September 30, 2020 - 6:25pm EST by
2020 2021
Price: 35.00 EPS N/A N/A
Shares Out. (in M): 69 P/E 0 0
Market Cap (in $M): 2,415 P/FCF 42x 10x
Net Debt (in $M): 1,240 EBIT 100 295
TEV (in $M): 3,655 TEV/EBIT 36.5 12.4

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Executive Summary


Cornerstone OnDemand (“CSOD” or “Cornerstone”), a leading talent management software company, is a unique asset that has been left behind in the market’s rush to own high growth SaaS companies, largely due to its complicated history, subpar track record and a recent acquisition that has been perceived as ill-advised and value-destructive.

Despite sitting at one of the ideal intersections for growth over the last decade – learning management solutions and software – after seeing explosive growth several years ago, the company has consistently underachieved in the last six years.  Growth investors have been burnt over the years due to subpar growth under a management team that failed to capitalize on tremendous industry tailwinds, while value investors have shied away due to the company’s struggle to generate meaningful cash flow and most recently, an acquisition (effectively a merger) that is optically expensive.  As a result, despite an attractive end market, large embedded customer base and scalable technology, CSOD trades at one of the cheapest midcap SaaS multiples (approximately 4.3x sales) today.

That said, Cornerstone’s acquisition of one of its chief competitors, Saba, resultant appointment of Saba’s CEO as the CEO of the combined company, and recent selloff due to investors’ aversion towards leverage in public software companies, provides an attractive investment opportunity.

We believe that under the new management team, the combined company should achieve HSD to LDD growth and generate meaningful free cash flow, with a minimum shareholder return of the free cash flow yield (10-15%) as the company deleverages.  At the same time, because of the spotty track record of the prior management team including a failure to proactively address competitive threats and rationalize a bloated cost structure, sellside support for the stock has been lacking over the last several years.  However, if the new team can execute off of a relatively low bar and expections, and achieve operational success, the company should rerate.  If the company exhibits growth and margin expansion that it has signaled and that we believe is very achievable, a rerating to merely reasonable average growth software company multiples should lead to an annualized return in excess of 25%.  Finally, as essentially the only large independent asset in the space, CSOD should be an attractive target to a host of potential acquirers as it executes the integration of Saba.  

Company Overview

Founded in 1999 by a visionary CEO and headquartered in Santa Monica, CA, Cornerstone is a leading global provider of learning and people development solutions.   With a stated goal of enabling organizations to manage the entire employee lifecycle, Cornerstone offers modules in Learning, Recruiting, Performance, Content and HR administration to over 6,300 global customers around the world via its SaaS offering.  The company has benefited from the migration of HR software to the cloud over the last decade and differentiates itself via its best-in-class learning, performance management solutions and tightly integrated platform, with a reputation of having the most advanced talent management suite in software.  In recent years, Cornerstone has committed to achieving the Rule of 40, but has struggled to get there due to increased competition, missteps in execution and a reluctance to restructure in the face of slowing growth.

Earlier this year, on February 24, 2020, the company announced fourth quarter and fiscal year results that came in below expectations.  Specifically, subscription revenue growth decelerated to 12% constant currency growth (versus 17% in the third quarter) and first quarter guidance fell below consensus estimates.  For the year, the company generated $577m in revenues and Non-GAAP operating income of $89m.  More importantly, the company announced the entry into a definitive agreement to acquire Saba, one of its chief competitors in the talent management space, for $1.395bn, or approximately 5.3x revenues (ttm).  Cornerstone’s rationale was based on (i) accretion to cash flow, (ii) large synergy opportunities (est’d $35m), (iii) enhanced reach and cross-selling opportunities, (iv) additional engineering talent, and (v) alignment on vision.  Largely due to the negative perception of the acquisition , looming COVID headwinds, increased pro forma leverage (estimated 6x gross leverage at closing, inclusive of the $35m of synergies) and worries that a management team that had struggled to manage its own company would now be responsible for integrating its largest acquisition by far, the company’s stock price tanked immediately, from $55.05 to $39.42 the next day, hitting a low of $23.89 in the midst of the COVID crisis. 

Because of the volatility and uncertainty around the COVID crisis, the company was able to negotiate a $100m reduction to the purchase price and closed the deal on April 22, 2020.  Subsequently, on May 11, 2020, Cornerstone announced the appointment of Saba’s CEO, Phil Saunders, to be CEO of the combined company.

In the most recent reported quarter (ending June 30th), the company reported subscription revenues approximately 6% ahead of consensus and increased its Saba runrate synergy target to $65m.  Though COVID-19 certainly had an impact on the business, the company also maintained its long-term targets of $1bn in revenue and a 30% unlevered free cash flow margin with meaningful margin expansion expected in FY 2021.

