Start-up financial technology investors, beaten down especially hard by the bear market, are getting some reprieve — but perhaps not in the way they hoped for. In the latest indication that stocks are trading for fantastic long-term values, private equity firms are going shopping and cashing shareholders out.
Software technology investor Vista Equity Partners is the latest to announce an acquisition: Duck Creek Technology (DCT), a provider of software for the property and casualty (P&C) insurance industry. Lessons abound in this deal for investors trying to get ready for the next (eventual) bull market.
A fintech company on the cusp of positive cash generation
Duck Creek offers a suite of cloud software tools (data and apps housed in a remote data center, accessed via the internet) for insurance companies. Solutions include customer relationship management, record keeping, and insurance policy updates. What does Vista Equity Partners want with Duck Creek?
Monti Saroya, the Senior Managing Director and Co-Head of Vista’s Flagship Fund, said in a prepared statement that “Duck Creek’s modern cloud architecture and demonstrated market traction position it to define the next generation of mission-critical technology for P&C insurance.” After a tumultuous couple of years since its IPO in 2020, Duck Creek investors are getting cashed out for $19 per share, valuing the company at $2.6 billion.
Besides acquiring Duck Creek for significantly less than what it was valued at a couple of years ago, Vista is purchasing a company that could be on the cusp of turning a healthy profit. Indeed, investing in up-and-coming software companies that successfully expanded beyond start-up ventures and are about to flip the switch from red to black on the bottom line is Vista’s modus operandi. Though the stock price may not reflect any kind of positive progress, that’s where Duck Creek is at right now.
In its latest quarter (the three months ended November 2022), Duck Creek reported a 10% year-over-year increase in revenue to $80.6 million. Net loss was $5.2 million (or positive $2.6 million on an adjusted basis), and free cash flow was negative $8.2 million (versus negative $25.5 million a year ago). Duck Creek is tiny, but even at this small scale, it has been making incremental steps toward sustainable profitability. Plugged into Vista’s portfolio of other software company investments, Duck Creek might be able to accelerate its sales. Vista will also no doubt encourage some cost-cutting as well.
Fintech stocks to focus on right now
Fintech stocks were clobbered over the last year, and that has encouraged private equity investors like Vista to go shopping. In fact, Duck Creek wasn’t the first fintech company Vista tried to acquire in recent months. It was engaged with Coupa Software (COUP 0.15%) before a deal was struck for the fintech to be taken over by fellow private equity software firm Thoma Bravo instead. At least one sizable investor in Coupa was displeased Vista was trying to make a takeover and forcing Coupa shareholders to “sell low.” Vista also completed the purchase of tax compliance software company Avalara in October 2022.
In fact, fintechs have been a focus of recent acquisition targets at Vista Equity, as well as peer Thoma Bravo. Clearly, the “smart money” with deep pockets sees long-term value and is happy to start deploying its cash. Selling low right now isn’t a great idea. Rather, investors should do the opposite and start moving out of cash if they are eyeing a long-term holding.
But a notable theme is emerging here. Private equity is making purchases of fintech companies that could easily turn the corner on profitability. Taking these companies private and exerting force to effect change isn’t something we retail investors can do. However, investing in companies that can make rapid progress toward profitable scale should be a must right now — especially given that the Federal Reserve has indicated it could keep interest rates higher for longer in 2023 and beyond to try and dampen economic activity and lower inflation.
As a reminder, higher interest rates lower the present value of stocks, especially those that don’t generate net income or free cash flow yet.
That isn’t to say there is no value in fintech companies that are still a ways off from profitability. When a bull market returns, these stocks could begin to march higher once more. However, stocks of money-losing businesses like these could continue to struggle in this market environment. Follow Vista Equity (and Thoma Bravo’s) lead and focus your investments on top fintech companies growing profitably — or that will soon start growing profitably. That is likely to be the best strategy in 2023, with the economy on the rocks right now and organizations facing mounting pressure to boost their margins above all else.
Nicholas Rossolillo and his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.