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Some Recent nCino History
I initially wrote about nCino at the time of its IPO in July 2020. Back at that time, I had calculated that a reasonable enterprise value for the company would be between $3.5 billion and $4 billion. That would have been about a share price of about $41. Of course the shares never sold there back at that time, and I never wound up buying a position. Ultimately, after reaching an all-time high of $88, the shares drifted lower until the great rerating. In fact, the most recent high on the shares was $77, after the company announced a major contract with Wells Fargo (WFC). Since then, the shares have fallen by about 45%, bringing their valuation to an investible level.
I want to stress at the outset that this is an article about nCino, its prospects, recent developments and its valuation. I don’t think anyone can imagine that nCino shares are going to appreciate substantially by themselves, almost regardless of anything short of an acquisition. I don’t think nCino’s business is going to be particularly cyclical if there is a recession-this isn’t the financial crisis, and nCino’s customers are certainly not facing any existential crisis of survival. But investors are fixated on a correlation between interest rates and valuation, and until that perception changes, nothing else is going to really matter in terms of the share price valuation.
nCino shares are currently valued at around $41, or an enterprise value of about $4 billion. In the intervening 20 months since I wrote my initial article, the company’s revenues have grown from about $180 million (the run rate at the time of the IPO) to over $400 million, (my current forecast for the next 12 months.) The company hasn’t yet generated cash, but again, and as compared to the expectation at the time of the IPO, it has made a specific projection that it will achieve positive non-GAAP earnings and free cash flow in fiscal 2024, the year that basically encompasses calendar 2023. Its RPO balance, i.e. its backlog has more than doubled; last quarter the RPO balance reached $912 million, up 52% year on year, and representing more than 2.2 years of my current revenue projection.
Back at the time of the IPO, I had projected nCino’s CAGR to be about 40%. nCino enjoyed a revenue spike because of business it was able to sell to its clients to support the payroll protection program. Last year, specifically, PPP related revenue was about $18.5 million or 6.5% of the company’s total revenue. Excluding that amount from the base, it appears to me as though growth the company is achieving about 35%+ on an organic basis.
Are the shares an attractive investment at this point? I think they are, but they obviously will not perform well until the current malaise in terms of valuations within the software space comes to an end. There is, essentially, an existential divide between those analysts and investors who are concerned about rising rates, and how they will impact the valuation of software stocks more than has already been the case, and other investors who see the current valuation malaise as presenting opportunities.
It is more than obvious that right now the debate is being won by those most concerned by rising rates, and apparently as well, those who feel that rising rates will bring on a recession that will impact many businesses. I think as well that it more than a bit likely that software companies, almost regardless of current circumstances, will provide the most cautious of guidance in this environment. There simply are far too many uncertainties in the environment for them to do otherwise.
Anything I might have to say on the subject of rising rates and valuations and growth has almost certainly been said many times before by many commentators. As mentioned, nCino is highly likely to become profitable and to start generating free cash flow in calendar year2023 but not this year, as it makes specific investments in the building up the capacity and capabilities of SimpleNexus. I understand in spades, that higher rates should, all thing being equal, lead to higher discount rates and lower share prices. This has happened already. The question is how much is already baked into valuations, and what kind of discount rate makes sense for software companies given some significant potential for a recession starting in 2023. The record over many years, is that the growth of software companies is not really nearly as cyclical in nature as is true for many other segments of the economy. But sales cycles can elongate, and deal sizes can be downsized. I have been there and seen that. That’s more likely to happen, again based on my own experience, for a company the size of Microsoft (MSFT) or even Adobe (ADBE), than it is for smaller, more specialized vendors such as nCino (NASDAQ:NCNO), or Braze (BRZE) to pick a couple of examples.
