Chit Chat Stocks - Bill.com (Ticker: BILL) Not So Deep Dive

Episode Date: June 20, 2023

Bill.com Holdings, Inc. (BILL) is a company that provides cloud-based software solutions for automating and streamlining financial processes, catering to businesses of all sizes and industries, and helping to modernize and simplify their financial operations. At the end of the month, we will publish an Arch Capital episode that will cover the company: Airbnb. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Shift4. Enjoy the show! ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (2:10) Industry | (17:50) Management & Ownership | (24:24) Earnings | (30:36) Balance Sheet | (33:12) Valuation | (35:32) Our Analysis | (36:42) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I'm joined as always by my co-host, Ryan Henderson. Today is the Tuesday not-so-deep-dive episode where we cover

an individual stock. We hit really the basics of its business model, its history, who runs the business, its capital structure, its ownership structure, its income statement, all the numbers you want to learn about as someone who's maybe interested in a stock as we are one. The reason we choose these companies is they're companies that we are potentially going to be interested in as well. And we kind of go with a pass or fail and decide whether we want to follow it further, put it on the watch list, et cetera, et cetera. Today, for the next 45 minutes to an hour, we are going to be covering bill holdings which is the owner of bill.com along with other stuff ryan is there anything else oh on these ones yes i should make a note if you like these episodes

if you want to get more of the charts that we might reference or sometimes i don't make them before tuesday but the numbers we reference the graphics all that stuff they will be in the newsletter, which is free that goes along with each episode. The link is in the show notes, or you can search Chit Chat Money, Substack, subscribe to that. It's free. It can really help you learn more about the business in conjunction with the podcast. All right, Ryan. I think that's it. Let's get right into it. Bill.com, or maybe we'll call it... It's the same company, Bill Holdings or Bill.com. What do they do? What's their product? All that good stuff yeah let's call it bill.com i find it they acquired one other business and all of a sudden

they feel compelled to call themselves bill holdings but just bill.com um i'm wondering if maybe we should name the episode bill.com just so people can actually recognize it a little more but uh that's that's a discussion for another time bill.com is basically they basically provide software that help small to medium-sized businesses. I think they target more than five to $100 million in revenue type businesses. They just help them automate their cash inflows and their cash outflows. And they do this in pretty much three ways. And so I'll maybe go through an example at the end here, but just try to follow along. So there's three, there's accounts payable automation. So the accounts or the bills that if you're a company, the bills that you're

receiving, paying those out. There's accounts receivable automation. So the flip side of that, invoicing customers and receiving payment. And then spend and expense management, which is really, it's kind of its own thing. It's its own platform. That's what they acquired in 2021 that provoked the name change. But let's start with accounts payable automation. So when you sign up for bill.com, if you're a company, let's say you run a small business, call it chit chat money holdings or something like that uh you will receive a bill.com email that your suppliers can then send invoices to so i'm trying to think of people that are really podcast suppliers i guess there really aren't a lot um maybe a producer maybe we market

yeah maybe we advertise on a different uh a different show or something like that They will invoice us a certain bill and they can send that directly. They can just send the email or send the invoice to that email and it shows up on my bill.com dashboard. Or let's say you have someone who likes to give out physical invoices. So let's say you receive a physical bill, one of those paper ones you get in the mail nonstop. You can easily scan that bill with bill.com. Typically, I think most people all use the mobile app for that. And it can detect kind of the due date of the payments, the designated dollar amount and who the associated supplier is. And it once again, just gets integrated right into your bill.com dashboard. And then from there,

it really kind of spans the entire accounts payable process. So users can go in, whoever the designated user is in your small company or your small to medium-sized business can then go in and approve the bill to make sure it's a legitimate bill with a single tap. And then they can pay it via multiple methods. So either you can automate kind of ACH transfers from your account, which is probably the ideal way to do it. And I think this is maybe where bill.com, when they were first getting started, provided a ton of value. You can choose to pay via a physical check and bill.com will do that on your behalf. So let's say you're like, okay, this company, whoever invoiced me only wants to be paid via physical check. You can just tell bill.com what

you want and pick check and it will print it out, send it out all on its own. So it's really doing all the legwork, which if you're a small business owner, I think that's a huge help because the last thing you want to do is be writing checks all day and going to the bank and sending things out or mailing these things. So it really is a big help there. And then it can also facilitate international transfers if needed. And then come reporting time, Bill.com integrates with pretty much all small business accounting systems. So everything can get easily recorded. Now on the accounts receivable side, Bill.com customers can easily create electronic invoices, customized with their logo. So let's use that Chit Chat Money Holdings example again.

