Q2 Holdings

QTWO : NYSE : US$13.68
BUY 
Target: US$17.00

COMPANY DESCRIPTION:
Q2 Holdings provides a cloud-based platform for
customer facing web and mobile banking solutions for
regional and community financial institutions. The
platform enables users to pay bills, check balances,
transfer funds, and deposit checks through a unified
online platform or mobile device. Q2 was founded in
2004 and is headquartered in Austin, TX.

All amounts in US$ unless otherwise noted.

 

GROWTH; INITIATE WITH BUY, $17 PT
Investment thesis
In our opinion, Q2 Holdings could be one of the quiet winners of the recent IPO
class. The firm sells customer-facing banking applications, competing largely
with legacy software vendors and aging custom code. Q2 signs 5+ year
subscriptions (excellent visibility), is growing revenues ~30%, but won’t likely
break even until sometime in 2017. If Q2 can articulate and demonstrate a
clear and consistent path to profitability, the stock could get re-valued into the
25%+ growth SMID cap cloud cohort, which implies a 7-9x forward revenue
multiple. As is our custom, our price target is more conservative and assumes a
modest deterioration in the EV/revenue multiple, but a 20% appreciation in the
face of 30% revenue growth. We are initiating coverage of QTWO with a BUY.
Investment highlights
 An upgrade cycle is underway. Regional and community financial
institutions (RCFIs) are increasingly becoming viable competitors to the
national mega-banks – this means that they too need online and mobile
banking functions and sleek, next-generation user interfaces. Enter Q2.
 Legacy competition. Being founded in the mid-2000s, Q2 has the
advantage of being constructed on a unified, cloud-based platform with a
mobile-first development mentality. The firm competes either with vendors
like Digital Insight (NCR) and First Data, who are attempting to morph
timeworn applications, or oftentimes in-house, custom-built code.
 Attractive micro-economics. Q2 signs 5+ year initial deals, dollar-based
retention including upsell tops 125%, and the firm crosses into profitability
after 1.8 years of a new customer relationship. This means that in the near
term at least, the faster Q2 adds clients, the more money they will lose.
 What it means for the numbers. From the firm’s roughly $65M run rate,
we expect Q2 to be a ~30% revenue grower for the next several years.
Gross margins should scale from ~40% this year to 60%+ with scale, and
Q2 should become cash flow and EBITDA profitable sometime in 2017.

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