Jan 2020 - Seeking Alpha Artice by VG Capital
Red Violet: An underfollowed growth story with significant upside
Core Thesis Points
Asset-light data fusion business set to double sales in 2020 with likely very healthy growth for years beyond that
Attractive fixed-cost business model resulting in rapidly expanding gross margins from about 60% today to almost 80-90% over the next 12 months
Sustained positive operating cash flow generation is also only a quarter or so away.
Highly experienced and well-incentivized management team that owns about 20% of the company and that have only been buyers in the open market.
Management played key roles in the development of the industry. They’ve played this game before and understand the competitive landscape deeply.
RDVT shares are at a significant discount to intrinsic value, trading at only 3-4x Next-12-Month revenue; other companies with similar qualities have fairly easily gone for 7-9x NTM sales or more.
The discounted valuation is being driven by the fact that (1) RDVT is a micro-cap spinoff with no institutional sell-side coverage and (2) until now, management has engaged in minimal investor marketing activity and given barely any guidance (this is starting to change now that a solid foundation for the business has been built).
Previous deals this management team has been involved with and simple multiple compression suggest that shares should be worth a multiple of where they trade today.
RDVT Business Overview
Red Violet (“RDVT”) is a rapidly growing data-fusion software business. Their main asset is what they call their “CORE” technology platform . CORE is a mind-numbingly massive database that consists of trillions of individual data points sourced from many different disparate data sources (i.e. property records, criminal records, court records, employment records, motor vehicle records, social media and on and on). Using these otherwise siloed data sets, the CORE platform fuses the data together into a single contiguous database that can be queried at lightning fast speeds and that can offer a nearly complete view on almost any individual in the country. RDVT currently does $30 million in annual revenue (2019E) selling two software products that sit on top of the CORE platform – idiCORE and FOREWARN .
idiCORE is RDVT’s flagship product which I estimate will have about 5200 enterprise customers (+56% y/y) and will do about $26 million in revenue by the end of 2019 (+70% y/y). idiCORE customers include many companies in the Fortune 500/1000 across a variety of industries, governmental agencies, and law enforcement organizations.
Customers can use the product to gain comprehensive background info on any individual/business – some use cases include ensuring KYC-compliance, hiring-related background checks, credit checks, and even locating individuals for debt collection (“skip tracing”). idiCORE can also be used as an API and serve as the underlying engine for a piece of software that the customer has developed themselves. Pricing for idiCore is tiered and broadly on an as-used basis. The average revenue generated from a paying customer has been increasing over time to about $5,800 per customer per year at the end of 2019, vs $4,400 at the end of 2018.
FOREWARN, is an app used by real estate agents which allows them to run real-time background checks on unknown prospects before meeting them. This is a real concern amongst realtors; a 2017 report cites that 25% of male agents, and 44% of female agents, have reported experiencing a situation where they feared for their security. FOREWARN’s uptake has been swift since its launch about 2 years ago – as of 3Q19, nearly 24,000 agents across the country use the app (over 4000 adds each quarter this year), each paying $20/month for the app. I anticipate FOREWARN will do about $5m in sales in 2019.
The beauty of this business model is in its cost structure. The primary cost of creating the product is the source data, which is bought by RDVT under multi-year contracts with a fixed pricing schedule. This means that once you’ve got your core product built and have a trained sales force in place, every incremental sale made is 100% profit because you’ve already paid for the data but you can sell it an unlimited amount of times. Management has publicly stated that as the business starts scaling up, gross margins should reach about 80-90% vs 62% as of 3Q19. At a $50m revenue run-rate (which I model will be achieved within the next 3-4 quarters), management believes they will start approaching this 80-90% range.
Data Fusion Industry Background & RDVT’s Origins .
Core to understanding the RDVT storyand getting comfortable with this management team is having a baseline understanding of the brief history of the data fusion business. While data fusion is a relatively nascent industry that has largely avoided tech headlines, its impacts have been far-reaching, especially in the fields of law enforcement and risk management. Perhaps one of the higher-profile applications of data fusion was its purported use in the locating of Osama Bin Laden by Palantir, a well-publicized private company in this space. While Palantir has had much of the limelight, the industry can actually trace its roots back to the colorful Hank Asher. Asher founded the first data fusion company, DBT Online, in 1992 but was eventually ousted and bought out for $150 million in 1999.
Immediately following his DBT Online ouster, Asher, alongside RDVT’s current CEO Derek Dubner and current CIO Jeff Dell, began building Seisint, a competing data fusion business. Within just 5 years, the team built Seisint up into a business doing $115m in sales and $45m in EBITDA and sold it to LexisNexis for $775m in 2004. This transaction price implies an externally validated 7x sales and 17x EBITDA valuation multiple.
