We believe that Blackbaud (BLKB) holds an entrenched leadership position in the social good community. The company provides market-leading software that supports nonprofits, healthcare organizations, and educational institutions. Its pedigree as a leading on-premises software provider has changed in recent years, with management committing to a cloud-based business model transition. Although we expect some near-term lumpiness in financial performance due to the transition, we think the company’s ability to maintain its industry-leading longevity remains secure and we see better lifetime value from customers as they move to Blackbaud’s cloud platform.
We think that Blackbaud is the only end-to-end vendor in its niche, fragmented markets. This end-to-end approach also simplifies the management and integration issues that often face the social good community. We believe Blackbaud’s full suite of offerings is a strong point of differentiation versus numerous small competitors and gives the company an advantage when selling to large, complex customers.
As Blackbaud focuses on selling integrated cloud solutions to its markets, we think it can reinforce the stickiness of its solutions as it becomes easier for clients to add additional products. With the addition of multiple products, such as payments or analytics, we believe client retention rates can increase to the mid- to high 90s from the low to mid-90s. While it is early days in the company’s transition to integrated cloud solutions, we think client conversations are now a return on investment discussion rather than a point product sale.
Sales effectiveness and efficiency will remain a key strategy for Blackbaud. The company is looking to aggressively ramp its sales head count and create an environment where there is better delegation between sales hunters and farmers. While existing client sales have driven the company, management is keenly aware that it needs to focus on selling to new customers to continue to drive healthy long-term organic growth. Given Blackbaud’s market-leading products, we think the company will be an attractive vendor for prospective clients.
Deep Knowledge and Expertise Keep Customers
We assign Blackbaud a wide economic moat because of its high customer switching costs and intangible assets based on its broad suite of essential customer relationship management software and deep knowledge and expertise within the social good community. Blackbaud provides end-to-end CRM, financial planning, digital marketing, payment, and analytics solutions for nonprofit organizations, corporate charitable organizations, healthcare institutions, and educational institutions. We believe Blackbaud’s size and scale in a relatively small niche market (the total addressable market stands at roughly $8 billion in fiscal 2018) insulate it from larger CRM vendors such as Salesforce.com (CRM) and SAP (SAP). These organizations are increasingly turning to software solutions to streamline and better manage their mission-critical operations. Blackbaud’s more than 35 years of experience and integral knowledge of the rules and regulations surrounding fundraising, capital management, and software development in these verticals place the company firmly as the market leader, boasting more than 40,000 customers.
Nonprofit organizations are the third-largest employer in the United States (behind only retail and manufacturing), generating over $2 trillion in annual revenue and expenditure. Blackbaud’s solutions are critical to the fundraising and donor relationship management processes that drive the operations of a nonprofit organization. The company’s CRM solutions are tailored to the size and nature of the organization, allowing Blackbaud to quickly offer solutions managing activities spanning charitable giving and tuition payment management. The company’s approach to the market has been streamlined in recent years; Blackbaud began sunsetting around 26 legacy products in late 2014, a move that has coincided with a migration to software-as-a-service product offerings. These solutions are largely displacing legacy, on-premises solutions and Blackbaud has begun layering in applications around financial management, marketing, payments, and analytics that have created substantial switching costs for its customers (as it works toward an all-encompassing cloud approach, roughly two products are being adopted per customer now). These switching costs are realized in robust renewal rates that hover in the low to mid-90s, slightly ahead of even best-in-breed SaaS vendor Salesforce.com. Further, Blackbaud’s customers are finding value in add-on applications; for example, customers that layer in analytics have renewal rates in the high 90s versus low 90s for those without analytics. Blackbaud customer contracts generally hold three-year terms.
Blackbaud is transitioning its customers to cloud-based solutions, most notably migrating its flagship Raiser’s Edge customers to its Raiser’s Edge NXT SaaS product. The company also offers its flagship accounting software, Financial Edge NXT, as a SaaS solution. However, the eventual end game is to shift from a single-point product approach to a vertical all-encompassing cloud approach built on Blackbaud’s SKY technology, whereby customers can easily access many add-on products and modules via a single sign-on platform. Blackbaud remains in the midst of this transition, which has meaningful implications for the business model. While this mix shift has short-term damping effects on margins and returns on invested capital, as the customer base migration enters the later stages, operating margins should expand by way of sales and marketing and other spending leverage.
