Thursday, October 4, 2012

Intuit is a Great Cloud Computing Play

If Intuit $INTU was a supermodel it would probably be Cindy Crawford. You could spend all day just looking at a small blemish and forget to look at the extremely attractive bigger picture. In Intuit’s case the market seems to have been obsessing over the fact that, by the company’s own admission, its tax season was not as strong as it might have been. Frankly I don't consider this to be a big issue and think the stock is undervalued. Here is why.

Essentially the company was aiming to grow do-it-yourself tax revenues by 6-8% but achieved closer to 5% and it also failed to hit its expectations with market share gains. No matter, such honesty is refreshing to hear from a management and these are largely execution issues that it can fix. The company continues to benefit from strong secular growth drivers and the long term story remains intact. The stock is becoming attractively priced.

Intuit and the Long Term Story with Cloud Computing

Whenever someone mentions Cloud computing, thoughts immediately turn to the high tech infrastructural plays, but a lot of investors miss the fact that traditional on-premise licence based software companies are going to be key beneficiaries too. For example Oracle $ORCL is making key acquisitions in order to fight competition from $CRM in the customer relationship management (CRM) market. Incidentally, Oracle also competes with Intuit by offering Cloud based financial and accounting apps. The advantage of a Cloud based model for Oracle and is that it tends to create increased return on investment (ROI) and higher customer retention rates. Indeed, as Intuit points out with QuickBooks Online, it gives a 20% increase in life time value (LTV) as compared with QuickBooks Desktop.

The secular shift to digital also should increase marketing efficacy and companies like Adobe Systems $ADBE and Google $GOOG are increasingly offering sophisticated analytics packages so companies can better understand their customers and- crucially- how to cross sell to them better, particularly if they have a sprawling and varied product base. In Adobe’s case it is about selling solutions alongside its traditional strength in marketing and publishing while Google is an aggressive early mover in the Cloud with gmail, Android and the Google App engine.
All of which leads to Intuit.

Its core business of tax preparation (TurboTax) and financial and accounting apps (QuickBooks and Quicken Online) are all offered online and all of the above benefits apply. Moreover, its core customer base is in the SMB market, and the opportunity to cross sell and convert clients from other sources is significant. It also makes Intuit capable of growing revenues even in recessions.
In fact, Intuit grew revenues every year for the last five years at a compound annual growth rate in double digits. Selling low ticket (but high retention) solutions to SMBs is an attractive business because let’s assume that, say, 50% of start-up SMBs fail within a couple of years, 100% of them will need accounting and financial solutions.

How Intuit’s Operating Metrics Are Improving

The shift to Cloud computing has also positively changed the operating metrics for Intuit with operating cash flow margins increasing over the last five years.

Turning to the guidance for 2013, Intuit is forecasting 10-12% growth in revenues with Non-GAAP diluted EPS gains of 12-14%, so no slowdown here.

As for the Q1 guidance, which seemed to disturb a few commentators, the revenue numbers should be lower because Intuit divested its Intuit Websites business, which had contributed $76 million in revenues for 2012. Intuit also sold its corporate banking business, so we are seeing a clear strategy to trade off revenues for margins. I like this step because it will allow Intuit to focus its efforts on its core business and executing better on its aims.

Where Next for Intuit?

Essentially, it’s more of the same.

Intuit needs to increase conversion rates and cross sell its product lines better. I think it has a good opportunity to do this because we are still in the early stages of utilizing analytics within Cloud based solutions. As for the tax season issues, they stem from the attempt to increase conversion rates from stores by hiring 700 telephone based staff to give tax advice. Growth was not as high as expected but management is addressing the issues in an effort to optimize activity. As ever with these sorts of initiatives there are lessons to be learnt and with an increased focus Intuit has a better chance to do this.

In conclusion, the company has a business model which is migrating towards favorable profit drivers both from a top line perspective and from operational efficiency gains. Intuit claims that 80% of its revenue is recurring, and combining this with its relatively recession resistant solutions means that investors can enjoy stability alongside the growth kicker of better execution with conversion rates and cross selling of its wide product offering to the SMB market. Intuit looks set to continue to drive earnings forward at a double digit pace and with over $1.2 billion generated in operating cash flow for a stock with a market cap of $17.3 billion, the stock is hardly expensive.