The company has recently closed on a significant merger, acquiring SimpleNexus. SimpleNexus appears to be the leading company in providing mortgage originators with cloud based software. The company is making a massive investment in the space, trebling the size of the SimpleNexus sales force in the last few months since that company was bought. There are substantial cross sell opportunities that should be realized over the next 12 months or so, as the strategy plays out.
nCino’s quarter-the highlights and the outlook for growth in the current year
nCino has been a public company now for about for almost 2 years. Thus far, all of its quarters have seen results that exceeded prior guidance, and this latest quarter was no exception. Specifically, nCino had forecast revenues of about $69 million. Actual revenues for the quarter came to $75 million. About $3.9 million of revenues in the quarter came from the acquisition of SimpleNexus; the “organic” beat of $2 million, or about 3% was fairly typical of the average level of beats that the company has reported after eliminating the impact of the payroll protection.
What was perhaps more noteworthy was the company’s very strong bookings metric. The company’s RPO balance rose by 52% year on year to $912 million. That is a jump of 27% sequentially, or 18% sequentially when adjusted for the contribution of SimpleNexus. Q4 is always a strong quarter seasonally, but this quarter the growth in bookings was bolstered by significant wins of both new customers and existing users. In particular, in the quarter, Wells Fargo, which initially became a customer in the September quarter, substantially expanded its commitment to nCino, contracting to acquire an updated software solution for the company’s consumer and small business banking division. That is a big deal in its own right, of course, given the size of Wells, but it also provides a significant reference customer, and suggests that nCino can deploy its solutions at scale rapidly and successfully.
In addition to Wells, other major 4th quarter wins included CIBC (CM-PQ) as well another top 5 Canadian bank. Overall, nCino now has 5 of the 7 largest Canadian FI’s as customers with significant expansion opportunities in all of these organizations. Canada is a far more concentrated banking market than the US, but this kind of penetration is rather extraordinary, doubtless a product of good sales execution, great references and the overall strength of the banking digital transformation market.
The company’s DBE ratio was 133% last quarter, and while that is down from the elevated 155% ratio in the year earlier quarter, that elevated number included the impact of PPP revenues which created what might be viewed as artificial expansion. The company observed that its long term expectation for DBE was at or above 130%. It also indicated that the DBE for the SimpleNexus component was probably higher than the core number for nCino.
The company saw considerable success in other international geos as well, Overall, international business rose to about 16% of revenue in the recent fiscal year, up from about 11% in the prior year, and in Q4 the international contribution reached 18%. In the wake of the disappointing guidance from both UiPath (PATH) and Duck Creek (DCT) there are those who question the ability of companies to continue to achieve strong growth in Europe. I think that nCino’s European revenues are so nascent, and its value proposition is so compelling, that the factors that have been an issue for both PATH and DCT in Europe really are unlikely to derail the success that nCino has most recently been enjoying outside of the US market.
In addition to the success in international markets and with Wells Fargo and a few other very large banks, the company enjoyed considerable success in what I might term bread and butter new customer wins. For example, one new customer last quarter that is basically a poster child for the kind of business that is driving growth for nCino was Armstrong Bank in Muskogee, OK. Armstrong Bk is hardly considered to be a leading fintech bank if it is known at all outside of northeastern OK. It is really a typical community bank with 20+ offices and perhaps 200 remote ATM’s scattered across NE OK, NW Arkansas and SE KS. . And yet Armstrong has adopted a full suite of nCino solutions, one of the few FI’s to have done so. It is a template for what the potential could be for nCino if it executes well and is able to maintain the high level of customer satisfaction it currently has achieved. And because of Armstrong’s deployment of the full suite of nCino solutions, it can look to some of its customers as the equivalent of a neo-bank. There is tremendous scope for nCino to upsell into its base, as well as to continue to acquire new customers.
nCino’s opportunities with Simple Nexus
The company consummated a rather significant acquisition last quarter, closing its purchase of SimpleNexus. SimpleNexus has been forecast by the company to generate about 14% of nCino’s revenue this year, although the assumption is based on no growth in revenues for that business despite a very substantial investment in sales and development resources. SimpleNexus can best be described as a mortgage lending platform, but it has nothing to do with underwriting credit. Its platform basically facilitates a digital experience in the home buying market. Modules include engagement, which is a collaboration tool between borrowers, realtors, and loan officers, origination which as the name implies is a mobile first tool to gather the information needed to originate a mortgage, closing, a mobile tool that streamlines the rather ponderous real estate closing process and tools that track overall production of brokers and loan originators and a BI tool, tailored for mortgage lenders. Right now, and despite the headwinds in the housing market, the demand for electronic closings is rising dramatically. Most consumers want to transact closings remotely, without some drawn out and expensive process in an office setting. I imagine the e-closings will become standard in the next few years, and this is going to be a substantial tailwind for SimpleNexus growth.
