The reason we think that UiPath has winning potential is that RPA is in its infancy and historically the company’s retention and upgrades are second-to-none. RPA is one of the best ways to participate in the benefits of AI/ML early-on with UiPath’s scalable automation solutions used by early adopters. As the market matures, we think the analyst jitters over a new business model will clear up over time. This is because it’s clear that once customers adopt PATH, they stay and upgrade – which consequently, a lack of upgrades is one reason why we exited DocuSign. My goal is to get you an update on DocuSign by Monday at the latest.
UiPath:
We’ve covered in the past that UiPath’s annual recurring revenue (ARR) is important to pay attention to and management emphasized again this in the latest call. Prior to the billing change, UiPath’s revenue led ARR growth, yet due to a billing cycle change, this is not the case temporarily. The billing cycle change could be misinterpreted as a sign of weakness, when in reality, it’s is motivated by UiPath wanting to attract a wider range of customers with shorter 1-year billing cycles. If the graph below is any indication, then revenue should normalize in time to where revenue again leads ARR, which is of course, an annual metric unaffected by this billing cycle change.
Here is what the CFO said in the earnings call:
“We have a structured process in place to calculate and report ARR, because it is invoice based, we believe that it is the most accurate and reliable measure of our true business activity. It most closely aligns to long-term cash flow and best aligns to renewals and given our strong dollar based gross retention rate, which was 98% in the third quarter. ARR is most reflective of customer commitment, regardless of deployment model.”
The global market size for RPA is at $2.07 billion in 2021, up from $1.23 billion in 2020. UiPath is expected to report $885 million in revenue for fiscal year ending in January. This means UiPath owns up to 42% of the RPA market and we expect this lead to continue given the remarks on the call about market share and competitors.
With the market expected to reach $7.01 billion by 2025, UiPath’s 40% penetration would equate to $2.8 billion or 3.3X growth. In 2030, UiPath could be reporting as much as $5.5 billion in revenue or 6.5X growth in revenue. This is all while nearing profitability, which is rare this soon after going public. According to other estimates, RPA services will expand the addressable market to $4.3 billion by 2022, which is higher than the estimates previously listed.
I think these estimates could be low given the cost savings that RPA offers. Below, we see enterprises saving millions of hours per year with savings in the millions of dollars from automation. Morgan Stanley seems to agree with a note that the RPA market could reach $56 billion with the firm concluding UiPath owns 30% to 32% of the market. Notably, Gartner has also pointed out that UiPath’s revenue growth is higher than overall RPA market growth.
We had covered in our original research report that owning Path and RPA is attractive for our portfolio because of the pain point the company solves. Automation is truly unique in terms of the benefits it provides to the enterprise. Here were a few states we had quoted:
“The ROI is astounding when you have an error-free employee who works 24/7 and does not tire or need bathroom breaks. To illustrate, a few automations can save 20 minutes of work per person daily and enabling 10K employees with a software robot could save more than $30 million a year (based on an average salary of $35/hour).
According to analysts like Forrester, 14.9 million jobs will be created by 2027 to work alongside robots. It’s not clear though how many jobs robots will replace and if the 15 million is actually a deficit.
According to McKinsey, $3.6 trillion of work can be automated. The piece of the pie that UiPath is after is the automation of applications for enterprises. The number of applications deployed by enterprises has increased by “approximately 70% over the past four years,” according to Wall Street Journal.
According to McAfee, the average enterprise has deployed 464 custom applications and deploys an additional 37 new applications in a 12-month time span. Companies with fewer than 1,000 employees run 22 custom applications while companies with over 500,000 run 788 custom applications, on average. The majority of these applications (58%) are used internally while 36.2% are used by customers, partners and suppliers. These larger enterprises – with the 788 applications on average — are the companies that UiPath is targeting.”
There are a few stats the company gave in the most recent earnings report, as well:
· Hana Bank has applied automation to 80 processes, an estimated saving of around 1.5 million hours per year.
· Saudi Ministry of Tourism reduced the time needed to collect process and analyze data by 95%, from 30 minutes per record to 40 seconds
· Toll Group freed up 170,000 hours and they are on track for savings of $1.6 million annually.
