some thoughts on: 

"8. Turner Bows Out of NBA as Amazon, Apple and NBC Vie for Rights."

I want to focus on the Turner side of the equation. The Lightshed squad feels that Turner will no longer retain NBA rights due to several reasons including:

• Cost Cutting being a priority
• March Madness and MLB deal is enough to lower churn in the bundle
• Smaller distribution on cable TV from cord cutting (I guess this is from NBA perspective)

If I had to make a prediction on whether Turner would sign up for a new NBA package, I would most definitely say yes they will. 

Why? A few reasons. 

First, I think that the NBA needs TNT. NBA on TNT is off to its best start of the season since 2017 averaging 1.67M viewers vs. ESPN's 1.41M viewers. There is no question that NBA fans love watching games on TNT.

A big reason for this, and for us reason #2, is the personalities involved in TNT's pregame show with Ernie Johnson, Charles Barkley, Shaq, and Kenny Smith. This is the #1 pregame/halftime show in all of sports and there is always social media gold coming from the show, mostly from Barkley and Shaq.

Speaking of Barkley, he signed a 10 year $100M deal with TNT that can approach $200M. Why would TNT sign Barkley to this massive contract if they were not going to retain NBA TV rights. The NBA wants Barkley and TNT has him. 

Additionally, Turner owns Bleacher Report who owns House of Highlights, an NBA focused social media account with 38.3M instagram followers alone. House of Highlights is a significant part of NBA culture and social media where the NBA is crushing it. 

$WBD CEO David Zaslav has talked a lot about a modern rights package that gives $WBD linear, digital, and streaming rights. Being on HBO Max to connect with the next generation, linear to get reach, and going even deeper on digital sounds like a dream come true for the NBA and $WBD. All that it comes down to is not if they do business together but at what price. 

Adam Silver, Commissioner of the NBA, and David Zaslav are two of the sharpest individuals in their respective industries, and I am sure they see the value opportunities for both sides that I have pointed out above. 

MEMES OF THE DAY

GOLDEN NUGGETS

• Sending our deepest thoughts and prayers to Bills Safety Damar Hamlan and his family. Thankfully, it sounds like we are heading in the right direction
• Denny Kellington is a hero 

• We were supposed to kick-off the newsletter with an update on my Fantasy Football team's performance in the championship, but it just didn't feel right given the events from Monday night. I did in fact lose in a close match, but that of course now, feels more pointless than ever. 

• Donovan Mitchell had the game of his life
• I am absolutely hooked on the TV show 1923.

Thanks for the read! Let me know what you thought by replying back to this email.

— Alan 

Disclaimer: The Crossover is not a professional financial service. All materials released from The Crossover are for educational and entertainment purposes. The Crossover is not a replacement for a professional's opinion. Contributors to the Crossover might have positions in the equities in the The Crossover Portfolio or mentioned in the newsletter.

Written by me, Alan Soclof.

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