Blue Prism looks under developed

On the face of it, London-listed Blue Prism (PRSM) sounds like it could be a contender. While it is based in Warrington, Lancashire, rather than Silicon Valley, California, aspects of its investment case sound just as ultra-modern and exciting. The company is in the business of robotics process automation (‘RPA’) – robots (software) that relieve workers of often mind-numbing back-office jobs. 

And like many young American high-tech companies, Blue Prism has yet to make a profit but is growing sales at a rapid clip. So the company implies a rather Amazon-esque (US:AMZN) pitch: shareholders should be willing to stomach big losses in exchange for rapid growth in a sector on the brink of a boom.

However, with competition getting tougher, we think investors should take that message with a pinch of salt. Indeed, in an industry where true competitive advantage is likely to hinge on product quality, we're concerned the company could lose out due to low levels of research and development (R&D) coupled with the huge amounts of capital being pumped into competitors by venture capitalists. 

We're not the only sceptics. Short interest in the shares stands at 4.5 per cent. While shorts are down from a peak of 5.5 per cent in July, the longer-term trajectory has been upwards, with shorts having risen from around 1 per cent in September last year.

Calm on the surface

Losses have widened at Blue Prism, with a £26m pre-tax loss in 2018 increasing to a £81m loss in 2019. Yet the business model ticks several boxes for a software company. It has a high proportion of recurring revenues at 96 per cent of the total and boasted a gross margin of 92 per cent last year. At the end of April, the company had almost 2,000 customers, and it has done a good job at squeezing more money out of them after the first sale. Upselling represented almost three-quarters of new monthly recurring revenue in 2019.

Trading so far this year has been healthy, with no severe impact from Covid-19 fallout, apart from some deal slippage. This is in part because of who the company sells to: usually big, deep-pocketed companies that generate enough mindless documentation work that forking out on software to deal with it cuts costs. That includes the likes of eBay (US:EBAY) and accounting firms such as EY and Deloitte. 

As such, Blue Prism’s top line has shot up in the past four years, by an impressive average annual growth rate of over 100 per cent. 

Source: FactSet

*Being taken over by RWS

Cost conundrum

However, Blue Prism’s costs make it look more of a sales and marketing business than a software development business. Its expenditure on sales and marketing in 2019 of £105m represented 104 per cent of revenues. That compared with costs related to research and development of just £6.1m.

A further £4.6m of development spending was capitalised (recorded as an asset on the balance sheet rather than as an operating cost on the income statement), but again this was dwarfed by the £23.6m of capitalised commission paid on sales. Capitalised items like these are accounted for in future periods as the company sees the revenue benefit from the spending. Commission on big multi-year sales are sometimes paid upfront, so a salesperson will get their cut of, say, a decade-long contract well before the full value has been realised on the group’s income statement. These are pretty attractive terms for software salespeople.

A key element of the sales spending is the huge amount Blue Prism has pumped into its staff, more than doubling its recruitment costs to £6.8m last year. This round of hiring more than doubled the company’s headcount to more than 1,000, compared with less than 100 people four years ago. But that also means that revenue per staff member has declined. It could struggle to pick up again, as we are thrown in to a prolonged period of macroeconomic uncertainty. 

Spending lots on sales is not bad initself, but we fear this focus could be coming at a detriment to the company’s competitiveness. In 2019, Blue Prism spent three times as much on travel and entertainment as it did on research and development. Even chief executive Jason Kingdon (who only stepped into the role five months ago) admitted in an analyst call that the company had not been giving enough to R&D. Indeed, Blue Prism’s own accounting policies write off development spending over a one-and-a-half to two-year period, reflecting just how fast-moving the industry is.

And while Blue Prism’s total spending has been rising, it has fallen as a percentage of sales from 7 per cent in 2018 to 6 per cent last year. Even the company’s plan to treble R&D by 2021 leaves us underwhelmed when looking to peers. For example, US competitor PegaSystems (US:PEGA), with a market value of $11bn, spent a quarter of revenues last financial year, or $205m, on improving its product as well as $475m on sales and marketing.

The risk of falling behind could explain Blue Prism’s acquisition of cloud-computing company Thoughtonomy in 2019. But the group cannot afford to lose pace with its competitors by not investing enough in its software. Even more so while competition in the sector gets tougher. The other main players are Automation Anywhere and UiPath, both of which are private US companies – although there are reports that the latter is considering an IPO in 2021. While the IPO could attract attention to Blue Prism, the rate at which UiPath has been able to raise money – including a $568m fundraising last year end $225m in April valuing it at $10.2bn – also suggests the big US players could have the financial fuel to leave Blue Prism in the dust.

Cash gobbler

In common with its US peers, Blue Prism is a cash-hungry beast. While it has an ambition to be “cash flow breakeven” by 2021, it has so far relied on regular equity fundraisings that have diluted existing holders. 

It is hard to judge what the group’s cash-generation potential could be in the future. But the high level of trade and other receivables, at 44 per cent of total revenue, is of note. This number does need to be seen in the context of rapid growth, which means historic sales are not reflective of the year-end run rate. The company also generates cash from taking early payments before it books revenue. Still, the money owing is worth taking note of in a sector where high debtor days have been known to cause investors problems: such as the £49m blow to cybersecurity firm NCC (NCC) in 2017, and more recently Ideagen (IDEA), where receivables led to a £2m charge this year.

Blue Prism’s shares are up by almost a third so far this year, compared with a FTSE All-Share decline of around 20 per cent. We think the market has underestimated the growing risks. And we struggle to see Blue Prism as being like Amazon during its loss-making aggressive expansion phase because the lack of development spending leads us to question if it is really building a competitive advantage through its increased scale. 

A forward 2020 price-to-sales multiple of almost 10 signals that a lot of hope is being placed on growth continuing and the company becoming profitable. As the saying goes, sales are vanity and profits are sanity. We’re yet to be convinced this business will be able to deliver the latter.