Let's say we had people that advertised on the show. We can then send them out an invoice via bill.com very easily. There's a simple template that you can just click, customize a couple of buttons, add your logo, get sent out directly to whoever you're billing. and it's a super intuitive process and bill.com really tracks the whole thing for you. So from paid out or I should say maybe from delivered

to open, to authorized, to collected, it's kind of got like that progress bar on your invoices that you send out. And then if you're the person that's receiving this invoice, let's say you're not a bill.com customer. So let's say someone's advertising on our show. They're not a bill.com customer.

we are, and we're not just for clarity. They will get basically a link that just, they can click on the link and just update their ACH data or give like card credit card info, and it'll pay it directly. It'll pay off that invoice directly. So it makes it really easy, even if you're not on the bill.com platform. Once again, even on the accounts receivable side, And it syncs really well with whatever accounting system a company is using. So it really just kind of makes the, like I said earlier, the cash inflows and the cash outflows process really intuitive and seamless. So the last one here, and this is a little bit different, is the spend and expense management.

This segment is comprised of their 2021 acquisition of Divi. With Divi, businesses can get spending cards for, and these are credit cards. I think it'd be credit or debit for all their employees and track all the expenses within the Divi software system. And so I kind of looked at this, looked up a couple of YouTube tutorials, and it looks like a really sleek platform. Honestly, the software allows you to customize different budgets for different departments. So you can make it a charge card where people have to get like, if you're an employee at a bigger company, they've given you out a Divi card. You can expense certain things that has to maybe get

approved. You can put that approval process in there if you want, but anyone at the company can instantly or whoever wants to see it can instantly see where that expense came from. And if you're the employee that paid that out, you can instantly go to your Divi app and say, got lunch with a customer, something like that. So it's very intuitive for the spending and expense management side of things. If you're a small business, Divi also extends customers up to $15 million in credit lines through their issuing partner banks. So they aren't really taking the credit risk on themselves, but they're being sort of an intermediary for the small businesses and credit providers. Yep. Don't say upstart, but similar in that regard where you're not taking

the credit risk, but if you give them bad loans, well, they're probably not underwriting it. That's not too relevant here, but to sum everything up, they want to make, in general, bill holdings and all their products wanted to make small business payments much more efficient, easier, automated. And then for that value they're providing, they're going to charge a subscription fee and a take rate on some of the transactions. And we'll get into how the virtual cards have a much higher take rate than say the ACH transactions or obviously a check. But yeah, Ryan, do you want to get into the history? It seems like a very classic Silicon Valley startup, unless i'm wrong here uh kind of uh yeah i guess similar or similar to a lot of other software

stories but renee lucert or lucert uh founded bill.com apparently he has kind of a family history of entrepreneurs his parents started businesses uh his cousin started a big uh software company called lucert some lucert software business that they i think sold for were like $400 million. So it comes from a decent amount of wealth and kind of an entrepreneurial background. But he started PayCycle a long time ago. I think it was like 1999, 2000 timeframe. And it was really hard for them to raise money, but they ultimately did. And PayCycle was meant to be this kind of online payroll software business. But he was ousted as the CEO from basically the board of directors in 2005. Apparently, there had been some stalled growth

And there was some turmoil between LeCert and his COO. So the VC firm that initially backed them, and it was like the only VC firm that backed them because they were raising money after the dot-com crash, asked him to step down. Right after stepping down, LeCert was already getting started on his next project. And I'll say PayCycle eventually sold to Intuit for $170 million. dollars. LeCert has had kind of this interesting back and forth with Intuit. Intuit is the owner of QuickBooks. He worked for them at one time. The first company he founded sold the QuickBooks or Intuit, I should say. And then there's a big partnership between QuickBooks and

build.com right now. So they've kind of had this intermingled relationship for a while. But anyways, LeCert instantly started working on this next project. I think, honestly, he was probably working on it while he was at his old company, maybe not working on it, but had the idea for it and wanted to do it. And so it launched, I think in 2008 was the first product. They acquired the domain name bill.com for $200,000 before having a product. So I think that maybe tells you that he had some money. Do you think that was a smart move? I think it was. I think it was. Bill.com is a good name. You understand. And I think it was worth $200,000.

I agree. But doing it before you had a functioning product was bold, depending on how much money he had. Like if you got VC money and you just spent all your VC money on a domain name, it's very brave. You can tell that he and the team, they're confident. Yeah. And the goal, Lacer basically pitched bill.com as a time saver for small businesses. He says, no more opening the mail, no more checking invoices, no more juggling when to pay which bill, and then writing out, recording, and reconciling checks by hand.

