We are short shares of Paycom, a $19 billion SaaS-based payroll services company that has been one of the best performing large capitalization software stocks since it went public in 2014. Even after the market turmoil of this year, Paycom trades at more than 70x the consensus estimate for this year’s free cash flow, a testament to the fact that, while unprofitable tech companies and temporary pandemic winners have been justly punished in the markets, there’s still plenty of froth left in allegedly higher quality fare. Paycom’s valuation, in particular, doesn’t come close to reflecting the near term headwinds of slowing employment growth, meaningful TAM saturation, and increasing competitive intensity.

Paycom’s steady and robust growth over the past decade has come by way of taking market share from payroll industry behemoths ADP and Paychex. Paycom has been accompanied in this quest by high-tech peers Paylocity (PCTY) and closely held BambooHR, and has been buttressed by secular job growth trends in the US small and medium business sector. But Paycom is no longer a $100 million annual revenue upstart, and neither are its peers. At $1.4 billion of run-rate recurring revenue, the company is a scaled business, and combined with Paylocity, Bamboo, and other dynamic tech companies in the sector, the group’s share of the SME payroll market is north of 40%. That’s a lot more than the blue-sky implications of Paycom’s 5% market share claim, and it means that further market share gains will be a lot more difficult going forward.

At the same time, ADP is fighting back, increasing its customer retention rate and growing its employee rolls. Rippling and Gusto, two rapidly growing startups in the space, have also recently raised capital at $10-billion-plus valuations, and are actively fighting for market share. All this means that the competition faced by Paycom is about to get a lot tougher. If that weren’t enough, US employment growth looks to be decelerating at a fairly significant clip, which means that all the payroll players will be fighting in a smaller field. For a SaaS company with an astronomical valuation like Paycom’s, price cutting is probably not something investors are accustomed to thinking about, but they might soon have to.

The corporate culture at Paycom is cutthroat. That’s partly reflected in the aggressive accounting strategies employed by the company that we believe materially overstate the profitability of its business. It’s also apparent in Paycom’s sales culture, which features questionable sales tactics (some of which have led to regulatory settlements), rapid sales rep turnover, and bare-bones customer service. That may have served Paycom well as a small unknown taking on industry giants, but as the pieces of a slowdown come together and competition intensifies, increased customer service costs will likely hamper margins. Yet the stock’s current valuation leaves little room for error. When a bubble pops, as the tech bubble has over the past year, not all stocks crash simultaneously. Some former darlings, like ZM, DOCU, TWLO and many more, have already seen their multiples decimated as investors transition to more realistic business expectations. Other darlings, like PAYC, still remain in bubble territory. The national job losses that are likely to accelerate over the remainder of the year may very well serve as the catalyst to bring PAYC’s share price back to reality.

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