Blackbaud: The Risk-Reward Is Balanced (NASDAQ:BLKB)

Elevator Pitch

I assign a Hold investment rating to Blackbaud, Inc.’s (NASDAQ:BLKB) shares.

Blackbaud’s stock offers a fairly balanced risk-reward proposition, which supports my Hold rating for the name. On the negative side of things, BLKB’s future financial results might be worse than what the market expects if economic conditions continue to worsen. On the positive side of things, an activist investor has taken a substantial equity interest in Blackbaud’s shares with the aim of enhancing the company’s value.

Company Description

Blackbaud calls itself a “cloud software company” focused on “the entire social good community” such as “nonprofits, higher education institutions, K–12 schools” in its press releases.

As highlighted in its 2021 10-K filing, BLKB earned the vast majority or 84% of its revenue in the most recent fiscal year from the US market. The UK and other markets accounted for 10% and 6% of Blackbaud’s FY 2021 top line, respectively. Blackbaud also disclosed in its fiscal 2021 10-K filing that the company boasted close to “40,000 customers with contractual billing arrangements” in the prior year.

Weak Stock Price Performance Is Attributable To Investor Concerns

In 2022 year-to-date, BLKB’s shares have fallen by -24.2%, as compared to a relatively milder -15.1% correction for the S&P 500 over the same period.

My view is that Blackbaud’s stock price weakness is driven by two key investor concerns.

The first thing that investors are worried about is the potential impact of weak economic conditions or even a full blown recession on BLKB’s future financial performance.

Assuming the macroeconomic environment turns for the worse, it is reasonable to fear that donations might decline in a big way and some of Blackbaud’s non-for-profit clients could potentially face challenges staying afloat. Such worries are reflected in the sell-side analysts’ consensus financial forecasts for BLKB.

In the last three months, four of the seven analysts covering Blackbaud’s stock have cut their respective Q4 2022 bottom line estimates for the company. In fact, BLKB’s fourth quarter normalized earnings per share projection was reduced by a very substantial -23% in this time frame.

The second issue that might have potentially made certain investors slightly uneasy about Blackbaud is the company’s financial leverage.

Blackbaud’s gross debt-to-equity ratio as of September 30, 2022 is approximately 1.24 times as per S&P Capital IQ data. A rule of thumb is that a gross debt-to-equity metric of below 1 times will be ideal.

At the company’s recent Q3 2022 financial results investor call, BLKB also acknowledged that its current net leverage ratio (net debt divided by trailing twelve months’ EBITDA) of 3.1 times as of end-September 2022 is still much higher than its “optimal debt levels” at “around 1.8x to 2x leverage.” It is also worthy of note that Blackbaud’s net leverage metric didn’t exceed 3 times between 2012 and 2021.

Taking into account the rising rate environment, it is natural that the market would have preferred that Blackbaud’s gross debt-to-equity and net leverage metrics were lower than what they are now.

The two factors mentioned above help to explain why Blackbaud’s stock hasn’t done well in this year thus far. In the next section, I touch on a potential positive re-rating catalyst for BLKB.

Activist Involvement Could Be The Catalyst That BLKB Needs

A 13-D filing issued in early-October 2022 highlighted that Clearlake Capital held a 18.4% equity interest in Blackbaud’s shares. In this 13-D filing, Clearlake Capital highlighted that it has “engaged in and/or may engage in communications with” BLKB to discuss matters such as “the review and evaluation of strategic alternatives, opportunities to increase shareholder value.” On its website, Clearlake Capital specifically mentioned its “history of active leadership as value-added investors.”

Based on S&P Capital IQ’s historical valuation data, Blackbaud has consistently traded at a consensus forward next twelve months’ normalized P/E multiple of above 30 times between 2015 and 2019. BLKB’s 10-year mean forward P/E metric was 30.4 times, and the stock has even traded at a decade-high forward P/E ratio of 46.5 times in mid-2015. Even though the worst of the COVID-19 pandemic is over, Blackbaud still trades at just 20.1 times consensus forward next twelve months’ normalized P/E as of December 2, 2022, which is way below the valuation multiples that the company’s shares used to command.

The substantial valuation multiple de-rating for BLKB in the past two years or so imply that there are opportunities for Blackbaud to work with Clearlake Capital or other investors to explore various means of value creation. One example could be a faster pace of deleveraging supported by either asset divestments or cost cutting.

However, it is slightly disappointing that BLKB has put in place “a limited duration stockholder rights plan” which will be triggered if a party “acquires beneficial ownership of 20% or more of Blackbaud’s” shares as indicated in an October 11, 2022 announcement. This is widely seen as a “poison pill” to potentially counter the future actions or moves of Clearlake Capital. Nevertheless, Clearlake Capital is still in a position to influence Blackbaud with its significant equity stake, and recommend actions that could help to unlock the value of BLKB’s shares.

Bottom Line

A potential investment in Blackbaud comes with both risks and rewards, and I think that a Hold rating for BLKB is appropriate. There is downside risk to Blackbaud’s financial performance going forward, assuming that the economic environment gets more challenging. But Blackbaud’s shareholders might also be rewarded with meaningful capital appreciation relating to BLKB’s stock, if the activist investor brings about positive changes for the company.