On the competitive front, the earnings call was quite direct about UiPath outpacing competitors. The primary competitors are Blue Prism, Automation Anywhere and Microsoft.
Microsoft is not building a best-of-breed product and there’s no indication they plan to take UiPath head-on right now.
“Our own data, if we take into account the deals where Microsoft is participating versus the deals where Microsoft is not participating, we are not seeing material changes in our winning rate. So right now currently, I can say Microsoft has — doesn't have a meaningful impact on our ability to win customers. What is going to happen in the next couple of years, first of all, I would like to make a case that Microsoft is focused with their RPA mostly on citizen developer and personal productivity. This is a small part of our overall TAM. So I don't see that in the coming years, Microsoft investment and competing with us will materially derail us from our growth trajectory that we are seeing and we are building right now.”I would like to make a case that Microsoft is focused with their RPA mostly on citizen developer and personal productivity. This is a small part of our overall TAM. So I don't see that in the coming years, Microsoft investment and competing with us will materially derail us from our growth trajectory that we are seeing and we are building right now.”
Regarding Automation Anywhere and Blue Prism, an analyst said the following:
“So Daniel, at your User Conference in Las Vegas, one of your partners was saying that this market in the past was a three-horse race and the two of the horses got broken legs. And there were so many stories of Blue Prism and automation anywhere customers migrating to UiPath, I'm just wondering if you can shed some light on whether you have a little extra tailwind from that type of activity?”one of your partners was saying that this market in the past was a three-horse race and the two of the horses got broken legs. And there were so many stories of Blue Prism and automation anywhere customers migrating to UiPath, I'm just wondering if you can shed some light on whether you have a little extra tailwind from that type of activity?”
The management responded by saying geographies like the Nordics, Canada and the United States are regions where competitors are “withdrawing their presence significantly.” However, management points towards the market being too new for this to be a tailwind (usually this becomes more important in a mature market). Instead, the growth is coming from keeping their current customers happy with the platform and also from new customers for growth.
A Note on Cloud …
There was some discussion on the forum over UiPath’s ability to perform well in cloud-native environments.
We had pointed towards the acquisition of Cloud Elements to expand UiPath from UI-based process automation to also include API-based could be an important competitive advantage for UiPath as it now operates with the same integrations as its competitors yet is more end-to-end. The analyst above is also implying that UiPath is taking market share from Automation Anywhere, the cloud-native automation platform. Here is what management said:
“Automation suite enables our customers to leverage the power of the full UiPath platform with the benefit of a cloud native architecture. However they choose, on-prem, public cloud or third-party hosted with the single install on Linux. 21.10 also included the introduction of Linux based software robots, a capability that is required to be a truly cloud native company. This allows our customers to achieve scalability and auto scalability in a cost-effective manner.”
The integrations with Crowdstrike, Snowflake, Qlik, AWS, etcetera, also point towards cloud-enabled solutions. Gartner seems to agree that UiPath has no issues competing in the cloud with the following analysis on the company’s weakness:
“Web-based development: Despite its strong focus on cloud-based RPA, and its existing web based UX App builder, UiPath still lacks a web-based RPA development environment — a shortcoming that will limit adoption by enterprises that prefer a minimal hardware footprint. However, UiPath does offer cloud orchestration capabilities and plans to build a web-based developer environment soon.”: Despite its strong focus on cloud-based RPA, and its existing web based UX App builder, UiPath still lacks a web-based RPA development environment — a shortcoming that will limit adoption by enterprises that prefer a minimal hardware footprint. However, UiPath does offer cloud orchestration capabilities and plans to build a web-based developer environment soon.”
As far as a decreasing TAM due to on-premises, I don’t see any evidence of this. UiPath’s end-to-end solution across all environments is a strength. The company is seen as a leader in RPA across many reports: Gartner, Forrester, Everest Group, MarketScape, etcetera. You’d be hard pressed to find any product analysis on RPA that doesn’t thoroughly assess UiPath’s product as the leading product across both cloud and on-premise. This is important because RPA may become a winner-takes-all due to scaling complexity.