You can do this all on our platform. It's cloud-based, very simple. And so it got off to a decent start, and they were kind of going one by one to small businesses and getting some of these businesses on board. But then they really started to grow when they started partnering with accountants and banks who would then recommend bill.com to the thousands of small businesses that they worked with. That was kind of their growth hack, if you will. And the initial business model was pretty simple. It was, you pay a monthly subscription and then there's small transaction

fees for depending on the type of transaction. So if you're paying out a check, you'll maybe get a certain percentage of that check that goes out to bill.com. And then a fee to non-subscribers for receiving payments via bill.com. Once again, it was a really small fee. I think this is basically just to make sure they're not losing money on certain transactions. And then we'll talk about it here in a second. They've added a third revenue line

once they reached a certain level of scale, but they were growing pretty quickly over the last, thanks to a lot of these partnerships, I should say. And once they reached, I can't remember when they first rolled it out, but they had reached a certain level of, between customers and transaction volume. And when those transactions are going through, it takes a while to clear. And so while the payments are being cleared,

bill.com can use that money to invest in short-term treasuries, different interest-bearing assets. And it was basically nothing. This didn't matter at all for the last three years. But now the interest rates have spiked. They call this float revenue. The float revenue has really ballooned and it's super high margin. However, keep in mind the duration for these things, it's payments clearing. So it's not like they're holding these in bill.com's platform for a long time. So they have to earn interest on a very small amount of days, but it's a huge amount of transaction volume. Because last year, I think they processed, I want to say $218 billion. Yeah. And I mean, it doesn't have to be the dollar that you get. It doesn't have to match

out what you pay. I think it's generally going to rise over time. And for reference, it's over as of the last quarter. I don't have the number in front of me, but I think this is the number. It's over $3 billion held in customer funds. That's kind of just a one-to-one match on their assets and liabilities. So as that grows, kind of do a little math, they can earn three to 4% on that. Not bad. Yeah. So the story has really been partnering with financial institutions that have relationships with small businesses one of those big partners as I mentioned was QuickBooks so they have

this pretty kind of seamless I guess just partnership basically QuickBooks just recommends bill.com to a number of its customers. It probably plugs in yeah I assume so we're no software experts as any

software expert that's listening we do not the ins and outs of how that stuff works is kind of disregarded yeah and Yeah. The nitty-gritty of it's not that important. I think what's important to understand here is that it's just a helpful route to get customers for bill.com. And they really grew throughout the last decade because of these partnerships. And then in December of 2019, bill.com came public. They raised a little over $200 million in the process. However, after pricing their shares at

$22, the COVID bubble brought it all brought shares all the way up to $335 within less than two years. So more than a 10 bagger in less than two years, it's weird going back and looking at this and saying like, how did, how did people not know that? I know it's, it's always harder in the heat of the moment, but yeah, it was, it got up to 60 times sales at one point. Yeah. Yeah. But that same year, Bill.com used its soaring stock to acquire Divi for two and a half billion dollars, primarily of stock. There was some cash payouts in there as well. And they bought Invoice2Go for $625 million that same year, also a big stock deal. And then they also had a follow-on offering of their stock that same year. And I think they raised $1.3 billion

in that follow-on offering. So I mean, they used, when their stock was valued at a premium, they used it wisely and for one, made a number of acquisitions, but also just directly listed more stock and raised more money. And so they do have a decent chunk of cash on the balance sheet, which we'll talk about. But for now, you want to talk about the industry? Yeah. So the back office payments market, any listener might be expecting this, but it is quite large there's so many customers to go after especially when you're looking at small businesses and medium businesses which is bill.com's bread and butter to be clear they are not going after large enterprises at the moment who have a custom say accounting solution or a

custom what do they call it erp solution so they're not going to say hey uh what's what company did we cover last week hey paypal why don't we do your back office accounts payable no no it's more of your local say well it's on the top of mine because i just went to one driving range that is going to use this. Bill estimates that there are 70 million small and medium-sized businesses, SMBs, which we might abbreviate to, and sole proprietors worldwide that they can target. They currently have 450,000 customers. And I think they describe their customers in different ways. And I don't think these are customers that are solely subscribing to them, but I think these are customers that in general contribute to their revenue. But again,

And they have a few different definitions too, compared to someone that's subscribing to them, someone that uses one of their products, or someone that gets an invoice from them, which is much larger. I think that's closer to 5 million. And if we look at the 450,000 customers, that is, according to them, only 0.6% of their target market. And the majority of their customers right now are in the United States. However, I would say that they are probably overstating this addressable market because I don't think every small business, and yeah, there's a lot, there's probably going to be like 10 million, 20 million out there that could use it, but not all these businesses are going to need an expense management solution.

for example, us right now. If we got larger, we could use it. But as of this moment, as of our size and we are small, there's no way we would need this thing. The value is not going to be there yet to be doing. They say in their bread and butter, I think they want something that's about $500,000 to a million dollars in revenue a year up to $10 million in revenue a year is their bread and butter. Ryan, anything to add there? Yeah. For a little bit of context on, And we're going to talk about QuickBooks here in a second. QuickBooks has, I think, 6 million paying users, a little more. So that's probably a good.

