Accrued Revenue: The Ultimate Cash-Sucker

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Hope you had a great week! Last week we discussed deferred revenue and why we should understand it. This week we’re examining its evil cousin: accrued revenue. There’s a lot in common. But here’s the key difference:

    • Deferred Revenue = job not complete but cash received
    • Accrued Revenue = job complete but cash not received

Alright let’s dive in.

What Is “Accrued Revenue”?

Accrued revenue occurs when a company completes a service or delivers a product but hasn’t received payment for that product or service. Let’s use our lemonade stand as an example.

If we sell a glass of $1 lemonade to a customer that promises to pay us tomorrow, that’s $1 of accrued revenue. We’ve completed the task of delivering our goods to the customer. Now we wait for reimbursement.

Why does this happen? You can thank GAAP accounting. GAAP accounting states that a company must recognize revenue at the time it’s earned. Not when the company receives the cash.

This is an important distinction. Most companies perform services and provide goods without accepting the cash up front. Think of manufacturing companies. Usually these companies supply parts and widgets on a Net-30 basis.

In other words, the customer (who receives the widget) has 30 days to pay for that widget.

You might know accrued revenue as another name, accounts receivable.

Mechanics of Accrued Revenue on Financial Statements

Accrued revenue hits the financial statement in two ways: the balance sheet and income statement. As soon as a sale takes place, the company recognizes that sale as revenue on the income statement.

If we don’t receive cash at the point of sale, we have to also record an increase in the accounts receivables account on the balance sheet.

When the customer pays for the goods or service, we reduce that dollar amount on the accounts receivable account and increase the company’s cash amount on the balance sheet.

The Importance of Accrued Revenue

Understanding accrued revs is important because it offers us clues to the underlying health of a business. It allows us to spot cash-flow issues before they reach an earnings transcript or analyst write-up.

Remember: when in doubt, follow the cash

Here’s what you need to know about accrued revenue analysis:

    • Rising accrued revenues = bad sign
    • Shrinking accrued revenues = good sign

Rising accrued levels means the company’s having trouble collecting cash for goods and services it already performed.

Lower accrued revenues means the company’s collecting more cash from goods and services than it’s recording.

We want to buy businesses that reduce accrued revenues over time and avoid those that grow such balances. Doing so will save us a lot of money and stress over time.

If you have any questions feel free to reach out.

GoodRX (GDRX) S-1 Breakdown Analysis

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GoodRX (GDRX) filed their S-1 earlier this week. I read It so you don’t have to (but you should). Here’s a thread on what I found interesting, fascinating and down-right incredible from the company. I’m starting at zero. Follow along here

GDRX Facts & Figures

  • #1 most downloaded medical app
  • 4.9M Monthly Active Users
  • 80%+ Repeat Activity
  • $20B+ in Consumer Savings
  • 150B daily pricing data points
  • 4 platform offerings
  • Est. Market Cap: ~$9.9B

Business Overview

Mission: To help Americans get the healthcare they need at a price they can afford.
 
So far it’s working (really) well.
 
The company estimates 18M of their customers could NOT have afforded to fill their Rx without the company’s savings tools.

How GoodRX Makes Money

Receives fees from partners, which is mostly Pharmacy Benefit Managers (PBMs) when customer uses GDRX code.
 
Fees are % of fees that partners earn OR a fixed payment per transaction.
 
Recurring nature to GDRX model as code is saved to consumer profile. 

Financial Results

  • GMV via prescription offering: $2.5B
  • Compounded annual revenue growth rate: 57% since 2016
  • Generated $388M Revenue in 2019
  • Generated $66M Net Income in 2019
  • 2019 Adj. EBITDA: $160M

Solving Healthcare Consumer Issues

GoodRX notes 5 major healthcare consumer “lacks” in its S-1:
  • Lack of Consumer-focused solutions
  • Lack of Affordability
  • Lack of Transparency
  • Lack of Access to Care
  • Lack of Resources for Healthcare pros

GDRX Total Addressable Market

GoodRX estimates their TAM around $800B. That’s a HUGE number.
 