Investment Thesis

Industry Tailwinds

The human capital management (“HCM”) technology market is one of the largest and fastest growing in the software market.  Most recently, at its 2019 analyst day, the company estimated the HCM and Content opportunity/TAM to be approximately $40bn, with Learning management estimated to grow 9-11% for the foreseeable future, Performance 5% and Recruiting 16%.  Though COVID-19 has slowed down near-term demand, the impact should ultimately only accelerate tailwinds as more companies and employees gain comfort with work from home and training from home.

High quality business

By combining the top two players in the industry, the “new” Cornerstone has annual recurring revenues in excess of $800m, a global client base of 6,300 and customer retention rate exceeding 90%, CSOD today.  Its global marquee client list includes Visa, Amazon, Nikon and BNP Paribas with a massive user base in excess of 30m.

The company has highly diversified ARR (with the no sector being more than 15% of total revenues), a budding content platform for third party license providers in a fragmented market (an estimated 5k content producers in North America with Pluralsight, Skillsoft and Lynda being the main competitors and none of them dominating the market) and as reflected in its renewal rates, a very sticky customer base.  

With gross margins approaching 75% and a large installed base, the company’s targeted mature unlevered free cash flow margin of 30% should be easily met.  Additionally, Saba’s cloud renewal rate has improved over the last few years, and the recent impairment to Cornerstone’s renewal rate as a result of Workday roll-offs over the last few years should dissipate as the Workday base becomes a smaller part of the underlying customer base.

Upgraded management team, board and governance

Under the prior team led by its cofounder, the company wandered aimlessly, consistently underperforming and destroying shareholder value.  The company failed to form and execute a coherent and effective strategy, and a very expensive and highly dilutive issuance of a convert to a private equity firm provided little to no return, either financially or strategically.  As mentioned, after the closing of the Saba deal, the company earlier this year announced the appointment of Saba’s well-regarded CEO, Phil Saunders, as the CEO of the combined company with the former CEO/founder transitioning to co-chair of the Board of Directors.  

Not only does the new CEO have a solid track record in both M&A integration and operational execution but he also has a reputation for building strong teams while making tough decisions.  Saunders recently enhanced the management team with others who have worked side by side with him, including the additions of the former Chief Marketing Officer and a former Executive VP at Saba.  At the same time, Saunders has sharpened his pencil on the cost structure and made the necessary headcount reductions that the prior management team was reluctant to execute upon. 

Additionally, approximately two years ago at the behest of several activist investors, the company de-staggered the board, separated the chairman and CEO role, and enhanced the board with the addition of a couple experienced and well-regarded software executives including Richard Haddrill (executive and board experience at Bally Technologies, Manhattan Associates and JDA Software) and Marcus Ryu (Guidewire, Ariba).  We believe that the prospect of elevating Saunders to CEO was a large factor in the board's decision to acquire Saba.

Solid financial profile

Since the announcement of the deal, the company has raised synergy guidance twice, most recently to a $65m runrate by year-end.   The CEO has also indicated that there might be additional upside and has already implemented significant cost cuts to drive operating margin. Ultimately, we believe that the company should be able to grow revenues at 8-12% while achieving free cash margins in excess of 30% due to the operating model of the business and the aforementioned industry tailwinds and company positioning.   The company’s confidence in achieving such success stems from a renewed focus on go-to-market initiatives including streamlining sales & marketing and leveraging win loss date to focus on “win zones” – i.e., areas with the highest probability of success while creating more of a meritocracy within the organization.

Attractive valuation

Cornerstone is currently trading at approximately 4.3x 2021 revenues, a substantial discount to both historical and comps multiples.  Though the Saba deal was originally panned by the market (due to leverage, an initial agreed upon price that seemed quite expensive, a closing the middle of COVI, and lack of confidence around the (former) management team’s ability to execute), including cost synergies the company should add $150m of free cash flow.  Cross-selling opportunities and the cessation of intense price competition between the two as a result of the merger should create additional cash flow opportunities.

By 2023, we estimate the company should generate approximately $370m of EBITDA and $305m of free cash flow.  Using “traditional” non-growth software multiples on EBITDA and free cash flow, and giving credit for debt paydown in the interim suggests and a 9x EBITDA multiple and 13% FCF yield providing ample downside protection.  We believe that given the terrific characteristics of a SaaS company with a high retention rate and steady growth profile would justify a revenue multiple rerating which would lead to a doubling of today’s stock price.


Finally, as the dominant scale player in a fast growing and attractive market, as both a backstop and potential catalyst, the company could be a very attractive target to strategics (e.g., MSFT, Ultimate, ADP) and private equity firms. 


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Additional synergies from Saba acquistion


Bounceback in growth

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