Yeah, that's what I would look at if you're trying to comp a scaled software business that targets small to medium-sized businesses. QuickBooks is kind of like the, you know, I think in a best case scenario, build.com could probably reach that kind of level of scale. Yep. And that relates right into the competition because As QuickBooks as well, they're competing with the same, they're competing with, well, it's a bit confusing, but let me just cover and I think people will understand what I'm trying to mean here.

So competition is hard to cover comprehensively because there are really a lot of point solutions out there. I'm not going to touch them all. There are a ton of startups that can get a couple of software engineers together, get a business plan and start launching something like this. And they all have strange names, so it's very confusing. But I think you can put, in general, from an investing perspective, the competitive threats into three categories. First is really easy, and it is Excel and paper solutions. So this is the white space that bill.com is going after where companies using older solutions, essentially pen and paper and checks, wire transfers, stuff like that. they are trying to convince them to adopt a more efficient, dedicated digital back office

payments product like bill.com. And when I say QuickBooks might be benefiting from this as well, is there's probably still a lot of white space left for QuickBooks to grow into the pen and paper market. So that six to 7 million customers could probably grow to at least 10 million. And I would say bill.com has that same total addressable market. And then second on the competitive front are the other point solutions that might sell into accounts receivable, accounts payable, or corporate spending products. These could include Brex, which targets startups. There's Cipalti. Like I said, these names are strange. They are a direct competitor with hundreds of millions in funding. They were valued at $8 billion in a private round, but

I doubt they would be at that in a public market. And there's many, many, many more out there. Bill.com is the leader. But again, there's a lot of competitors. And if there's a bull market in these kind of software solutions, again, there could be some more coming online and a lot of marketing spent going after these small and medium-sized businesses. I think third, and the most important and probably the one I'm scared about the most, if I was a Bill.com, I guess, as a prospective Bill.com shareholder is Intuit slash QuickBooks. QuickBooks is ubiquitous among smbs and like ryan mentioned they are a bit of a friend to bill.com but intuit is slowly creeping in on bills.com's turf with new products and they have invested into a competitor called melio

uh this is definitely like i said the biggest competitive threat i'm concerned about and could end up being a real moat test for bill.com if quickbooks integrates its features natively into you know right like if they copy a lot of bill.com solutions and say hey if you subscribe to quick books you can get these as well you don't have to use bill.com anymore yeah they have um so in december and it's really soon right really recently yeah in december they rolled it out i think as a beta and then over the the like la the next three months after december so kind of the start of this year they started to roll it out to everyone so they have native bill pay within quickbooks but it's when i looked up bill pay quickbooks the first thing that came up was a sponsorship

between bill.com on quickbooks and then if you scroll down one more it's like uh you can pay your own bills directly through quickbooks powered by melio or whatever so So it is, I mean, yeah, they're encroaching, I think, on Bill Payne's or Bill.com's turf here. Yep. Thank you, all the software companies for supporting Alphabet's business model. Yeah. And I think that probably leads into Bill.com's high level of marketing spend, which I'll make sure to put a good chart there. Their marketing spend as percentage of gross profit, even with absurdly high gross margins is very, very high. But let me hit management ownership. Pretty simple here. I'm going to keep it short. It's a very boilerplate Silicon Valley

software startup ownership structure. The concerns are basically what I've had for almost all of these type of companies. And I didn't really find any big red flags. So first, the company is founder-led by Rene Lissert. Still, he owns 3.3% of the company. The board has 13 members. They all get paid over $200,000 a year. So it's one of those where it's like, eh, the board members for company this size probably get paid a lot, but it's fine. They have a lot of them. There are a bunch of venture capitalists on the board. And then there are executives from three companies, Yext, Fastly, and Salesforce. I got to say that combination does not really entice me from a, hey, let's manage this business for profits standpoint.

point. Is this to you a significant red flag to see this board composition? Yeah, it's somewhat concerning just because we're going to talk about the financials here in a second. They're not profitable and they seem to have a little bit of a private markets mentality of keep growing at any cost, we'll find financing down the road and that'll fund us for further growth, which is just, it's not my typical cup of tea. The other thing, and I think we should maybe start our shows out by mentioning this. You mentioned the $200,000 a year for the board members. This is a $12 billion market cap business. So to kind of give some context on the size. Billion dollar revenue. Yeah. It's not tiny. So it's not like the $200,000 a year is just

egregious but i don't know i mean for 13 board members though for a company this size you usually don't see 13 board members unless it's a big kind of multinational like exxon mobil or microsoft yeah that is true 2.6 million dollars a year paid out to some people for doing what you know yeah no they're doing nothing well i mean come on fastly that's a throwback fastly haven't heard that name in a while but let's keep going it's quick on here for this management notice subject section, base salary, cash bonuses, and equity incentives are how they pay out their executives. Let's say it got $10 million in stock options or something similar last year, which I thought as someone who owns 3.3% of the company is a little bit egregious, but again,

it's not as bad as some other companies out there. And then I think the most important thing I saw from the compensation part was that bonuses, the cash bonuses are based on revenue growth. and it didn't say anything about organic revenue growth unless i missed it and then non-gap earnings targets and i think it was earnings either margins or just non-gap earnings numbers either way they're targeting a non-gap earnings something do you think these are bad incentives because i think it's a little worrisome yeah i think those are really bad incentives i mean it just, it really encourages management to use the stock as a form of financing, because revenue growth, if you go out and acquire companies with a bunch of stock, like they did with Divi and