Here’s how it breaks down:
  • $524B Prescription Care
  • $30B Pharma manufacturer solutions
  • $250B Telehealth
Initial Surprises: Telehealth is nearly 32% of TAM

The GoodRX Value Proposition

It’s the coveted win-win-win:
 
– Consumers: Simpler, more affordable Rxs
 
– Healthcare Pros: Increased medication adherence and greater price transparency (also links w/ EHR)
 
– Healthcare Co’s: Reach & provide affordable solutions (Rxs) to customers

What Makes GoodRX Different

There’s six strengths that reinforce GoodRX’s powerful network effects:
  1. Leading platform
  2. Trusted Brand
  3. Scaled & Growing Network
  4. Consumer-focus
  5. Extensible Platform
  6. Cash generative monetization model
See image for descriptions…

Analyzing Income Statement

– GDRX grew revenue from $99M in 2016 to $388M in 2019 (crazy growth)
 
– Biggest operating expense currently: SG&A, which was 46% of revenues last year
 
– Operating Margin: 36% (real nice)
 
– Pre-Tax Earnings: $83M (21% margin)
– EPS grew from -$0.11 to $0.19 in four years (w/ growing share count)
 
– 2019 EPS of $0.19 is computed using weighted average shares post-IPO.
 
– Six-month ended YoY: $0.09 vs. $0.15 in 2020 on $15M more income
 
– SBC: <1% of revenues

Analyzing Balance Sheet

– $126M in actual cash
 
– If you adjust for the pro-forma IPO, they get nearly $800M in cash
 
– Total Debt (incl. LT debt): $700M
 
– Total Est. Capitalization: $1.078B
 
– Financed Biz via Cash from Ops (crazy, right?)
 
See breakdown below …
(Debt & Contractual Obligations)
 
  • <1YR: $41M
  • 1-3YR: $85.6M
  • 3-5YR: $82.7M
  • >5YR: $711M

GDRX Key Operating Metrics

One of the most important KPI’s to measure for GDRX is Monthly Active Users (MAU).
 
GDRX’s MAU trend is absolutely incredible:
 
– 2016: 718k
– 2017: 1.28M
– 2018: 2.02M
– 2019: 3.18M
– 2020: 4.88M

Where Will Future Growth Come From?

GDRX outlines 3 ways to grow revs outside Rx codes:
 
– Subscription offerings: Gold, Kroger Savings
 
– Pharma Manufacturing Solutions: Provide low-cost solutions to expensive brand-name meds
 
– Telehealth: Online visits / marketplace

Recap: How To Track GDRX Bull Thesis

– Monitor MAU growth & Repeat Activity
 
– Size + Strength of Healthcare Partner Network
 
– Growth of Platform & Telehealth

Meet The Founders (Letter Analysis)

– Making healthcare easy is *crazy* hard
 
– Consumers (insured or not) needed tools to help
 
– Reduce cost of nearly every generic drug by >70%
 
– Prices are less than typical insurance

Thinking About GDRX Valuation

At the current estimated IPO price and shares, GDRX will trade roughly:
 
– 25x 2019 Revenues
 
– 62x 2019 EBITDA
 
– 119x 2019 Pre-tax Profits
 
They’re also growing 57% compounded since 2016.

Deferred Revenue: Don’t Miss The Next SaaS Winner

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Hope you’ve had a great week! We paused our accounting series to highlight our Collective membership service. Doors closed last Sunday. If you didn’t get in but remain interested, shoot me an email.

I know, you missed your weekly dose of accounting knowledge.

But we’re back baby! This week we’re covering Deferred Revenue. It’s an important topic in the age of SaaS business models. If we don’t understand it, we’ll pass on an amazing business.

Let’s dive in.

What Is “Deferred Revenue (DR)”?

Deferred revenue is money a company receives before delivering those goods or services. Think of it like an advancement payment. Like we mentioned above, deferred revenue is common in the SaaS space. But older, more blue-collar industries also use deferred revenue.

Let’s use lawn care as an example. A lawn care company might need a 50% down payment before they even get to your property. They haven’t performed any service, yet have your money.

That’s deferred revenue.

Where Does It Sit on The Financial Statement?

Now it’s time to get into the weeds. Since deferred revenue isn’t “earned” in the traditional sense — we can’t show it on the income statement. So where does it hide? The liabilities section of the balance sheet.

At first glance, that sounds weird. Why should potential income live as a liability? Think about it this way. It’s like an IOU with another company for future services. You are liable as a company to perform those services or deliver those products.

If we don’t, we’ll lose that revenue and face a potential lawsuit. Let’s look at an example of this with a name we’re currently digging into at the Collective.

