Uptick in Guidewire's Fair Value, Shares Mispriced

After taking a fresh look at wide-moat

Guidewire’s business model is predicated on converting low-gross-margin services revenue into high-gross-margin software license and maintenance revenue. The firm is in the midst of transitioning customers to the cloud, leading to elevated service revenue and lower fiscal 2018 gross margins, which we predict will continue into fiscal 2019. Thereafter, we predict more normalized licensing revenue growth in fiscal 2020 and 2021. We assert that the firm will need to eventually gain leverage in its services segment as it relies on partners to lead cloud-based implementation for customers.

We remain confident in cloud sales, particularly as it was addressed last quarter that nearly 50% of new sales this year have come form cloud-based subscriptions. Looking ahead to fiscal 2019, on a positive note, the firm should see a boost in subscription revenue and will be able to capture the beneficial economics of early adopting customers of the firm’s cloud products. Further, the firm will be able to recognize two years of revenue upfront with term license contracts signed in fiscal 2019 under ASC 606. Conversely, the firm will be forced to convert the second year of license revenue to retained earnings for contracts signed in fiscal 2018 as part of the adoption of ASC 606, and elevated cloud sales will serve as a temporary headwind to revenue given the ratable revenue recognition of these agreements. In totality, management expects ASC 606 will have a net neutral impact on revenue, and we continue to model roughly 20% total revenue growth in fiscal 2019, which we believe is in line with the early qualitative commentary management has provided.

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