SimpleNexus has proven to be very popular amongst mortgage originators currently deployed at 300 mortgage banks and 100 traditional banks and credit unions. Even prior to the merger, SimpleNexus software was being used to originate 15% of mortgage loans processed last year.
The SimpleNexus deal was essentially predicated on achieving substantial revenue synergies. In the current fiscal year, nCino is expecting that SimpleNexus revenues will reach about $55 million, which would be essentially no growth whatsoever compared to the results of the prior year. nCino has already trebled the size of the SimpleNexus sales force and has various programs in place to achieve cross sales to its existing customers. SimpleNexus was acquired for about $1 billion (the consideration was actually $1.2 billion when the transaction was announced but by the time it closed, nCino shares had fallen significantly, reducing the value of the 13 million shares that were given to acquire the equity in SimpleNexus) so I think it is fairly straightforward to imagine that nCino expects that the application of resources to the SimpleNexus go-to-market activities and through the enhancement of the SimpleNexus platform coupled with cross-sells of the platform to some of its major customers will have a material positive impact on revenues.
The SimpleNexus revenue model is seat based, rather than being based on loan production, and that provides for a measure of stability, even if the housing market contracts this year as seems most likely given the significant rise in mortgage rates, and the decline in housing affordability. Overall, and despite the likely decline in home sales, one reason to expect that nCino’s revenue forecast will be exceeded is the conservative guide provided by the CFO with regards to the revenue contribution of SimpleNexus in the current fiscal year.
nCino’s Solutions and Competitors
nCino is addressing a large and rapidly growing market with a product set that appears to be market leading. Banks and other consumer facing FI’s simply have to provide their customers with digital solutions in order to remain competitive. Mobile apps are key, and while the word “experience” is much overused in the IT world, most bank customers under the age of 40 just will not do business with banks that don’t offer advanced digital experiences.
nCino has several “pillars” (another poor overworked word) to its offering. The product has been built on the Salesforce multi-tenant architecture, and in that regard is similar to Veeva’s (VEEV) original offering. nCino calls its core offering a Bank Operating system in that many of the functions needed to operate a bank these days are apps on the operating system platform.
The most significant app currently is that of Commercial Banking. Commercial Banking at nCino encompasses several pieces of functionality. The software automates the process of onboarding customers, opening accounts, originating and approving loans with specific applications for commercial, industrial and agricultural loans as well as mortgage backed loans on commercial property. Automating these processes, using cloud software has tremendous benefits for bank customers and is one of most significant productivity tools available to banks at this time.
nCino has a set of small business solutions that does much the same things as its Commercial Banking solution, and one reason, I believe why Wells Fargo expanded its relationship with nCino so rapidly as the processes used to automate Commercial Banking and small business banking are very similar.
The company also has a set of solutions for retail bank customers. These solutions are mobile enabled and allow customers to open accounts, apply for loans and to analyze consumer behavior across a retail portfolio to see what’s working and what isn’t.
Analytics, which is the company’s nIQ product has become a major factor in terms of the company’s offering, and its differentiation. Analytics for banks involves “spreading” documents which is the process of transferring information from a borrower’s financial statements and feeding it to the bank’s financial analysis spreadsheet. Automating this process, and using AI technology to provide portfolio analytics and commercial pricing and profitability are the three key components of nIQ. Spreading, because it is a considerable pain point for banks is currently seeing the most significant acceptance. Over time, the company anticipates that its nIQ offering is going to contribute about 20% of the ACV. It is a long way off that kind of contribution at this point and it is one factor to consider in arriving at an estimated CAGR for nCino.
