Modernization Could Drive 20% Earnings Growth Here

Dan Romanoff: We see wide-moat Guidewire as an interesting long-term investment opportunity in the mid-cap space. The underlying growth thesis revolves around a modernization theme for the core software systems the P&C insurance industry uses. We think both the initial penetration and subsequent cross-selling opportunities are tremendous, given so many carriers lack a modern core system and the advanced add-on features that go alongside it. We see earnings growth compounding at 20% for a decade, as the company has low-single-digit market share in at least a $10 billion market. Our fair value estimate is $117 per share and implies a P/E of 65 times on adjusted 2020 earnings.

Guidewire is the largest software provider focused exclusively on the property and casualty insurance market. It provides the core operational software suite that allows a P&C insurance company to analyze risk, write policies, collect premiums, manage the claims process, manage an army of agents, create new products, do business in a digital world, and help perform related financial and statutory reporting. The three main pillars of its solutions are ClaimCenter, BillingCenter, and PolicyCenter, but Guidewire has been busy introducing important new solutions in the last couple years, including predictive analytics, digital portals, and, more recently, a move to the cloud.

Insurers are highly risk-averse and have been reluctant to change, so many insurers are still using legacy COBOL-based mainframe type of systems. Over the last 10 years, Guidewire has had sales meetings with virtually all insurance carriers, demonstrating what modern software can offer relative to custom-built legacy systems. This helped the company rise to a substantial product and market share lead. Still, carriers have been adopting on-premise software and are only now beginning to move to the cloud. Given the slow-moving nature of the P&C insurance industry, we believe the modernization theme will take place over more than a decade, and Guidewire will lead the way.