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Morningstar | Blackbaud’s Recurring Shift Remains on Track; FY19 Will Be an Investment Year; Shares Undervalued. See Updated Analyst Note from 07 Feb 2019

Blackbaud’s fourth-quarter results were mostly in line with our expectations, although the firm’s non-GAAP margin was slightly ahead of our forecast. The quarter was emblematic of Blackbaud’s ongoing shift to recurring revenue at the expense of its declining one-time services & other revenue line. For the quarter, GAAP recurring revenue rose 4.9% year over year and constituted 90.4% of the company’s total revenue. We expect the firm’s continued onus to be on growing the recurring revenue line. However, the impact is that we forecast a deterioration in one-time services & other revenue, which will impact Blackbaud’s short-term results. We believe the company sits in a strong competitive position, and with the firm shifting to a cloud-based subscription model, we see ample headroom for the firm to expand within its large underpenetrated addressable markets. The cloud-enabled expansion into faith-based communities and higher education markets, development, and partnership with Microsoft, and recent acquisition of YourCause reinforces our wide economic moat rating for this firm. Over time, we also think there’s significant opportunity to address wider markets via the utilization of systems integrators and other third parties that will shift the firm from being mostly direct sales focused. After accounting for the quarter and fiscal 2019 guidance, we retain our $87 fair value estimate. We believe the firm is still trading at an attractive discount despite a notable jump in the stock after its results were published.

For the quarter, total GAAP revenue grew 1.8% year over year to $221.2 million. Recurring revenue increased year over year to $199.9 million, while one-time services and other revenue fell 20.5% year over year to $21.3 million. We expect fiscal 2019 to be an investment and building year for Blackbaud long term.

We forecast elevated investment in sales and marketing and research and development spending as the firm further scales its sales team to support its cloud-related growth initiatives. While a better delegation of sales resources is expected, we also think the firm’s shift to a total solution selling approach by vertical will help support ongoing growth of products per customer and overall higher customer lifetime value.

In terms of margins, Blackbaud’s non-GAAP operating margin slid 240 basis points year over year to 19.1%. The decline was attributable to the company’s heightened investment toward the back end of last year, which was to support greater incremental sales hiring, software engineering skills, and some acquisition dilution. For fiscal 2019, we expect these elevated expenses to continue, resulting in a depressed short-term operating margin and EPS performance. As the firm scales its sales team and becomes almost entirely cloud based, we expect significant long-term margin expansion.