I’ve highlighted the DR section on the liabilities side (note: also called “unearned revenue”):

Now that we know where it sits, let’s learn why it’s important to track.

Why Should We Study Deferred Revenue?

There’s two reasons we should study this. First, we can plot the long-term growth of a company’s DR. We don’t want a dramatic increase in DR. A high DR balance signals underlying issues. Does the business have problems bringing products to market? Is there something wrong with distribution?

Second, it helps us value SaaS businesses that might show little in current revenues. If we ignore deferred revenue, we could miss a good software business. Accounting for DRe allows us to model what the company may earn once it’s collected on those revenues.

Next week we’ll look at Accrued Revenue.

If you have any questions feel free to reach out.

Other Income Analysis: Spot Danger Before You Invest

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Last we discussed R&D costs and whether we should expense or capitalize such investments. You can check that out here.

This week we’re shifting gears and focusing on a reader’s request: Other Income (OI, for this article)

I love this topic and can’t wait to dive in.

Let’s go!

What Is “Other Income”?

Remove line items on an income statement and you see nothing but revenues, expenses and bottom-line income. If that were the case, we’d have no hierarchy of income streams.

But GAAP does separate the income statement by line items. And we do have a hierarchy of income streams.

This is where we see the term other income. What is OI? In short, its earnings generated outside normal business operations. The keyphrase here is normal business operations.

Such earnings include:

    • Interest
    • Gains on investments
    • Sale of long-term fixed assets
    • One-time gains on credits

It’s one thing to know this exists. But why does it matter?

Why Should We Care?

It’s important to know where and how a company generates profits. The more a business earns outside its normal operations, the less reliable the income.

If a company can’t generate profits from its core business we shouldn’t buy it. But many investors buy companies that look cheap thanks to one-time other income gains.

Why do they buy them? Quantitative value screens. Think about it. Screens don’t discern between “OI” and “core income”. All they see is the bottom-line number. A company that generated a large OI gain will look cheap on that basis.

“OI” Example: Facebook (FB)

Let’s use FB as an example for OI. Check out FB’s last two years’ income statement numbers (via TIKR):

The line items highlighted in blue are sources of OI.

You can see that it doesn’t matter in FB’s case. They generated nearly $24B in core operating income in 2019. $800M in OI is a simple rounding error.

But that’s not the point. The point is to train your eye to look for these line items. Because not every company looks like FB.

How To Gauge Other Income Severity

OI analysis is important. It tells us whether a company generates most of its earnings from its core business. Or if other (unreliable) streams of income bolster the bottom-line.

Here’s a quick heuristic to gauge whether a company’s OI is something to worry about.

OI Ratio: “Other Income” / EBIT

This ratio reveals how much of a company’s total operating income comes from its other earnings sources. Higher ratios signal less reliable income streams.

But again, everything comes with a caveat.

The best way to run this ratio is over time on a rolling basis. We shouldn’t punish companies for true one-time asset sales or restructurings.

Examine this ratio over the last five years. What’s the trend? Is it consistent? These questions help pinpoint exactly how the company truly makes their nut.

If you have any questions feel free to reach out.

Capitalizing R&D: Learn What GAAP Fails To Teach You

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Last we discussed Accounts Payable and the role they play in cash flow efficiency. We learned that one company’s A/R is another company’s A/P. This week we’re analyzing one of the more complex accounting problems: capitalizing research & development (R&D) costs.

We’ll learn the difference between capitalizing vs. expensing, why it matters and how it changes margins, profits and returns.

Why We Should Capitalize R&D Costs

US GAAP accounting requires companies to treat R&D as expenses on the income statement (P&L). That biotech company spending $1M developing a new drug? Under GAAP that’s a $1M expense, not an asset.

This distorts profits, margins and ROA calculations for many tech/R&D heavy firms. That’s not ideal. Think about it. Companies that leverage R&D to generate revenue and cash have periods of massive R&D investment.

If you don’t adjust for R&D, the income statement looks like a bouncy ball on cocaine.

Investments in R&D support the long-term cash-flow generation of a company. They’re operating assets. As such, we should capitalize them on the balance sheet.

Capitalizing R&D is also a more conservative estimation of a company’s returns and profitability for two reasons:

    1. Capitalizing increases a company’s total assets (which could reduce ROA/ROE)
    2. Capitalizing keeps an amortization expense on the income statement

Let’s learn how to do that.