After a 4-year hiatus, Asher started building yet another data fusion company called TLO (“The Last One”), this time alongside not just RDVT’s current CEO Derek Dubner, but also RDVT’s current President James Reilly and current CFO Dan MacLachlan. Unfortunately, Asher suddenly passed away in 2013 and left behind some confusion with regard to TLO’s future and finances as a significant part of TLO’s funding came from loans from Asher’s estate. To sort out the mess left behind, TLO entered bankruptcy court (despite TLO being on the verge of immense profitability, Asher’s estate lawyers were forced to sell the business in bankruptcy court given their fiduciary duty and the optics of funding a business losing $1-2m/month) and Asher’s daughters were named co-CEO’s through the process. TLO was put up for sale during the bankruptcy process which sparked an all-out bidding war between several very large competitors, including LexisNexis and TransUnion (TRU). After 20 straight hours of bidding, TRU won the aution with a bid of $154m (LexisNexis was about to up their bid to $180m but got timed out by the attorney overseeing the process). I view these bids as a relative valuation floor for RDVT, which currently has an EV of $240m.
RDVT’s current management team wasted no time following the sale of TLO. With the goal of building an even better version of the product they’d built together twice before, the team regrouped in 2014, and began a company called TBO (“The Best One”; an apparent homage to Asher/TLO) and started developing what is today the CORE platform. TBO renamed itself Cogint (ticker: COGT) and publicly listed itself. In 2018, COGT merged with Fluent and began trading under the ticker ‘FLNT’ during this time. Less than a year after the COGT/Fluent merger, the combined company decided to spin out RDVT (rebranded version of legacy TBO/COGT) into its own entity and the entire ex-TBO/COGT team left FLNT to go with the spinoff. With most of the initially heavy R&D capital investments covered during this time via Fluent’s free cash flow, RDVT was ready to hit the ground running after the spinoff.
Competitive Landscape / How Big Is RDVT’s Opportunity?
While it is admittedly tough to pinpoint the exact size of RDVT’s current and future potential market opportunities, “very large” with “strong secular growth” would be apt descriptors. RDVT cites in their corporate presentation a $10 billion plus “Serviceable Risk Analytics” TAM and an incremental $88 billion “Addressable US Big Data/Business Analytics” TAM, but I don’t put much stock into these estimates as they are just too large and too squishy to be able to draw a concrete readthrough to RDVT. Instead, I choose to look at how competitive products sold by public companies have grown and developed over time. These products together do billions in revenue each year and at the end of the day, RDVT only needs to achieve a small fraction of what these competitors do in order to be a successful investment.
There are several products out there that are roughly competitive to RDVT’s idiCORE (some cater more to the private investigator community while others are broader and cater to risk management for enterprises as well – the direction that RDVT is headed). Notable products include TLO (owned by Transunion), Clear (owned by Thomson Reuters), and Accurint (owned by LexisNexis/RELX Group). Below are some public data points from each that give me a rough sense for the opportunity RDVT has ahead of it.
• TLO/Transunion TLO is now a core product and growth driver of TRU’s USIS segment which did ~$1.5Bn in sales in 2018 and grew at a 14% CAGR organically 2016-2018.
• Clear/Thomson Reuters Clear is one of a handful of products TRI sells in its Legal Professionals & Corporate segments, which together do ~$3.5Bn in sales.
• Accurint/LexisNexis/RELX Group (REL): LexisNexis today is a fairly broad suite of data analytics products that does ~$5Bn in sales and grows organically in the MSD area (comprised of their Risk & Business Analytics segment that does ~$3Bn in sales and grows 8% organically, and their Legal segment that does ~$2Bn in sales and grows 2% organically).
My key takeaways from these incremental pieces of information from competitors are as follows:
There is a very real and very large market here. RDVT’s addressable market is not one that management hopes will appear over time – there is clearly a lot of demand out there today
This market’s growth is secular, not cyclical , and should show durability for years to come – even in a recession scenario
Given the sheer size of these competing products, I would not be surprised at all if RDVT over the long run is able to generate multiple hundreds of millions, if not billions of dollars in annual revenue
While RDVT only sells two products today , there is ample demand to expand into adjacent data fusion applications over time.
A question you might have now is: “if the market is so large and the economics are so attractive in this market, why don’t more tech companies copy them?” My discussions with management on this point suggest the core barriers to entry here are (1) there are only a handful of people on the planet that know how to build a robust and market-leading data fusion business and one of them – Ole Paulsen – is leading RDVT’s technical product development, and (2) nothing that RDVT has built thus far is off the shelf – they have literally built their own programming language for the product themselves. This creates an immense moat around their business . The only way a large competitor could reasonably enter this business without drawing a a ton of attention would be to buy RDVT outright.
