Personal Finance

3 Things Paycom Software Investors May Be Overlooking

Paycom Software (NYSE: PAYC) has had an incredible run in its short life as a public company. In the three years since its IPO, shares have more than tripled as investors have piled into this fast-growing provider of payroll and human capital management software. After digging a little deeper into Paycom's most recent earnings report, I'd like to highlight three things that may help the company exceed the steep expectations baked into its stock price.

Image source: Paycom Software

1. Paycom will benefit from rising interest rates

Last quarter, Paycom held an average daily balance of $680 million in client payroll funds. In the same way that insurance companies benefit from "float," Paycom earns interest on these funds during the interval between receiving the cash and paying its customers' employees. At the moment, interest rates are still hovering near historic lows. But with the Fed suggesting at least two rate increases this year alone, Paycom stands to earn a lot more interest on these funds if rates rise.

What's even better is that any increase in earned interest would be incremental to the company's current guidance. Paycom CFO Craig Boelte explained in the company's recent conference call, transcribed by Seeking Alpha :

... on the interest rates, you know our guidance basically assumes rates are where they are today. You know there is talk about two, possibly even three interest rate increases during the year of 25 basis points. I think it's somewhat dangerous to include those because you just never know if they are going to happen. One thing I would though remind you is we are holding a significant amount of client funds. During the fourth quarter our average daily balance was around $680 million, on a pretax basis that's about $1.7 million. So that really falls to the bottom line..

When you consider that the company's total net income (non-GAAP) was $10.8 million in the fourth quarter, that potential $1.7 million in interest looks a lot more significant. Over the next few years, if rates continue to rise, this could provide a nice tailwind for income.

2. Larger clients should boost recurring revenue

While Paycom primarily targets clients in the 50-to-2,000-employee range, on the last several earnings calls, management has been announcing the signing of some larger customers as well. And since Paycom's contracts generally include an additional fee per employee, signing larger customers results in higher amounts of recurring revenue.

To put that in more concrete terms, on its most recent conference call, management stated its "annualized opportunity per employee" was $400 or more. That's a lot of incentive for the company to keep targeting larger clients.

In the past year, Paycom has publicly noted at least a dozen new customers in the 2,000-to-8,000-employee range. If Paycom can continue to successfully close sales to larger companies like these, it should help juice the company's growth even further.

3. ACA-related revenue losses will be less than feared

In 2016, Paycom received a significant revenue boost from customers that needed to ensure compliance with the Affordable Care Act (ACA). Last year, CEO Chad Richison remarked that 5% of its revenue would be at risk if the ACA were to disappear overnight. However, according to recent news reports, the timetable for the eventual repeal of the ACA is still unclear, likely delaying any revenue impact until later this year or even 2018..

And that impact may end up being fairly negligible. On the fourth-quarter earnings call, Richison updated the "at risk" revenue figure above, saying that the company would only need to replace approximately 3% of its revenue if the ACA went away today. Secondly, Richison noted that if the decision is to "repeal and replace" with another set of government regulations, its clients will continue to rely on Paycom's software for compliance:

If responsibility goes to the individual states, we could have separate state laws and regs with sub-regs for several states while other states may have none ... The ACA could also be repealed and replaced with something still requiring the annual reporting of employee information. ... So while the immediate elimination of ACA would have a minor impact on our revenue from a certain number of our current clients, we do not believe it would impact our overall value proposition or our new business on-boarding pace.

If it becomes apparent that ACA repeal is likely to be revenue-neutral, it would remove one of the biggest short-term risks facing the company. And with the potential of additional revenue from larger clients, plus income from rising interest rates, Paycom's future may wind up looking even better than anticipated down the road.

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Andy Gould owns shares of Paycom Software. Andy Gould has the following options: short February 2017 $40 puts on Paycom Software. The Motley Fool owns shares of and recommends Paycom Software. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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