Guidewire’s winning formula for software

What happened

Our Fintech portfolio has significant exposure to software companies, with approximately 50% invested in "financial software" as of 11 October 2024. This segment is split into “vertical software”, targeting specific industries like banking or insurance, and “horizontal software”, addressing the needs of multiple sectors such as accounting. This high exposure reflects our strong conviction in the software industry across all our strategies. For instance, in our Artificial Intelligence & Robotics portfolio, we frequently assert that there is no artificial intelligence (AI) without applications.

Financial software firms are pure technology enablers that aim to accelerate the digitization and automation of the financial industry. At the same time, they must quickly offer their customers the latest technology to remain competitive.

Last week, Guidewire Software Inc, a leader in software solutions for property and casualty (P&C) insurers, hosted its Analyst Day, providing insight into its future growth expectations. In particular, the firm confirmed that its “long-term financial target” of reaching $1.5bn of annual recurring revenue was actually for the fiscal year 2028. If we consider all revenue (target of $1.7bn by 2028), Guidewire is on track to deliver a steady compounded revenue growth of 15% per year. In parallel to that, the bottom line will benefit from margin improvements.

The recipe behind this financial success comes from a strategic business plan built on three pillars: (1) barriers to entry in a large market, (2) providing solutions that clients need today, and (3) innovating for future needs. Let’s explore each of these drivers to see why we continue to hold a strong conviction in Guidewire and, by extension, what we seek in other financial software firms.

Before we move on, it is worth noting that we have been invested in Guidewire since the launch of the Fintech portfolio in 2017. The stock is currently our largest holding.

Impact on our Investment Case

High barriers to entry and a large addressable market

Not all software is created equal, and barriers to entry can vary drastically. For example, while building a payment gateway can be achieved for as little as $150-250k, developing core banking or insurance software is far more challenging. Deep industry knowledge and understanding of complex processes are essential to create reliable, scalable solutions.

Guidewire’s core proposition is its ability to allow insurers to focus on their core business. Large insurance companies face mounting pressures, ranging from evolving customer expectations to increasingly complex regulatory environments. Guidewire steps in by offering a comprehensive suite of software solutions that handle the full policy lifecycle with key functions such as policy administration and underwriting, claims management, risk analysis, and billing​.

Higher barriers to entry ensure limited competition. Fewer than 10 software companies can provide the software quality and performance needed by the larger insurance companies in the world. The processes in the insurance market are so specific that these software companies focus usually only on the insurance market – going after other industries would require too many changes in the backend and software architecture.

Guidewire focuses on a niche market made of the top 300 P&C insurance companies, that manage approximately $2.5tn of direct premiums written (or >2% of the global GDP). Guidewire currently provides solutions to only a quarter of them. These are sticky customers with a high retention rate, given the challenges of changing the core system. In terms of serviceable addressable market, Guidewire estimates to have <10% market share of a total core insurance system software estimated currently at around $15bn with an annual growth rate of ~10%. Guidewire is gaining market share.

The Cloud transition and its monetization

The financial industry is seeing a gradual but undeniable shift away from maintaining legacy systems, with many companies – including tier-1 insurers, accelerating their move to the cloud​. This transition has been slow to materialize, due to the sensitivity of the data and the resistance to change in the organizations. But now, even core systems are being migrated to the cloud as insurers recognize the long-term benefits in terms of scalability, security, and flexibility​. Guidewire is at the forefront of this transition, offering cloud-native solutions that enable insurers to modernize their operations while reducing the complexity of maintaining multiple systems​.

Previously, customers purchased perpetual licenses, which allowed indefinite product use but with limited updates. Now, the cloud model has transitioned the industry to a subscription-based model, where customers pay recurring fees to access the latest versions of the software. This shift is highly attractive to investors, including us, as it provides better visibility into future revenue and cash flow.

Guidewire’s cloud transition is evident in its financial performance. For the fiscal year that ended in July 2022, recurring revenue accounted for $664mn, or 82% of the total revenue. As more insurers transit to the cloud, Guidewire expects to reach recurring revenue of $1bn in July 2025 (or 88% of the total revenue).

AI as a driver of future growth

Guidewire’s success in the P&C insurance sector stems from its consistent investment in product innovation. With the rise of artificial intelligence (AI), the company is already positioned to deliver the next generation of product enhancements.

Generative AI will allow Guidewire to streamline and automate critical processes, such as claims management and policy administration. AI-driven bots will handle routine claims and generate personalized policy pricing based on the information provided by policyholders. Additionally, machine learning models are being used to improve risk assessment, claim severity predictions, and fraud detection.

How much should AI be charged? The monetization of AI tools remains a big question mark. For the moment, the first modules are offered free of charge. It allows companies to establish a competitive advantage and create a network effect before determining the most effective pricing structure​. Moreover, the company can collect feedback from its users, which will help refine these tools and build deeper user engagement.

Over time, as customers become more reliant on AI-enhanced functionalities, Guidewire will likely monetize these offerings either through its current subscription model or through new usage-based pricing models. The development of “pay-as-you-go” models has accelerated lately in the industry. From a user perspective, it makes sense to have a fee schedule based only on the system's actual usage.

Our Takeaway

As of 11 October, our “vertical software” exposure, focusing on solutions for banks, lenders, and insurers, has contributed to approx. 11% pt. to the total performance of the Fintech portfolio (+22.6% year-to-date), with Guidewire accounting for around half of that figure.

Guidewire’s strong performance in our fintech portfolio underscores its value as a long-term growth asset. Its strategic focus on niche market specialization, cloud migration, and AI integration positions the company well for continued success.

Given the company’s robust performance and forward-looking strategy, we maintain our strong position in Guidewire. Beyond the insurance industry, other industries in the financial software ecosystem—such as banking, investment management, and accounting, can similarly capitalize on software-driven transformations. These industries all need tailored software solutions to focus on their core business and fulfill the promise of doing more with less.