Invoice2Go, yeah, you're probably going to hit your revenue targets because you can just tack on that revenue. And then on a non-gap earnings target, you back out all that stock you just paid out to your employees. You do pay out a lot of stock to their employees. So, yeah, I think for us as outside shareholders and not employees of the business, yeah, it's a bummer. But if you're an employee, these are great targets. Yeah, go work here. Seem to pay well. It's kind of like a Dropbox, maybe.

I think that's it, though. Very simple ownership structure. No really big red flags outside of the classic ones that I think we both expected going into it. Let's hit earnings next. Ryan, what were the big takeaways you saw? I did see they were buying back stock in north of 10 times sales. I'm curious what, I guess we do own a company that does that too, but what were your thoughts on that?

Who, who do we own the? Autodesk. Are they at above 10 times? Well, not right now, but they have in the past. Yeah. There is a little bit of a difference in profitability there as well, but the bill.com does just under a billion dollars in revenue. it's been growing really quickly. Now, a lot of that is inorganic. Like we mentioned,

they acquire companies and they can tack on that revenue, but the actual core business is growing pretty quickly as well. So it's been kind of a revenue growth story here. 63% of that revenue is from transaction fees. And actually the majority last quarter of those transaction fees come from Divi. However, 24% is from subscriptions, quite high margin, and 12% is from float revenue. Now, I mentioned float revenue earlier. This was basically non-existent last year. However, they are now generating a good chunk of interest income or interest revenue, whatever you want to call it, from the money that's waiting to be have, or from the payments that are waiting to clear. And that is 100% margin. There's no

variable cost to, I mean, maybe you have some fees, like broker fees to buy the treasuries or something like that, but it is incredibly high margin. So that's been a big driver too of kind of the profit improvement. They have 85% gross margins across the business as a whole. it's basically a software business. So very capital light. Within Divi, I imagine they pay out a decent chunk to Visa of their transaction or of their take rate because the Divi cards are powered by Visa. So I imagine it might have slightly lower gross margins than the rest of the business. But when we look at earnings, there really aren't a lot. It's negative. So $334 million in operating losses over the last 12 months.

Keep in mind, though, they do earn a lot of interest income, which is not encapsulated there because the interest income comes after the operating earnings on the income statement for anyone that doesn't know. And so you're actually going to see better net income than operating income as long as rates are staying high and Bill.com is able to invest that float. And then they have actually $90 million in free cash flow. However, they pay out a lot of stock based compensation. So the difference between the gap earnings here and the free cash flow is all stock based compensation and amortization of intangibles. So yeah, they're not profitable

and they do love to issue stock to their employees. My concerns here, I guess I'll go through the most recent quarter. They reached 455,000 customers. Customers are growing at 18% year over year. So really solid. Total revenues grew by 63%. If you exclude the increase in float revenue, which I think was up like, I don't know, like 30,000% or something like that, because it was off of a zero base. It was growing at 45%. So still solid growth, pretty much any way you look at the business. However, here's what concerns me. Over the last quarter, the average sales price to sales ratio of the business or of the stock i should say was i think right around 12 times which is expensive and they were buying back shares which feels just not worth it um

so i it feels like one of those things where it's kind of promotional like pumpy yeah they're they're classic they do explicitly say we are buying back shares to offset dilution and they say that like we should be proud of them when in fact everyone just gets mad that they heard doing that uh it's it's one thing to say look if you own the stock i don't think you should ever have problem with a company buying back shares because if you own it you think it's undervalued and so you think that the company should buy back shares but as someone who's looking to invest it's a bit of a concern yeah right because i if you complain about buybacks and you own a stock you uh well don't own it, but that's a philosophical conversation for another day.