At the time when nCino went public it had estimated that its addressable market was $10 billion. A current 3rd party survey linked here says that the market will be worth $22 billion by 2030. Another survey has the TAM at $28 billion by 2028. There is of course, a trend in which banks are replacing legacy applications with mobile, web based systems that facilitate digital transformations. Very often, market research groups do not yet include nCino as a major competitor in the space. I have linked here to an overall 3rd party analysis of the competitors in the bank operating system market. Many of the competitors that are called out are really professional services firms with some kind of offering that facilitates bank operations but which are really professional services assignments.
The two best known alternatives to what is being offered by nCino are FIS (FIS) and Oracle (ORCL). Most of the other competitors are small, private and some of them are not really focused on the banking segment. The Oracle product in the space is called FLEXCUBE, While Oracle advertises FLEXCUBE as core banking software, the review linked here says that nCino is a better choice in the banking space. FIS has what it describes as a core banking platform. It is not highly rates, according to the survey linked above and it is certainly not a cloud first/mobile first set of solutions.
nCino talks about having a platform being built by bankers for bankers. Of course that is a commercial but there is more than an element of truth in the commentary. The management team has banking backgrounds and has focused on this space for a very considerable time period. At least so far as I can tell, nCino management knows what are the pain points that banks have with their software, and they have products whose goal is to provide a much needed bridge from 1st generation banking software to banking software that is aligned for modern workflows and an optimum consumer experience.
In analyzing nCino competitors, the reality is that much of the competition for Bank Operating System software comes from the internally developed software of the largest banks. Just as an example, JPMorgan Chase (JPM) has 50,000 technologists on staff, a number that dwarfs the development staff of nCino. Of course most of those technologists are kept busy maintaining legacy systems rather than in trying to prioritize digital transformation software.
But even beyond the issue of resources is the issues of organization and prioritization. It can take years for a digital experience project to be agreed to, funded and deployed at JPMC. nCino apparently has a culture that is focused on evolving its solution set rapidly and making its users successful. Most banks obviously cannot compete substantially in terms of their costs. The difference in the cost of funding between banks is not great. And that means that the prices banks charge-for loans, or for other services do not vary greatly either.
What banks can compete on, is the quality and breadth of digital experiences they offer to their customers. A bank like Well Fargo or CIBC obviously has the resources to provide borrowers with a digital experience using their own resources. But they can reach the same result more rapidly and with a better overall set of features that have been tailored to their own unique use cases by partnering with nCino. Armstrong Bk has taken the example even further by acquiring and deploying essentially all that nCino has to offer.
I think in evaluating the competition, nCino really has as much of a moat and product differentiation than might be seen in any other area of the application software space. This is one of the key components of the nCino growth story.
nCino’s Business Model
I think one of the more intriguing comments made by the CFO last quarter is that nCino will report non-GAAP profits and generate free cash flow next year. Much of the projected loss this year is a function of massive investments being made into the opex categories for SimpleNexus. Overall, it seems that the guidance suggests that revenue growth is expected to be robust in the next fiscal year, while the cadence of opex increases will moderate notably.
Last year the company’s non-GAAP gross margin was 62%. That is low for a software company, although gross margins have been increasing gradually since nCino has gone public. The non-GAAP gross margin on subscription revenues was 73%. Part of the relatively lower gross margins for this company, compared to other enterprise software companies are the costs associated with the use of the Salesforce platform. In addition, until recently, the company had mainly sold to sub-enterprise users, and this has resulted in relatively elevated hosting costs. The enterprise component of nCino’s business is accelerating and this is one factor, amongst several, that is likely to lead to gross margin improvements. In addition, the company is shifting implementation workloads to partners, thus reducing the growth of low margin professional services revenue. That trend was very visible last quarter with professional services revenue only growing by 5% year on year. Professional services revenue is now down to 16% of the total, and is forecast to fall to 14.5% of revenues in the current year.
