Alkami Technology: Growing Alongside The Massive Banking Industry

Thesis highlight

Alkami Technology, Inc. (NASDAQ:ALKT) has 16% upside. The banking industry is massive and constantly evolving, with a strong focus on technology and security in recent years. Mobile banking and cloud computing have become increasingly important, with the latter allowing for more efficient and cost-effective service delivery. ALKT’s platform offers a strong value proposition for financial institutions looking to streamline their operations, attract new customers, and maintain existing ones.

Company overview

Alkami is a digital banking platform. The Alkami Platform allows banks to streamline their operations, attract new customers, and maintain existing ones all at the same time. ALKT has built up contractual relationships with its customers on a long term, subscription basis.

The banking industry is fertile ground for new technology

About $23 trillion in assets are held by commercial banks in the United States, making this sector of the economy one of the largest in the world. Several trillion dollars in revenue were generated by the banking industry in the United States in 2022, demonstrating a sizeable total addressable market (“TAM”) that fuels fierce competition and an economic significance that requires stringent regulation on both the state and federal levels. But banking isn’t a stagnant business. In recent years, technological advancements have helped financial institutions stand out from their competitors, leading to increased market share, improved productivity, and better regulatory compliance.

There have been huge investments in technology and security to keep up with the changing banking industry. While banks spend money on technology for a variety of reasons, some trends are having a disproportionately large impact.

One is the development toward mobile use. Mobile banking is rapidly transforming both consumer and corporate finance. Today, consumers and businesses alike can use their mobile devices to open bank accounts, apply for loans, and transfer funds almost instantly. The rapid pace of technological change is a major factor in the precipitous drop in customers visiting traditional bank branches.

The second, and arguably more crucial, point is the development toward cloud computing. The advantages of cloud hosting and computing form the basis for many initiatives and change that serve as key differentiators across industries today, including banking. With the advent of secure cloud-based multi-tenant infrastructures, technology providers can now offer services previously available only to the wealthiest of their customers to a much wider audience. In addition, data can be easily gathered and synthesized as well. Finally, low-to-no-code architectures permit nearly instantaneous alteration to meet shifting demands from consumers or economic difficulties. As innovative, cloud-based platforms continue to gain market share across many different industries, the recent COVID-19 pandemic serves as a prime example of the value of these advantages.

Last but not least, financial institutions are enticing targets for cyberattacks because of their role as safekeepers of customers’ money and data in today’s increasingly digital and interconnected financial system. Today’s bank robber can target any financial institution from any location in the world, using only a computer as his weapon of choice. This is why banks are investing heavily in cybersecurity and other forms of security technology.

Alkami’s platform offers a single point of integration

The Alkami Platform is a cloud-native infrastructure that supports a multi-tenant, single-code-base continuous delivery platform. The ALKT platform acts as the main point of contact for customers, merchants, and banks, and it integrates with both internal and external systems. One of the main advantages of this model, in my opinion, is that it does away with the inadequacies of point-to-point integration by offering a single point of integration that makes switching between channels simple for customers.

The Alkami Platform’s third-party partnerships and integrations with more than 1,000 endpoints are a key component of the platform. Financial institutions can now choose from a wide range of 3P service providers instrumental in developing a unique digital user experience and seamlessly connect with them through these integrations.

Plenty of room for expansion

In my opinion, the current clientele has a lot of untapped potential for expansion. There is still a lot of room for ALKT to continue cross-selling into the userbase, as the average customer now purchases 11 of Alkami’s over 30 products (source: JPMorgan Global Technology, Media, & Communications Conference, May 2022). Also, I wouldn’t be surprised if ALKT introduced new product modules; they’re a very creative company, which would further increase the cross-sell opportunities.

In addition, Alkami is providing discounts to customers in an effort to achieve greater market share. The average revenue per user and the amount of revenue made (monetization) could both rise with a reduction in discounting. I believe that digital banking is becoming increasingly important for customer acquisition, retention, and industry competition, which will incentivize financial institutions to offer a comprehensive range of products. In light of this, I have complete faith in ALKT’s potential to boost cross-sell activity and increase net retention even further.

Gross margin expansion

Alkami’s infrastructure is built on Amazon Web Services (“AWS”), making it easy to add more users and roll out updates to everyone at once. These advantages stand out in comparison to those offered by traditional, on-premise implementations of core processors. The cost-effectiveness of scaling a cloud platform is crucial, in addition to its myriad competitive benefits. Compared to competing solutions, Alkami’s multi-tenant SaaS on the public cloud deployment is faster and requires fewer resources, leading to a higher subscription gross margin for new sign-ups.

Alkami recognizes revenue and incurs expenses for new customer implementations over the course of the contract term. The market for implementation services is highly competitive, and Alkami has generally subsidized the first contract for services (loss-making). I think this is a smart strategy that most software companies employ as it is a reasonable price to pay for ensuring the loyalty of customers for the foreseeable future. At renewal, the customer’s implementation gross margin no longer acts as a drag on Alkami’s subscription revenue, which then rises to very high double-digits (I estimate around 70%). Because of the increasing size of renewal cohorts, I anticipate a substantial increase in gross margin as ALKT grows.

Competition

Core processing vendors like nCino, Fiserv, Jack Henry, and others are direct rivals of Alkami. Another digital banking vendor, Q2, is also in the race. ALKT competes not only with third-party offerings but also with custom solutions built by customers, whose capabilities may be more limited for smaller financial institutions like credit unions and banks. After doing some reading around and talking to some actual customers, I think the ALKT digital banking product stands out in a few key ways.

1. Whereas most of ALKT’s competitors offer cloud or on-premise solutions, ALKT offers a fully multi-tenant SaaS solution. Since Alkami only has one code base and its architecture serves multiple tenants, it can release software updates more quickly than its rivals.
2. It appears that customers at credit unions and retail banks are the most enthusiastic about Alkami’s product suite. However, larger customers, especially those with commercial banking needs, appear to have had more success in Q2.
3. Alkami stood out from the competition because of the variety of integrations it offered with other products.

Valuation

My model suggests a price target of $15.26 in FY23, representing a 16% upside. This assumes continuous fast-paced revenue growth in the near term, and the forward revenue multiple will be 4x in FY23e.

Given the strong secular trend for digitization, I believe ALKT will be able to grow over the long-term, steadily, while enhancing its market position in the banking space.

In my opinion, ALKT has suffered the same fate as many other high-growth software companies in terms of valuation (profitless). While I believe ALKT will eventually generate a lot of free cash flow, I don’t see any catalysts that will cause its valuation multiple to return to its historical average due to the significant shift in valuation paradigm. As a result, I believe ALKT will continue to trade at this level as it grows.

Risks

Consolidation risk

Since ALKT caters to smaller FIs, it runs the risk of losing clients as a result of industry consolidation, which would have a negative impact on the company’s bookings and revenue growth.

Not profitable, yet

Because of its ongoing growth investments, ALKT is currently losing money and will likely continue to do so in the near future. The risk of the necessity of scaling back expansion plans due to a lack of available capital could result from unfavorable capital market trends (like what is happening now).

Shift in valuation paradigm

Even if fundamentals are strong, the market’s reaction to any further changes in investor sentiment could lead to a general decline in the value of SaaS stocks, which would have a negative impact on ALKT’s stock.

Conclusion

Alkami Technology, Inc. is a digital banking platform provider that offers a cloud-native infrastructure with a multi-tenant, single-code-base continuous delivery model. The size of the banking industry, with over $23 trillion in assets held by commercial banks in the United States and several trillion dollars in annual revenue, provides a large market opportunity for Alkami Technology, Inc. to tap into.