Yeah. All right. Balance sheet. They've got $2.7 billion in cash and short-term investments, $3.1 billion in funds held for customers. That is what they're earning interest on there. And then on the liability side of things, there's really one big thing, which is the convertible notes in sort of the height of COVID when rates were very low, they raised zero interest convertible notes. So for anyone that doesn't know convertible notes, you're not paying interest or, okay, I shouldn't say that. In this case, you're not paying interest, but you're not paying it gradually. Once the date of that debt comes due, you're either paying the cash out if it's below conversion price, or if it's above the conversion price, it's converting to stock. However,

there may be some discretion in there as well, and you might be able to roll the debt, but that's the basics of acquiring that type of debt. And so the initial conversion price for their first lump of convertible notes, which is more than a billion dollars in 2025, is $161. Right now, I think the stock trades at around 114. So it would take, I think, probably about a 40% to 50% return from here over the next two years, which is doable, but I would not say it's guaranteed by any means. So there's a good chance that this debt is going to come due. And then the second one, which I find interesting, due in 2027, a little less, It's about half the dollar amount has an initial conversion price of $415.

So it would be a four bagger within four years. That would be super smart. I mean, who is giving them a step because this is an incredible, it's just free money. They're going to be able to pay back easily all the, during the time being, they're just going to earn 5% on the cash balance.

Yeah. A hundred percent. And so that's, I mean, that's the bulk of the balance sheet. They have enough cash to pay it off right now. and they technically are generating cash, albeit at the shareholder's expense. So the balance sheet is not a concern at all. I would just say this is a business that's

trying to grow at pretty much any cost. Yep. All right. Let me hit valuation. I want to do a couple of metrics here since they're not profitable. I like using for the software businesses EV to gross profit. That's enterprise value divided by trailing gross profit and then EV to operating income. However, since they're not profitable, I wanted to go what their long-term margin guidance was. This wasn't formal guidance, but this was somewhat of a guidance number that they talked about at a conference, and that was 30% operating margins. So if we look at EV to gross profit on a trailing basis, they're trading at 14 times, which is expensive. Typically, a company will trade about five to seven times or even lower. And if we look at EV to operating

income, it's negative. But if you look at EV to operating income at 30% margins, it is 38%. So still quite expensive across the board. I think, well, I don't think, the market is clearly betting that revenue growth is going to continue growing at a high rate, or excuse me, revenue is going to continue growing at a high rate. And I think if you're an investor in this company, you got to be expecting strong double digit growth for the foreseeable future. All right. Anecdotal evidence. Let's get to the fun stuff. Ryan, any thoughts here? It seems like a software product that works well. That's kind of my thinking. Yeah. It's pretty simple. I would say if our podcast was bigger, and this probably goes for

a lot of small businesses where it's like, if we get to a decent size, this makes a lot of sense. it really simplifies a pain point for a lot of uh for a lot of small businesses so yeah a software system that works well i also watch just a bunch of youtube videos on customers a lot of it's just accountants um saying like oh this makes it so much easier for our bank or for our small business customers everyone seems to really like the platform seems to have really good kind of reviews so i think it'll be sticky but i do have some questions about their ability to attract new customers in the with kind of increasing competition coming online yep and if whether the core stuff is a commodity and whether they can really differentiate

themselves from someone else i'd also say that from what i saw the reviews were good across the the board, people seem to really like that. And it's not a concern here is that the software is bad. I think it's the concern is that it's Intuit and other competitors, but let's hit future growth opportunities. Ryan, what do you think? The one I picked was Divi. So I already spoke about the functionality here, what Divi does, but I think it's a pretty sweet solution kind of looking at it uh we you know we keep i keep using ourselves as an example but we have i think this is a platform we could use where maybe if we got larger um using native like whatever your bank is using just expense cards through them doesn't always work so well and it's not always easy to

track you have to do a lot of that stuff manually so going through divi can make it a lot more uh simple and intuitive so i think it's a cool platform they paid two and a half billion dollars to acquire them in mostly stocks they definitely need to prove that it's worth it and so far i think they have divi actually generates like i said the majority of build.com's transaction revenue in this quarter that transaction revenue for divi was growing at 65 year-over-year so much faster than the core business now some of that might have come from cross-selling divi to bill.com's existing customers because the business customers, Divya is 27,000 business customers, and that was growing 50% from last year. So it seems to be getting pretty good

attachment from small businesses all around, I think, predominantly the US. 100%. Yeah. And they have talked about basically combining all of the stuff they've acquired into one native bill.com solution. So we'll see when that comes down the line over the next few years, or I think they said over the next year, but either way, they might rebrand this, they might do something along those lines. My future growth opportunity is the float income that I think investors may be underrating or maybe not anymore, but the potential here is still pretty strong. So if we run the math, if interest rates stay around 5% and if they continuously grow the, what is it? What is the thing they call their customer funds held on the

balance sheet? If that grows to say $5 billion and interest rates are at 5%, you know, that could lead to what? $250 million in net interest income. That's pretty good for a company of this size. However, I think over time, this feels like a strength that could turn into an area of weakness if a lot of competitors or their customers kind of look at this and say, hey, you need to pay us sort of like a bank and give us a little bit of that interest kickback as well. I think some competitors have talked about that. It's a blessing and a curse.

