Vista Equity Partners buys a Fintech stock – what investors need to know

Startup fintech investors, particularly hard-hit by the bear market, are getting some reprieve — but perhaps not in the way they hoped. In the latest indication that stocks are trading for fantastic long-term value, private equity firms are trading in and bailing out shareholders.

Software technology investor Vista Equity Partners is the latest to announce an acquisition: Duck Creek Technology (DCT), a provider of software for the property and casualty insurance industry. Lessons abound in this deal for investors trying to get ready for the next (eventual) bull market.

A fintech company on the verge of positive cash generation

Duck Creek offers a suite of cloud software tools (data and apps located in a remote data center, accessible via the internet) for insurance companies. The solutions include managing customer relationships, record keeping and updating insurance policies. What does Vista Equity Partners want with Duck Creek?

Monti Saroya, Senior Managing Director and Co-Head of Vista’s Flagship Fund, said in a prepared statement that “Duck Creek’s modern cloud architecture and demonstrated market traction position it to define the next generation of mission-critical technology for non-life insurance.” After a tumultuous couple of years since its 2020 IPO, Duck Creek investors are being paid $19 per share, valuing the company at $2.6 billion.

Data from YCharts.

Besides buying Duck Creek for significantly less than what it was valued at a couple of years ago, Vista is buying a company that could be on its way to making a healthy profit. In fact, investing in up-and-coming software companies that have expanded beyond startups and are about to flip the switch from red to black on the bottom line is Vista’s modus operandi. While the share price may not reflect any kind of positive progress, that is where Duck Creek is right now.

In its most recent quarter (the three months ending November 2022), Duck Creek reported a 10% year-over-year increase in revenue to $80.6 million. Net loss was $5.2 million (or positive $2.6 million on an adjusted basis), and free cash flow was negative $8.2 million (vs. negative $25.5 million a year ago). Duck Creek is small, but even on this small scale it has taken incremental steps toward sustainable profitability. Plugged into Vista’s portfolio of other software company investments, Duck Creek might accelerate sales. Vista will also no doubt encourage some cost cutting as well.

Fintech stocks to focus on right now

Fintech stocks solidified over the past year, and that has encouraged private equity investors like Vista to go shopping. Duck Creek wasn’t actually the first fintech company Vista tried to buy in recent months. It was engaged with Coupa software (DEAL 0.15%) before a deal was struck for the fintech to be taken over by fellow private equity software firm Thoma Bravo instead. At least one significant investor in Coupa was unhappy that Vista was trying to make a takeover, forcing Coupa shareholders to “sell low”. Vista also completed the acquisition of tax compliance software company Avalara in October 2022.

Indeed, fintech has been a focus of recent acquisition targets at Vista Equity, as well as colleague Thoma Bravo. Clearly, deep-pocketed “smart money” sees long-term value and is excited to start spending their money. Selling low right now is not a good idea. Rather, investors should do the opposite and start exiting cash if they are looking at a long-term holding.

But a remarkable theme emerges here. Private equity makes purchases of fintech companies that can easily turn around profitability. Taking these companies private and exerting force to effect change is not something we retail investors can do. However, investing in companies that can make rapid progress toward profitable scale should be a must right now — especially given that the Federal Reserve has indicated that it may keep interest rates higher for longer into 2023 and beyond to try to curb economic activity and lower inflation.

As a reminder, higher interest rates lower the present value of stocks, especially those that aren’t generating net income or free cash flow yet.

That doesn’t mean there isn’t value in fintech companies that are still far from profitability. When a bull market returns, these stocks can start marching higher again. However, shares of money-losing businesses like these may continue to struggle in this market environment. Follow Vista Equity’s (and Thoma Bravo’s) lead and focus your investments on the best growing fintech companies profitable – or which will soon begin to grow profitably. That’s likely to be the best strategy in 2023, with the economy rocking right now and organizations facing increasing pressure to increase their margins above all else.