Paycom's Recurring Revenue Reaccelerates as Beti Implementation Finalizes

Meaning

Paycom Software is a major player in the Human Capital Management (HCM) software industry. HCM software companies typically offer a suite of different products which encompass all HR related functions. Some companies, like Workday and Oracle, focus heavily on the employee management sector whereas Paycom, ADP, Paylocity and others lean more towards payroll functions. Overtime, the services offered by all HCM companies seem to be converging as each competitor seeks to take market share across every HR function.

After spending a few years at ADP, Chad Richison moved back to Oklahoma in 1998 to start his own payroll processing company in Oklahoma City which is where the Paycom’s headquarters remain today. Chad has served as the Company’s CEO for over 26 years.

Paycom was an early mover in the online automation of payroll processes while legacy providers like ADP and Paychex lagged behind in the non-digital world. Overtime, all payroll processing companies followed the online path paved by Paycom and others. Paycom officially listed its stock on the New York Stock exchange in 2014.

As a Software as a Service (SaaS) company, Paycom generates revenue by selling its HCM software products to 36,800 clients on a tiered subscription-based model. Historically, Paycom has targeted small to mid-sized companies with 50 to 1,000 employees. Today, Paycom continues to further penetrate the small to mid-sized market but has strategically shifted most of its attention upmarket to large enterprises with 5,000+ employees. Paycom charges a client based on the client’s employee headcount and the number of distinct HCM software products the client uses, of which there are 42 in total. A few products offered by Paycom include:

• Applicant Tracking: Streamlines hiring, data management, job postings, and analytics
• Onboarding: Facilitates hiring with online task checklists for employees
• GONETM: Automates and standardizes time-off requests and decisions
• BetiTM: Enables employees to manage their own payroll, improving payroll efficiency
• Paycom Learning: A data-driven learning resource system for employee development

Paycom reports its operations as a single segment. Paycom’s sales force is vital to the company’s growth. The sales force is split into 55 teams, 54 of which are “Field Sales” and the other is labeled as “CRR and Emerging Markets.”

• Field Sales: General sales team comprised of experienced sales professionals focused on acquiring new clients. Teams are organized geographically across the US.
• CRR and Emerging Markets: A specialized sales team comprised of experienced sales professionals who have historically focused on cross-selling Paycom products to existing clients. Emerging Market reps focus on "high-potential" clients with less than 50 current employees.

Recently, Paycom’s CRR revenue contribution has dropped dramatically. The introduction of Paycom’s 2021 product, Beti, has been adopted by most of Paycom’s existing clients at discounted prices. This has been a major time consumer for CRR reps as they transition clients onto the new product. When questioned about the decline in revenue growth due to Beti, Paycom’s CEO stated,

• “I've said it many times that it's a lot easier to sell a client an additional product than to get them to actually use it. And we've implemented several strategies to make sure that clients are able to utilize and achieve a full client ROI in value before we sell them another product and in many cases, before we even will bill them, even though we've sold it.” (2024 Q1 earnings call).

Furthermore, the discounted pricing has assisted in transitioning existing clients, but has led to reduced CRR revenues compared to the prices the CRR team has historically charged for other HCM products. Management appears to be extremely focused on promoting Beti’s adoption.

Beti’s efficacy was made evident by a recent third-party study, “Our recently commissioned third-party study on Beti highlighted three benefit areas. On average, a greater than 80% reduction in errors, and 90% reduction in time spent processing payroll and improved employee engagement” (2023 Q4 earnings call). Consequentially, clients now experience fewer payroll errors, meaning they don’t need to run payroll as often. Additional payroll runs are expensed to the client and have historically boosted CRR’s revenue contributions. Management is aware of this revenue cannibalization and believes that the long-term benefits of Beti outweigh the cannibalized revenue.

The resulting deceleration in revenue growth has been a major contributor to the share price decline Paycom has experienced over the last three years. Management believes revenue will reaccelerate.

Moat

Like other business-to-business SaaS products, the HCM industry naturally benefits from a switching cost moat. Most HCM services provided by Paycom and its competitors are integral to their clients’ operations, with payroll being the most crucial. Employees are often characterized as the “lifeblood” of a company. Without a robust system in place to compensate its employees, a company will fail.