I can see it'd be a benefit, but I think they might have to start paying it out over time. Yeah, or... Because we use Wise, right? And they pay 4% and they hold some of our funds. If it started to take longer or if it started to take a shorter amount of time for payments to clear, that would limit how much they can earn on interest. True. That is true as well. But that hasn't seemed to happen for quite a while, if I'm not mistaken.

Yeah, I would guess customer funds held by them are going to grow over time along with the whole business. All right. Highlights and lowlights. Ryan, what'd you like, dislike about this one? I mean, it seems like a good solution for small to medium-sized businesses. Really, I think tons of product market fit here, and they seem to be demonstrating that with their ability to continuously add new business customers. The other thing I like, it's pretty inflation-protected through the transaction fees, assuming that I think most of those transaction fees are variable, so it's just a percentage of the transaction.

I think there might be some part of that that's like plus two cents or something. I don't know. But generally as the payments, as the dollar volume on payments goes up, so too there's their transaction fees. And then the float revenue in a way is also inflation protection because the assumption here is that if inflation goes up, interest rates go up, they earn more on their float revenue. So two positives there.

The last one I'll say, I read somewhere that I think it was an asset management firm called Kane Anderson Rudnick. They said 80% to 90% of businesses still rely on paper checks as a primary form of payment. Now, this is in 2020 or 2021 when this article was written, but that automated checks component of bill.com, I still think is a big sell for customers. So as long as that trend continues. I think there's a pretty clear customer value proposition that bill.com provides. Lowlights for me though, they still kind of seem to have that growth at any cost mentality, which really doesn't make me eager to be a shareholder. They're not profitable, not even close, frankly. Okay. Maybe they're getting close, but they're not there yet.

And they were buying back shares this quarter at like 12 times sales that, yeah, that doesn't excite me i think that's i think they've got some of their capital allocation philosophy mixed up and the other part is just because your stock declines 80 percent doesn't mean it's a good time to repurchase shares and if you're doing that just to kind of promote it where it's like hey guys we're buying back shares so should you it's like okay come on you're still issuing a bunch to your employees other stuff will say quickbooks adding native bill pay that's That's concerning considering that I imagine a lot of Bill.com's customers use QuickBooks as well.

Estimated over half. Yes. Yeah. You know, if people start to adopt that native bill pay on QuickBooks, potentially that's a big competitive threat. The other thing is even if it doesn't get Bill.com's current customers to turn off, If you're looking at new solutions for how to pay your bills and you're a small business and you can get it natively on QuickBooks and you're already using QuickBooks, it's a lot easier to just do that than to subscribe to some new software. So it seems like it's going to be more competitive, attracting new customers.

And then the last one I'll say is if the time to clear payments transactions ever shrinks, that's bad for Bill.com's business. Yeah. Float revenue is a blessing and a curse because basically they get to bank for free. My highlights are that they have great unit economics. As we looked at, I think it's clear throughout this episode, that should lead to 30% plus profit margins over time, at least according to management. Probably should even be higher too, given their float dynamics, but they don't want to over-promise anything, I'm assuming. Second one is the growth track record has been fantastic. You can see the numbers when we put out the newsletter. It's going to be really, really good. Some is inorganic, but still, the past has been really strong. And with a lot of

white space out there, like Ryan mentioned, so many small businesses are still using pen and paper and checks. There's still a lot to go after for the rest of this decade. Lowlights don't understand the capital allocation. I agree with Ryan there. I also agree with the competition from QuickBooks, is there anything that bill.com offers that QuickBooks cannot copy? Maybe the network, there's a slight network effect of the relationship between, you know, each person using the platform. But besides that, I don't think there's anything QuickBooks can't copy. I think some software businesses are reluctant to copy the check printing and mailing component they could say that just because it requires a little more capital intensity than

digital revenue oh yeah but from what i understand a lot of when i was reading through these reviews and maybe quickbooks is planning to offer this um the a lot of the attraction was that you can get your checks mailed for you yeah but that's not like there's no it's copyable yes i'm not saying that the cookbooks will i'm saying they could there's no reason they can't i guess i'm trying to get it it was a workaround question to saying that bill.com probably doesn't have a moat right now or it's extremely weak yeah that's i agree all right and then last um no cost efficiency on the sales and marketing expense line that is fine when you're growing revenue 100%, but when revenue growth moderates, which it will, how are they going

to balance that? We've seen it time and time again over the last three years. Companies do not, when the revenue growth slows, they let the sales and marketing spend balloon for a little while. They look terrible. Company looks so unprofitable, stock tanks, and they're like, wait, wait, wait. We overhired. We got to lay off people. I could see that same scenario happening here. Let's wrap things up. Bull case, Ryan, what do you think? These prices, what kind of numbers are you throwing out for what could go right here? Well, I think a lot needs to go right in order for this to work out as an investment. You really have to believe in the growth story here. And I think you probably have to assume at least 20% gap net income margins at some point in