Although last quarter was a small beat on the EPS line, the company has not yet started to achieve any real economies of scale. Because the company owned SimpleNexus for several weeks in the quarter, it is difficult to know exactly what its organic opex growth might have been last quarter. Given the very strong growth in bookings, I imagine that sales and marketing expenses were partially driven by higher than average commission expenses. Non-GAAP general and administrative costs did show some positive trends. In the 4th quarter, general and administrative expense fell from about 17% on a non-GAAP basis to 15.6%. In Q4, both sales and marketing and research and development expenses were 29% of revenues. Overall, the Q4 non-GAAP operating expense ratio was around 75%. That brought the non-GAAP operating margin to a loss of about 11% for the quarter and about 6% for the year.
The company is forecasting that its non-GAAP operating margins for the year will fall to (9%). About half of the loss for the year is projected to be a function of the excess costs associated with integrating and investing in SimpleNexus. Excluding those costs, the company is expecting a modest reduction in the level of non-GAAP losses even after absorbing the loss of PPP revenues. The company has made a rather straightforward commitment to achieving both non-GAAP profitability and positive free cash flow in FY’24 (essentially calendar 2023). I think the path to profitability is pretty self-evident as the company should be able to realize leverage at scale for its nCino business and to achieve substantial growth from the conservative forecast that it has presented for SimpleNexus.
Wrapping Up: Valuation and the case to buy nCino shares
nCino is the leader in providing software to facilitate the digital transformation of banks and other financial institutions, in the US, Canada as well as EMEA and APAC. The company ended its fiscal 2022 year on a high note, exceeding its projections for organic revenue growth and for earnings. Its bookings in the quarter were at record levels, and led to an outsize growth in the company’s backlog which is now more than 2X its projection for annual revenues.
In the quarter, Wells Fargo Bk., which purchased its first set of nCino solutions in September, expanded its commitment significantly based on the success of its initial deployment. In addition CIBC, Canada’s 5th largest bank, as well as another, unnamed top 5 Canadian bank became nCino customers. nCino now is deployed in 5 of the top 7 Canadian financial institutions, a really significant accomplishment for a company of this size. Overall, Q4 was marked by a mix of new logos and expansion business with the DBE ratio at 133%, suggesting the platform and the applications were achieving the results the customers had anticipated. Even within the current nCino base, the company’s penetration is probably only around 15%. It has begun to see a few of its customers contract for the entire platform which includes 8 discrete applications.
In the quarter, nCino consummated its previously announced merger with SimpleNexus, a leading platform that automates residential mortgage applications, analysis, and closing. While 2022 is not going to be a halcyon year for mortgage originations and refinancing’s, SimpleNexus has a seat based revenue model which does not specifically depend on the volume of transactions to generate revenue. The cross sell opportunities for SimpleNexus are quite substantial, and it is certainly possible to anticipate that revenues, currently running at $55 million/year, could double or more after a couple of years of sales effort to introduce the solution to the nCino user base.
It can be difficult to precisely define the market potential for what nCino and some others describe as a bank operating system. When the company went public, it used a $10 billion TAM. Since that time other market research firms have suggested a $30 billion potential. The TAM for nCino expanded substantially with the acquisition of SimpleNexus. But regardless of the specifics of the TAM, nCino’s growth runway is substantial and more than adequate to support elevated growth for several years. The company’s DBE ratio alone, which was 133% over the past year. suggests both the value of the company’s offerings to customers, and suggests that a 3 year CAGR that I have estimated to be 33% is likely to prove conservative.
While there are certainly many companies who offer bank operating systems, none of them seem to be as extensive or as functional as those offered by nCino. While using the slogan “A Business Operating System built by Bankers for Banks” sounds hyper promotional, the anecdotal checks I have made suggest that there is substance behind the claim. I believe that nCino has a substantial competitive moat, better than that of many other applications software companies.
nCino shares have been expensive since the initial public offering. The impact of a share price down by 47% since the level of late early November, coupled with revised estimates that show positive free cash flow generation starting in 2023, have significantly altered the calculus on valuation. My estimates, suggest a current NPV more than 50% above the company’s current share price. Even the relative EV/S ratio has compressed to below average.
At this point, nCino shares tick many boxes for me, and I have started to acquire a position. I like the current set-up in which the consensus seems based on exceptionally “prudent” guidance. I think from this level the shares can readily generate positive alpha over the next year.
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