Guidewire looks like a great company, run for the benefit of insiders, but a ticking time bomb for investors.
Top line has grown sequentially for over a decade, and gross margins have expanded to mid-60s.
That's the good news.
Now for the bits I really don't like.
Despite strong gross margins, Operating Margins have been negative for most of the last decade, and net earnings margins is mid single digits. That doesn't justify being capitalized at 8x revenue. Not even close, particulalry against the 10 yr treasury now yielding over 5%. It makes no sense.
This is a business that is burning capital. Just look at the retained earnings on the balance sheet.
How can a profitable company be burning capital?
Declared stock based comp is running well above net earnings. That number isn't real. It's just a GAAP approximation. The real cost of stock based comp appears in the cash flows from financing. Last financial year it spent over $600m on repurchases. It wasn't to benefit shareholders. The share count, which has moved sequentially higher year on year over the last decade, slowly diluting shareholders, barely moved on that $600m spend. These were buy backs to offset dilution from SBC. That's where all the capital is going. That's the real cost of SBC.
So insiders are syphoning off all the profits for themselves.
Meanwhile, shareholders see a decade of dilution and zero dividend.
You want to pay 89x earnings for that?
By the way, you can't calculate FCF for a company like this as 'Cash Flow from Ops - CAPEX'. Is the spending on buybacks not real? Are capitalized lease expenses not real? Of course they are. They need to be deducted in addition to CAPEX. That reveals what is truly left as free cash flow attributable to shareholders. Last financial year it was very, very negative.
Even after the drawdown, this stock is hugely over priced and poorly managed (from an external shareholder perspective).
Avoid at all costs, is my instinct. This one could have much further to fall.
SBC was $182M so definitely higher than $139M net income. Buying back the 1.55M shares issued to employees cost about $230M (64% of free cash flow).
Over the longer run you also have a point: the share count is about where it was in 2019, despite $1B of buybacks
So the 33x FCF I quoted was indeed way too generous.
The leases I think are operating leases, so their cost is already in operating cash flow. And FCF after SBC was still positive, at about $130M
The case for GWRE is mostly on the outlook. Most past losses came from the move to the cloud, and operating margin went from -24% in FY22 to 10% in FY26, with about 12% guided for FY27. Revenue also looks durable: ARR grew 19%, attrition is under 1.5%. Let’s see if owner cash flow gets to about $220M this year as guidance implies and where SBC and share count are going…
GWRE was a small starter position for me, but I think you’ve given some good arguments to take a critical look at this position. Appreciate it!
It is a number that the company has to estimate under GAAP rules.
It is usually the mark-to-market value of the stock at the time SBC was granted, which will not be the same as the value they have when they vest, which is the real cost to the company when they repurchase in the market to offset dilution.
So ignore the SBC number in the cash flow from operations. Its noise. It's unreliable.
If you want to know the true cost of stock based comp, you need to look at how much is being spent by the company on repurchases that do not reduce the share count. That number is unhelpfully buried in the cash flow from financing section and ignored by most investors when they calculate FCF.
Think of it this way
Between 2021 and 2026 (5 years), GWRE spent $1.067 billion on repurchases
Over the same period, the diluted share count INCREASED from 83.5 million to 85.4 million.
So over $1 billion of shareholder capital was, from a shareholders perspective, wasted.
There was no financial benefit for the shareholder, who was actually diluted 2.5% over the period.
Worse, over the same 5 year period, Free Cash Flow, calculated at Op Cash Flow - CAPEX looked like it was $940 million.
But that wasn't free cash flow to shareholders, because we now know that the company wasted over $1bn enriching insiders.
So the real Free Cash Flow over that 5 year period was NEGATIVE $127million
That is what shareholders are buying.... negative shareholder returns. And they are paying a silly premium for the privilege of having their wealth transferred to insiders.
The sooner investors wake up to this, the sooner companies will be held to account by shareholders and this abhorrent practice will be forced to stop.
Thanks James, I clearly have some studying to do to better understand this topic. Appreciate you walking me through it and sharing a case study, will definitely check it out
Guidewire looks like a great company, run for the benefit of insiders, but a ticking time bomb for investors.