Below is a chart that shows the percentage of interest in RPA as of 2017 compared to the number of companies that had deployed it:
The most recent survey from Deloitte stated that 73% of organizations have looked into automation, up from 58% in 2019. The issue is that very few have reached automation at scale with the far majority in the piloting stage. We think this will resolve over time and this is the primary reason we are invested in UiPath – real demand with high anticipated penetration being consistently reported across analyst firms, yet many companies are stalling out due to the complexity of the solutions, and UiPath leads the category. We also think that as organizations chose UiPath over other vendors, that the high switching costs will be nearly insurmountable.
Financials:
I agree with the forum comment that the earnings report was unremarkable. The company did beat on both top line and bottom line and increased the forward, yet the market is still trying to factor in the slowdown in growth from previous years which was roughly 127% in fiscal 2019 and 80% in fiscal 2020. Will the slowdown stabilize or continue to meaningfully erode? That’s why the company hasn’t quite won the confidence of Wall Street yet.
Regarding my comment on the fact that high switching costs are nearly insurmountable, I can’t give you a clear reason as to why UiPath did not discuss their net retention rate in the most recent earnings reports. In the past, it’s been an industry-leading number of 145%+ and my hope is that it continues to be above minimum the 130% range for the next few years.
As stated, the company emphasizes ARR, yet this is declining although still above 50% on the forward guide. The YoY growth in ARR was at 64% in fiscal Q1, 60% in Q2, 58% in Q3 and is expected to decelerate again to 55% in Q4. Despite the beat, the company’s deceleration is being penalized as are nearly all decelerations in cloud from the Q3 reports.
If we read between the lines, we see that Covid had a negative upfront effect on UiPath although Deloitte believes in the long-term, digital transformation will be a tailwind for UiPath. Cost could be one factor as to why we are seeing slowing growth and the other could be that organizations had to prioritize cloud migrations. Regardless, the $3 billion market size is communicating that RPA is early and the slowing growth is not because demand is slowing; rather it may have been paused or de-prioritized. It’s true that investing in Path is a bet that it’ll resume stronger growth in the future.
The key metric that is most exciting from the recent report is that customers with $1 million plus ARR was up 82% year-over-year. The customer category above $100K was up 52% year-over-year. UiPath also plans to be profitable next quarter but this could be lumpy depending on how many investments the company makes. Nonetheless, gross margins remained robust as consolidated gross margin was 85% and software gross margin was 93%.
Remaining performance obligations (RPO) increased 80% to $579.5 million, while RPO to be completed in the next twelve months (NTM RPO) increased 11% QoQ to $359 million. Looking forward, NTM RPO represents 33.0% of the NTM revenue estimate, an improvement of 70 bps QoQ. The improvement in NTM RPO relative to forward sales expectations provides a ‘floor’ for future sales, improving the quality of forward estimates.
However, it should be noted that cash support for future sales has declined. For instance, current deferred revenue relative to NTM RPO declined QoQ from 73% to 70%, which lowers the quality of recently reported RPO. However, the billing cycle discussed above may be temporarily skewing this metric, as management is prioritizing one-year deals over multi-year deals. We will be watching this metric going forward and anticipate an improvement as the trend annualizes. Furthermore, current deferred revenue has increased relative to subscription sales for the past two quarters, highlighting that one-year deals appear to be healthy and suggesting the lower cash support is due to the drawdown in multi-year deals.
Moving down to cashflows, quarterly cashflows from operations declined from $7 million down to an outflow of -$25 million. The steep drawdown in cashflows is likely a result of the company’s billing cycle change mentioned above, as the upfront cash payments from multi-year deals is being replaced with relatively smaller amounts of upfront cash payments from one-year deals. We should expect cashflows to improve going forward as this trend fully annualizes. Management has discussed that it does not have to sacrifice as much margin (and cashflows) with one-years relative to multi-year deals, so in the long run this change should improve cashflow generation, all else equal.
Conclusion:
I’ve heard UiPath called a story stock and I agree. The story here is quite compelling in terms of the percentage of organizations that are pursuing automation (70%+) compared to the number that have scaled RPA solutions (low single digits). I believe there is enough evidence that UiPath is the leader and will continue to lead. I tend to not counter invest in product leadership. The ongoing integrations and partner network also certainly doesn’t hurt which we covered in our original analysis here.
Bradley Cipriano contributed to this analysis.