Here’s why nCino can build a powerful moat – Natural Self Esteem

Almost every company wants to develop a competitive advantage – an advantage that is difficult to replicate and makes it difficult to displace the company from its place in the market. Those that succeed tend to gain and retain strong market share in their industries, allowing them to generate strong sustainable profits.

One company that I think has the potential to develop a strong moat is the cloud-based banking software company nCino (NCNO -2.83% ). Here’s why.

put up the flag

It’s difficult to thrive in the world of banking technology. Financial institutions are known for their conservative nature, and replacing their core technology is a tough task because even as they bring new systems online, they still need to be up and running for their customers. That’s why so many banks still use outdated legacy systems and lots of manual processes. But given the long-term impact of the pandemic and broader industry trends, for most of these institutions, updating technology isn’t a “if” but a “when” — and NCino could play a big part in those changes.

Image source: Getty Images.

In the core processing area — creating the systems that banks use to facilitate day-to-day banking transactions — a handful of companies like it fisherv, jack henryand FIS have conquered most of the market.

While nCino does not compete in this money movement space, it offers a technological solution for a core banking operation. The software helps banks digitize the lending process and seamlessly connects front, middle and back office staff with customers and third parties. NCino banking operating systems automate much of the lending process, eliminating human labor in areas like data entry. This speeds up the lending process and creates the potential for more volume.

It also gives banks all kinds of analytical tools they can use to help with pricing, keep credit trends informed, identify new opportunities, and more. Built as a single cloud-based platform based on Foreclosure platform, nCino became a critical tool for banks during the pandemic as it allowed the lending process to be handled more smoothly by people working remotely. It has also been helpful for banks in administering their portion of the Paycheck Protection Program.

In the core processing niche, sales cycles can be lengthy, as installing new systems for a bank can be highly disruptive, likely to require a reasonable level of training, and can incur large upfront costs, particularly for smaller financial institutions. The same issues apply to nCino systems.

Once nCino has signed a deal, their contracts typically run for three to five years. However, the company uses a “land and expand” subscription model. So, first, a bank can use nCino to digitize their lending platform for commercial lending. Then it can start using some of nCino’s analytics tools, and later potentially bring its software to other divisions like consumer and small business lending, mortgages, or deposit account openings. The result of this is that the software enjoys long contracts that add value and increase customer loyalty.

NCino annual contract value statistics.

Image source: Getty Images.

As the chart above shows, the small number of customers who started using nCino in 2013 increased their annual contract value (ACV) by 360%. However, larger, younger cohorts range from 120% to 180%. NCino attributed these lower subscription revenue retention rates in its fiscal 2022 cohort, which ended Jan. 31, to a higher mix of new customer sales with longer-than-expected activation schedules. CFO David Rudow advised analysts to consider 130% as a good long-term target when the company announced its earnings on March 31. That’s still a very strong net sales retention rate. A customer’s annual contract can start at a few hundred thousand dollars a year and then grow to $1 million by the fourth or fifth year.

Lots of opportunities ahead

Each time nCino wins a new financial institution as a customer, its competitive advantage grows as the deals are large and growing and there are significant switching costs associated with these projects.

Additionally, nCino has generally helped its financial institution clients improve efficiency and increase revenue. It’s only just begun to tap into a viable addressable market valued at $16 billion, but by the end of March it had already done business with 12 of the top 25 banks in the US Wells Fargoone of the largest banks in the world, recently announced that it has extended its contract with nCino.

The company is not yet profitable and is forecasting an operating loss of up to $35.5 million for fiscal 2023, which ends in late January. However, revenue growth is forecast to be around 46%. The company is by no means cheap on a sales basis, trading at about 10.5 times futures sales. But given the flag nCino has planted, the effectiveness of its products, and the company’s ability to maintain and grow contract values, I think the company’s competitive moat makes nCino a long-term buy-and-hold.

This article represents the opinion of the author, who may disagree with the “official” endorsement position of a Motley Fool premium advisory service. We are colourful! Challenging an investing thesis — including one of our own — helps us all think critically about investing and make decisions that help us be smarter, happier, and wealthier.

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