AI-Driven Automation Will Support Steady Margins Amid Rising Competitive And Execution Risks

Catalysts

About Paycom Software

Paycom Software provides cloud based human capital management solutions that automate HR and payroll for businesses.

What are the underlying business or industry changes driving this perspective?

• Although the company has invested approximately $100 million to expand owned AI enabled data centers that support IWant, future GPU and infrastructure requirements could rise faster than expected as usage scales. This could constrain free cash flow and limit further margin expansion.
• Although command driven automation through IWant and Beti is reducing service tickets by 20% to 30% and improving client ROI, competitors are likely to fast follow with similar capabilities. This could compress pricing power and slow recurring revenue growth over time.
• Although AI driven self service is widening adoption among new employees and C suite users, there is a risk that clients do not fully roll out or engage with advanced automation features. This could mute expected uplift in module attach rates and limit upside to revenue per customer.
• Although automation has enabled workforce reductions of roughly 500 primarily administrative employees and supported adjusted EBITDA margins near 43%, future efficiency gains may prove harder to capture. This could cap net margin improvement despite continued top line growth.
• Although management sees significant white space with less than 5% penetration of its addressable U.S. HCM market, execution challenges in scaling the sales force and opening new offices could prevent a return to low teens growth and keep revenue and earnings on a more moderate trajectory.

Assumptions

This narrative explores a more pessimistic perspective on Paycom Software compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Paycom Software's revenue will grow by 8.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 22.6% today to 21.8% in 3 years time.
• The bearish analysts expect earnings to reach $551.3 million (and earnings per share of $9.76) by about December 2028, up from $453.2 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $633.4 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 19.1x on those 2028 earnings, down from 20.2x today. This future PE is lower than the current PE for the US Professional Services industry at 25.0x.
• The bearish analysts expect the number of shares outstanding to decline by 1.93% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.16%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• If AI driven products like IWant and Beti continue to see rapid adoption across existing and new users, including thousands of C suite executives and newly onboarded employees, Paycom could convert its innovation lead into sustained double digit organic recurring revenue growth. This could drive the share price higher rather than flat through stronger top line expansion.
• The front loaded investment of roughly $100 million in owned AI focused data centers, combined with ongoing automation that has already reduced internal tickets and call volumes by 20% to 30% and enabled workforce reductions of about 500 administrative staff, could support structurally higher adjusted EBITDA margins near 43% and growing free cash flow. This may justify valuation multiple expansion and share price appreciation.
• With less than 5 percent penetration of the U.S. HCM total addressable market, a more effective sales force, new office expansion and marketing around differentiated automation could accelerate new logo wins and module attach rates. This could lift recurring revenue growth back toward the low to mid teens and increase earnings power, which would put upward pressure on the share price.
• Strong balance sheet health with $375 million of cash, no debt, and significant remaining buyback and credit capacity, alongside an ongoing dividend program and over $1 billion already returned to shareholders since 2023, could enhance per share earnings through further repurchases and support higher valuation. This would contradict the expectation that the share price will remain unchanged.
• If secular trends toward automation, decision fatigue reduction and AI powered workflows in HCM continue to intensify, Paycom’s first mover advantage with fully deployed solutions across 100 percent of its client base may drive higher client retention, win backs of former customers and premium pricing. This would improve long term revenue visibility and net margins and could result in a rising share price instead of a flat outcome.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Paycom Software is $165.0, which represents up to two standard deviations below the consensus price target of $209.94. This valuation is based on what can be assumed as the expectations of Paycom Software's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $250.0, and the most bearish reporting a price target of just $165.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $2.5 billion, earnings will come to $551.3 million, and it would be trading on a PE ratio of 19.1x, assuming you use a discount rate of 7.2%.
  
• Given the current share price of $166.61, the analyst price target of $165.0 is 1.0% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.