Management believes revenues could grow more than 100% in 2020 ($60 million).
• idiCORE will likely end 2019 with ~4.6K customers on average through the year, up +1.3K y/y vs 2018. Given that much of the proceeds from RDVT’s recent $7.5m capital raise will go towards sales reps and engineers, I assume this can accelerate to +2K customer adds in 2020, +1.5K adds in 2021, and +1K adds in 2022. Average revenue per idiCORE customer in 2019 will be about $5.8K, up about 30% y/y vs $4.4K in in 2018. I assume this metric can continue to grow at a ~25%/year clip, bringing avg revenue per customer per year to ~$7.3k in 2020, ~$9.2K in 2021, and ~$11.5K in 2022.
• Average # of FOREWARN users for 2019 should come in around 22,000 – a 15,000 increase from 7,000 users in 2018. I assume this trend holds in the near term and FOREWARN users increase by 15,000 in 2020 and 10,000 in each 2021 and 2022.
• FOREWARN pricing is roughly $20/month/user for unlimited use and I assume this rate is constant over the entire projection period
Putting these assumptions together gets me to revenue estimates of $57m in 2020, $86m in 2021, and $118m in 2022. One way we can cross-check whether these estimates are reasonable is by looking at the productivity of RDVT’s sales reps. RDVT now discloses enough information to calculate this – as of 3Q19, each sales rep was able to generate about $700,000 in annualized sales while costing RDVT about $150,000 per year. Note that the annualized sales generated per rep should continue to grow over time as RDVT’s products get further embedded into customers’ workflows and usage rates per customer naturally increase without incremental sales efforts. Let’s assume RDVT uses half of its recent $7.5 million capital raise to hire new reps at $150,000/rep and let’s assume that sales rep productivity increases to $1.0 million/rep within the next 6-9 months (it increased from $450k/year to $700k/year in the first 9 months of 2019). This would get us to a sales force of almost 75 reps, each pulling in $1m in annualized sales by around mid-2020 (takes 3-6 months for a rep to get to full productivity). This suggests that RDVT doing $75m in annualized sales within the next year or so is absolutely within reach and that my estimates for $57m sales in 2020 and $86m sales in 2021 are certainly not unreasonable.
Now that we’re directionally comfortable with our estimates for RDVT over the next few years, let’s get to the fun part: figuring out how much this stock is worth. For one, if you blindfolded me and told me you had a company that (1) had an asset-light, recurring-revenue software business with a large TAM, (2) had a well-experienced and well-incentivized management team, (3) had revenues that were set to double next year w/ strong DD growth for years beyond that, (4) had 60% gross margins that were set to expand to a steady-state 80-90% within the next year, and (5) was on the brink of sustained operating profitability and then asked me what a fair price for it was, I’d say easily 7-9x NTM sales… If you then told me that that same company was trading for only 3-4x NTM sales (which RDVT currently is) I’d be trying to hock everything in my house that wasn’t nailed down so I could buy more shares.
This management previously sold Seisint to LexisNexis for 7x sales and 17x EBITDA when the business was doing $115m in sales and $45m in EBITDA. By simply applying this same valuation to our 2021 estimates for RDVT, we get to a $55/share price target.
Primary Risks To The Thesis (And Possible Mitigants)
This is clearly a competitive space given the size of the TAM and the expertise required to build and maintain the business. While RDVT’s official headquarters is in Florida, their development offices are in Seattle which is a hub for software talent.
Given that the lifeblood of RDVT’s business is the source data it acquires, there is some risk that could arise from the reliance on data suppliers. That said, I’m sure RDVT management is experienced in dealing with the needs and concerns of data suppliers given how long they’ve been in the business for. Plus, RDVT’s annual reports disclose each year how much longer their largest data supply contracts are for and that figure seems to get pushed out each year.
As with any business, especially those in competitive markets, litigation risk may arise in the future. However, RDVT’s CEO is a lawyer by training and is a good person to have at the helm in this regard.
Google has the ability to close a 10-year lead very quickly with its vast resources and brain power. That said, I haven’t seen anything from Google or other Big Tech companies that might suggest they are working on developing a product that would directly compete with RDVT. If such news were to arise or if I start to see a tangible degradation in RDVT’s tracking metrics, I would reassess the thesis
• Continued revenue growth and margin expansion
• New product launches
• Analyst coverage / institutional attention
• Increased & continued communication btw mgmt and investors
• Potential Russell 2000 inclusion if all goes well