Once a client has integrated an HCM system, it is unlikely that they will choose to switch to a competitor and virtually impossible to build a sufficiently capable internal service at an economically sensible price. Furthermore, most HCM software companies offer very similar services and functionalities, making the industry somewhat commoditized. This commoditization can actually be viewed as a positive for Paycom as it strengthens their switching cost moat – why would a client incur all the extra costs of switching to another HCM software provider when the competitor’s products aren’t any better than what they are already using?

While most companies benefit from the industry’s inherent switching cost moat, Paycom’s recent product developments further strengthen their moat relative to competitors. Beti, which Paycom introduced in 2021, completely changes the way payroll is managed. With Beti, clients’ employees track and manage their own payroll. Employee payroll management leads to reduced errors, saves clients money, and demystifies payroll for the employee. Heavy employee interaction deepens Paycom’s switching cost moat as an entire company would be required to make the switch from Paycom to another provider instead of just an HR department. “And obviously we have lower, much lower attrition with businesses that use Beti versus those that don't” (2023 Q4 earnings call).

As a complete shift in payroll processing, Beti can be a competitive advantage which enables Paycom to take market share from existing competitors while also boasting the most attractive payroll option for companies who have not yet adopted a comprehensive HCM software provider. Paycom’s CEO estimates that they have about 5% market share, meaning there is a long runway ahead.

As mentioned earlier, HCM software products are largely commoditized. Beti may remain as a unique product for Paycom, but more likely, competitors will copy Beti, and employee self-service payroll management will become the industry norm. Regardless, Paycom will be at an advantage as the first mover. Competitors will incur significant research and development costs to create a similar product, costs which are already in Paycom’s rearview mirror.

As Beti continues to take market share, Paycom will exercise pricing power to reaccelerate its revenue growth. Furthermore, Paycom’s CRR team will again refocus on cross selling additional HCM products.

Management

Chad Richison is the founder, CEO, and Chairman of Paycom. Chad started the company in 1998 during the “dot com” bubble with an SBA loan and a few credit cards. The company is now valued at about $10 billion.

Chad grew up outside of Oklahoma City and earned his BA in Communications from the University of Central Oklahoma. After working for ADP for two years, Chad returned to Oklahoma to start Paycom with the idea of creating an internet-based payroll processing company.

Still owning over 11% of Paycom, Chad’s net worth of about $2 billion is mostly tied to Paycom stock. Recently, he has been regularly selling shares. Keep an eye on Chad’s selling – if his overall ownership were to decline below 10%, he would be conceding some of his significant influence over Paycom, which could be viewed as a sign of reduced conviction in his company.

Chad has been ultra-focused on improving Paycom’s products and delivering unmatched ROI to his clients:

• “Our client value achievement strategy that we're working throughout the year really has to do with meeting clients where they live and making sure that they're achieving the full value of ROI that's available to them through the appropriate usage of our software. And so, we've been focused on that… I've said it many times that it's a lot easier to sell a client an additional product than to get them to actually use it. And we've implemented several strategies to make sure that clients are able to utilize and achieve a full client ROI in value before we sell them another product and in many cases, before we even will bill them, even though we've sold it.” (2024 Q1 earnings call)

Thesis Catalysts

• Improve revenue retention rate over the next four quarters as transition to Beti begins to finalize among existing clients
  • 90% retention as of Q1 2024 - been as high as 94% pre-COVID
• Reacceleration of growth in total employees serviced – return to double digit growth
  • 5% in FY2023
  • High single to double digit growth in this figure will prove that the company's book of business is growing quickly even if revenue is not, which could continue to be temporarily depressed by CRR's and management's focus on the Beti transition.
• Reacceleration of growth in New Recurring Revenue (non-reported metric)
  • New Recurring Revenue (RR) can be calculated by subtracting Prior Year's Recurring Revenue from current year's Recurring Revenue
  • RR Growth = 10% in FY2023. RR growth is typically at about 30% per annum on average over the last 10 years.
  • Growth in this figure will prove that the company’s recurring revenue is growing even if total revenue isn’t growing, which could continue to be temporarily depressed by CRR's and management's focus on the Beti transition.
  • New Recurring Revenue is strongly correlated (0.95 R Squared) to Sales and Marketing Expense from the preceding year. We can gauge whether New RR will grow based on the growth in Sales and Marketing Expense.
    • 10 year average Sales and Market Expense growth has been about 24% per annum. FY2023 lagged the average, coming in at 21% growth. As Beti completes its implementation process, expect personnel expenses to be shifted back towards sales and marketing.