Guidewire Software (GWRE), a holding in Titan’s Opportunities portfolio, released its Q4 results this week, showing positive momentum behind the company's cloud transition. Cloud deals exceeded analyst expectations, driving very strong beats across the board for the quarter.
However, the weakness in overall Q1 and FY 2022 profitability guidance highlights the cash burn and investment required for GWRE to execute its business model transition. The robust deal activity in the quarter cannot be extrapolated linearly, given the long sales cycles and hand-holding required to win a cloud deal, whether it be for new or existing customers.
Guidewire’s ARR (Annual Recurring Revenue) momentum is the most important—and encouraging—guidepost to benchmark the company's execution. A strong beat in the quarter and FY 2022 (+3% each) is a positive sign, although it should be noted that YoY percentage growth expectations did not change.
We see three key drivers at play for GWRE’s performance:
1) Progress on Cloud Transition: The company's transition to a core cloud platform accelerated, as it closed 17 core cloud deals in Q4, which was more than all of FY 2020 combined. This was a big positive and exceeded analyst expectations.
2) Execution Timeline and Risk: The key question revolves around the timeline of actioning the transition from on-prem to cloud and the attendant execution risk. Management did not shy away from the challenge ahead and made sure to temper analyst expectations, given the heavy operational lift of a cloud deal. Notably, these integrations ("go-lives") take anywhere from 6-9 months (or longer), requiring a team of over 10K people globally to execute implementations.
3) Margin Drag and Cost of Carry: One concern here is that Guidewire could need to offer excessive discounts to drive transitions within its customer base, in addition to new customers. Additionally, ramping cloud capacity will require significant investment in core infrastructure. To state the obvious, we believe this will drive margin compression and excessive cash flow burn. Additionally, management stated next year is expected to be an inflection point in margins, as scale starts to impact the underlying economics.
The bottom line: We believe GWRE is positioned to be the dominant system of record for the Property & Casualty Insurance industry. However, Guidewire’s timeline to execute on its cloud vision is highly uncertain. We’re pleased with GWRE’s performance, but will continue to evaluate forward IRR.
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