their future, plus continued 20% to 30% revenue growth. To be honest, I was a little lazy here. I saw the valuation and I knew that it's going to take some sustained growth plus significant margin improvement. So I didn't really do the math or back into it, but a lot needs to go right for this to be a good investment. Yeah. And you also got to assume that trades at 20, 25 times earnings. Yeah, I had the same thought. I think you need to expect double-digit revenue growth to continue. And what I mean for that is probably the next five years at least, and then you hit a 30% operating margin. If that happens, the stock probably works fine, but you got to remember that today we're trading at, let me just confirm, enterprise value of $11

billion. There's got to be SBC that affects that. And look, if they're doing a billion dollars in earnings which remember today they're doing a billion dollars in revenue so that means they have to be doing if they're going to have a 30 billion excuse me 30 percent margin they got to be doing what would that be let's just say like three to four billion dollars in earnings or i can't i can't speak revenue then they'll have a billion dollars in earnings that's quite a long ways from here and you got to expect strong double digit growth that's durable i can't talk right now But I think you understood that, Ryan. What's the bear case for you?

I think people can probably assume what we both have here, and that is Intuit and the company itself. Yeah, I think competition eating away at new customer growth. And I think if customer growth begins to slow because of that competition, the stock will see significant valuation deterioration. And so those are two very big risks, in my opinion, and that would definitely lead to this being an underperforming investment. My two concerns are bad management of the income statement and competition from QuickBooks. I know the valuation's tough, but I'd say those probably are a bigger concern to me over the long term, at least if we're talking from identifying the business quality of the

security. Now, let's close things out. Go ahead, Ryan. I was just going to say. I think there's a lot of companies and a lot of management teams that think, okay, well, we can pull back and get to profitability if we need to, when the time comes. Yeah. And that time comes a lot quicker than a lot of management teams expect, because I think

we've seen this with a number of different software businesses that were just plowing money into sales and marketing throughout COVID and they were growing and they were issuing stock. And so they're able to constantly keep raising money and they're like, well, you know, we got a great balance sheet. We can do this for a while. And then all of a sudden they're having to lay off employees because it's harder to rein in costs than they think. So it feels kind of like one of those where it's going to take a big, maybe, I don't want to say a CEO change, but it would take, because the CEO's gone through one of those before, but I think it needs to take a significant change in the cost structure. at this point yeah frugality has to be a culture it can't just be something you turn off and on because if there's we've seen it with all a lot of these big tech companies where they say look we're not just going to spend willy-nilly anymore there's this expectation that the employees have

had and it can really upset them um it just seems like a bad situation you'd rather start out frugal i'd say but more or less interested ryan last question as we leave the listeners today more interested it reminds me a little bit of remitly where it's got a great name customers instantly know what it is great product fast revenue growth yeah it's it's clearly demonstrating that customers want it but the cost structure just isn't quite there yet and the valuation is a little stretched. So something that I'll watch, but it would need to be a much, much cheaper price before I consider it a position. Yep. I'm in a similar boat, more interested. I say this looks like a good business that could potentially widen its moat. I said it's pretty weak, but I'd say

there's a chance they could widen the moat this decade and turn it into a great business over the next 10 years. If they pass a moat test with Intuit and QuickBooks, that could really increase how much I like this business at the right price, which is significantly lower than here, probably five to six times sales at least, I think it would look pretty darn compelling. Typically when I think a good rule of thumb is if you're looking at a software business,

you think can have good unit economics or does have good unit economics, could have strong margins, but is losing money today, you want an extra discount. And I would say that means if you think you can have 30% operating margins at scale, you probably want three to four times sales. You want a pretty big discount because they have not proven that they can generate a profit yet. And there are a lot of businesses out there that are in this similar situation financially in terms of operating margins. and they trade at three or four times sales

because there's the risk that they might not get to profitability or that competition could come along and ruin their plans for operating leverage. And that's why you need kind of that discount is if it doesn't have a huge moat and you're betting on a big change, you should get paid for that change.

Yeah, you need a big, big potential reward. All right, next week, we're going to be covering Visa. Very excited about this one. something i want to put on we basically it's like on our watch list but i think we'll probably need to formally put it on the watch list after next episode everyone knows it's a great business we're going to go through the details probably get some fun facts all that good stuff it's such a fascinating business remember if you like this episode give us a review on spotify or apple

podcast it is the best way to support the show subscribe to the newsletter if you want free access to the show notes graphics and charts that we use to power this episode we are not financial advisors. Anything we say on this episode is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you everyone for tuning in and listening to the Bill Holdings episode. We'll see you next week.