Top line has grown sequentially for over a decade, and gross margins have expanded to mid-60s.
That's the good news.
Now for the bits I really don't like.
Despite strong gross margins, Operating Margins have been negative for most of the last decade, and net earnings margins is mid single digits. That doesn't justify being capitalized at 8x revenue. Not even close, particulalry against the 10 yr treasury now yielding over 5%. It makes no sense.
This is a business that is burning capital. Just look at the retained earnings on the balance sheet.
How can a profitable company be burning capital?
Declared stock based comp is running well above net earnings. That number isn't real. It's just a GAAP approximation. The real cost of stock based comp appears in the cash flows from financing. Last financial year it spent over $600m on repurchases. It wasn't to benefit shareholders. The share count, which has moved sequentially higher year on year over the last decade, slowly diluting shareholders, barely moved on that $600m spend. These were buy backs to offset dilution from SBC. That's where all the capital is going. That's the real cost of SBC.
So insiders are syphoning off all the profits for themselves.
Meanwhile, shareholders see a decade of dilution and zero dividend.
You want to pay 89x earnings for that?
By the way, you can't calculate FCF for a company like this as 'Cash Flow from Ops - CAPEX'. Is the spending on buybacks not real? Are capitalized lease expenses not real? Of course they are. They need to be deducted in addition to CAPEX. That reveals what is truly left as free cash flow attributable to shareholders. Last financial year it was very, very negative.
Even after the drawdown, this stock is hugely over priced and poorly managed (from an external shareholder perspective).
Avoid at all costs, is my instinct. This one could have much further to fall.
Thanks James
Agree on the SBC.
SBC was $182M so definitely higher than $139M net income. Buying back the 1.55M shares issued to employees cost about $230M (64% of free cash flow).
Over the longer run you also have a point: the share count is about where it was in 2019, despite $1B of buybacks
So the 33x FCF I quoted was indeed way too generous.
The leases I think are operating leases, so their cost is already in operating cash flow. And FCF after SBC was still positive, at about $130M
The case for GWRE is mostly on the outlook. Most past losses came from the move to the cloud, and operating margin went from -24% in FY22 to 10% in FY26, with about 12% guided for FY27. Revenue also looks durable: ARR grew 19%, attrition is under 1.5%. Let’s see if owner cash flow gets to about $220M this year as guidance implies and where SBC and share count are going…
GWRE was a small starter position for me, but I think you’ve given some good arguments to take a critical look at this position. Appreciate it!
The $182m SBC you quote is fantasy.
It is a number that the company has to estimate under GAAP rules.
It is usually the mark-to-market value of the stock at the time SBC was granted, which will not be the same as the value they have when they vest, which is the real cost to the company when they repurchase in the market to offset dilution.
So ignore the SBC number in the cash flow from operations. Its noise. It's unreliable.
If you want to know the true cost of stock based comp, you need to look at how much is being spent by the company on repurchases that do not reduce the share count. That number is unhelpfully buried in the cash flow from financing section and ignored by most investors when they calculate FCF.
Think of it this way
Between 2021 and 2026 (5 years), GWRE spent $1.067 billion on repurchases
Over the same period, the diluted share count INCREASED from 83.5 million to 85.4 million.
So over $1 billion of shareholder capital was, from a shareholders perspective, wasted.
There was no financial benefit for the shareholder, who was actually diluted 2.5% over the period.
Worse, over the same 5 year period, Free Cash Flow, calculated at Op Cash Flow - CAPEX looked like it was $940 million.
But that wasn't free cash flow to shareholders, because we now know that the company wasted over $1bn enriching insiders.
So the real Free Cash Flow over that 5 year period was NEGATIVE $127million
That is what shareholders are buying.... negative shareholder returns. And they are paying a silly premium for the privilege of having their wealth transferred to insiders.
The sooner investors wake up to this, the sooner companies will be held to account by shareholders and this abhorrent practice will be forced to stop.
If you want a real world example using META as a case study, watch this: https://rockandturner.substack.com/p/the-dangerous-game-investors-are
Thanks James, I clearly have some studying to do to better understand this topic. Appreciate you walking me through it and sharing a case study, will definitely check it out