Customers attest to Blackbaud’s personal touch and deep industry knowledge. With over 35 years of experience, deep industry knowledge is ingrained in the company’s products and is an intangible asset that represents a secondary moat source for Blackbaud and an additional source of competitive advantage over its peers. Software for the philanthropic market must adhere to complex regulatory standards and accounting legislation for nonprofits on the state and country level. Further, each organization has unique needs based on the cause it serves and the type of fundraising it engages in, which range from accounting for and distributing donations, managing fundraising events, and allocating in-kind products and services from donors. This differentiation results in a need for tailored solutions, and Blackbaud provides customization for its customers across the entire constituent relationship management suite, from task automation and marketing to analytics and payment processing. We think this value proposition sets Blackbaud apart from other large-scale vendors (namely Salesforce.com) that attempt to retrofit vanilla, horizontally focused solutions for the nonprofit market that cannot match the breadth or depth that Blackbaud offers without bringing in additional vendors to fill the functionality gaps.
Blackbaud has made several shrewd, tuck-in acquisitions that have mitigated immediate competitive threats in its operating verticals. Notably, the company acquired competing CRM vendors such as Convio (whose Luminate product continues to run on Salesforce.com’s platform) and MicroEdge while expanding into the educational market by acquiring Smart Tuition and Whipple Hill and into the church management market via its Seraphim Software acquisition. While these acquisitions (coupled with the migration of customers to cloud-based ratable subscription revenue model) have compressed returns on invested capital in recent years, the company has avoided major margin compression. While we think there’s some inherent cyclicality in the nonprofit organization market with peaks and troughs recently highlighted in the charitable giving market, those impacts have shown only a modest effect on Blackbaud’s business. We believe the company’s sizable market lead over next-largest competitor Intacct (which generates less than 20% of Blackbaud’s consolidated annual revenue and was acquired by Sage), its operating model, and increasing attach rates for secondary products should support strong consistent returns on invested capital over the long term as customers complete their cloud migrations over the next few years.
Competition and Cyclicality Are Risks
We assign Blackbaud a high fair value uncertainty rating. First and foremost, Blackbaud faces competition across its multiple vertical markets. Many of these competitors are larger and better capitalized, which could pose a long-term operating risk. The most notable competitor is Salesforce.com, which competes primarily with Blackbaud’s CRM software through its foundation, Salesforce.org. Salesforce could become a bigger player in the philanthropic space, but currently, its non-profit-related revenue is minimal relative to Blackbaud, and to date it has largely been limited to the low end of the market because of its offering’s limited functionality in this vertical.
There is an inherent level of cyclicality in the nonprofit market (as the end of fiscal 2018 illustrated), though donation levels have grown consistently for several decades, and we believe most foundation failures occur at the lower levels of the market, mitigating much of the risk to Blackbaud. Operationally, software-as-a-service companies face security risks when hosting software themselves and delivering it over the Internet. Any failures to maintain data integrity, security, and uptime could lead to customers exploring alternative software vendors, given the mission critical nature of Blackbaud’s offerings. Finally, Blackbaud utilizes acquisitions to bolster its long-term competitive position and growth outlook. Blackbaud faces overpayment and integration risk by using this strategy that could erode or destroy shareholders’ capital.
In contrast to many software companies, Blackbaud has an elevated debt profile. Nevertheless, we believe the company remains in decent financial health and see its increasingly strong operating cash flow generation as a reassuring factor. While the current cash balance looks low, Blackbaud deploys its cash efficiently, and it has consistently worked to pay down debt when taken on, all while maintaining consistent dividend payments. The company has averaged nearly $150 million in operating cash flow over the past four years, and we expect operating cash to hover around $300 million in fiscal 2022 as the company’s cloud migration progresses and operating leverage materializes. Management has said that it requires roughly $22 million-$23 million in cash to maintain its dividend as presently constituted, which we model in our forecast and think is secure.