Capitalizing R&D Investments (Step-By-Step): Boeing, Inc. (BA)

We’re using Boeing (BA) as our example. Remember, we’re keeping things simple with this example. You can get more complex (see here), but that’s not our goal.

Step 1: Find Amortization Duration 

The first step in capitalizing R&D is to determine the useful life of a company’s R&D assets. The longer the usefulness, the longer the amortization period (i.e., how many years we expense). High-tech companies in ever-changing industries have low amortization periods.

BA makes airplanes that have long lifespans. We’ll use ten years.

Step 2: Calculate Value of Amortized R&D Asset

We calculate the amortized value of the R&D asset by using the straight-line amortization method. This means we amortize 1/10th of the total sum of the last ten years’ R&D expense. If we chose 7 years, we’d amortize 1/7th of the total sum of the last seven years’ R&D expense.

Then we calculate the annual amortization expense by dividing that year’s R&D by 1/10th (0.1).

Here’s what that looks like:


Step 3: Recalculate Book Value of Equity

We need to add our capitalized R&D value to tangible book value to get a better picture of the company. This is simple. Take Tangible Book Value and add R&D value.

Here’s what that looks like in 2018:

$339M (BV) + $3.27B (R&D value) = $4.059B

Step 4: Recalculate EBIT

Next we adjust EBIT to reflect our capitalized R&D investments. To do this, we take our current year EBIT, add current year R&D expense and subtract total amortization of R&D.

Here’s what that looks for BA in 2018:

$11.6B (EBIT) + $3.27B (R&D) – $3.71B (Amortization) = $11.16B Adjusted EBIT

Why does EBIT drop after adjusting for R&D investment? BA’s decreasing R&D investment (see above).

To Be Continued …

I know, capitalizing R&D is confusing. But it’s important if we want to understand the true economics of an investment-heavy business.

We’ll review this concept in more detail next week, don’t worry.

If you have any questions feel free to reach out.

Unity Software: Breaking Down S-1 Filing

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Unity Software released their S-1 filing yesterday morning. I spent the afternoon digging into the filing pulling out what I thought interesting, fascinating and down-right awesome. Here’s the link to the S-1 if you want to follow along at home.

The below post is the unrolled version of my earlier Twitter thread. You can find that here. Let’s get to it.

Unity (prop ticker: $U) filed their S-1 this AM. I read the filing so you don’t have to (but you should). Here’s a thread on what I found interesting, fascinating and down-right incredible from the company. I’m starting from zero.

High-level Facts & Figures

These high-level stats impressed me:

  • 1.5M monthly active creators
  • 50%+ of all mobile/PC/console games made w/ Unity
  • 3B app downloads per month (!)
  • 15K new projects made per day
  • Creators span 190 countries

Business Motto: “We believe the world is a better place with more creators in it. Creators, ranging from game developers to artists, architects, automotive designers, filmmakers and others, use Unity to make their imaginations come to life.”

Power to the creators.

What Makes Unity Great?

Offering: $U provides set of software solutions to create, run and monetize real-time 2D/3D content for mobile, tablets, PCs, consoles and AR/VR.

End-Result: A fundamentally more engaging and immersive gaming experience. Instant adaptability.

What Makes Unity Great (pt.2)

$U offers tremendous scale. They can service huge development teams as well as individual creators.

Individuals can rapidly create and tweak new games (increases adoption)

Once built, $U games can run on 20+ platforms (zero barriers 2e)

A Two Solution Biz Model

Create Solutions: Lets users (artists, devs, engineers, etc.) create 2D/3D interactive, realtime content

Operate Solutions (more interesting): Offers cust. ability to grow & engage with user-base, as well as run/monetize content.

How Unity Monetizes Two Solutions

Create Solutions (CS): monthly subscription

Operate Solutions (OS): Rev-share and usage-based

The reason: Generate revs as builders develop content and ALSO generate revs as their game grows and becomes successful.

CS DRIVES OS!

Create Solutions: 43% of Revs

Five plans customers can buy with Create Solutions:

  • Unity Plus
  • Unity Pro
  • Unity Enterprise
  • Unity Personal
  • Unity Student

Customers typically buy 1-3 yr subscriptions, billed monthly, quarterly or annually.

Operate Solutions: 57% of Revs

Revenues from this segment are lumpy (depending on popularity of games)

Unity relies on expanding their customer base to smooth revenue volatility

Aligned incentives: U generates more revenue as their customer’s game gains popularity

Let’s Talk About TAM, Shall We?

Unity sees their TAM around $29B across both gaming and other industries.

They’re looking beyond gaming and their current markets.

Future TAM could be (according to mgmt) “multiple times larger than the opportunity today.”

Rapid Revenue Growth, Shrinking Operating Losses

Unity grew revenue 42% YoY ($380M to $541M).

They’re currently losing money ($163M last year and $131M in 2018).

Net cash used in operating activities decreased from $81M in 2018 to $68M in 2019.

The Power of Real-Time 3D

Unity is banking on the power of Real-Time 3D to drive creative innovation, more engaged users and better games.

They break down the power of 3D:

  1. Interactive: Connect with content & other gamers
  2. Real-Time: 120 images per sec
  3. 3D: more real

Technology Driving Real-Time 3D Adoption

Rapidly evolving tech allows $U to create better, more realistic and interactive games than ever before.

This new tech relies on these four pillars:

  1. Computing power
  2. Platforms & Devices
  3. Distribution
  4. Connectivity

Unity Growth Strategies

$U has identified five ways they can grow in the future:

  1. Invest in product innovation
  2. Grow existing gaming customers
  3. Grow new gaming customers
  4. Grow beyond gaming
  5. Grow across global markets

See more below:

Diving Into Financial Data (What Stood Out)

In 2019, $U generated $541M in revenue and $423M in Gross Profit (>78% GM!!)

Shares Outstanding: 114M – Customers > $100K revenue: 600 in 2019 vs. 484 in 2018

Dollar-based Net Expansion Rate: 133% in 2019

Diving Into Financials (Balance Sheet)

Assets:

  • Cash: $453M
  • Working Capital: $339M
  • Total Assets: $1.29B

Liabilities:

  • Deferred Revs: $107M
  • Total Debt: $124M

Equity:

  • Shareholders Equity: $647M

Interesting Graphs on Customers, Retentions Over Time

Check out these graphs on:

  • Customers > $100K over time
  • % of Revenue Rep by Customer > $100K over time
  • Dollar-based Net Expansion Rate over time
  • Customer Cohort Analysis

Letter From Unity CEO

I liked how the S-1 included a letter from $U CEO.

Here’s a couple interesting quotes from that letter:

Unity Reviews from Other Game Studios

The consensus: Unity allows game developers to rapidly create, test and curate new games. This in turn fosters a more creative environment, which leads to more potential blockbuster games.

Customer Diversification

The company has myriad customers using both its Creative, Operate and Architecture Solutions, including:

Creative:

  • Arena of Valor
  • Iron Man VR
  • Pokemon GO

Operate:

  • EA
  • Tencent
  • Ubisoft Mobile Games

Architect:

  • Samsung
  • Skanska (Volvo)

Executive Management Comp

  • CEO: $8.4M total compensation (owns 3.4% of company)
  • CFO: $5.23M total compensation

Shareholder Split:

  • Sequoia Capital owns 24% of shares
  • Silver Lake Partners owns another 18.2%

Account Payable: What They Are & Why They Matter

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Last week we learned about Accounts Receivables (A/R). Check it out here if you missed the email.

Also, let us know if there’s one accounting concept you want us to cover. We’d love to tailor it to your specific needs.

We’re staying in the balance sheet this week and looking at another type of account. Except this time it’s on the liabilities side of things.

This week’s lesson: Accounts Payable (A/P)

Let’s roll!

What is An Account Payable (A/P)?

A/P is a short-term outstanding debt (credit) from a company’s supplier or vendor. AP represents the total amount due to suppliers for goods and services that the company hasn’t paid.

Another way to think about it: one company’s A/P is another company’s A/R.

Lemonade-Stand Example

Last week we looked at a credit exchange to show A/R. We viewed this transaction from the company’s perspective. But remember, one company’s A/R is another entity’s A/P.

Part of operating a lemonade stand is buying key supplies like lemons and sugar. You have a great relationship with a local lemon supplier, Lemons, Inc.. You need 100 lemons for next week’s forecasted demand.

But you don’t have the cash right now. You spent it all on advertising/marketing to attract new customers.

So you go to Lemons, Inc. and say, “Hey, I need 100 lemons and I’ll pay you within 30 days from receipt of the lemons.”

The other company agrees because they know the relationship and they know you’ll pay on time. They ship you the lemons with a $200 payment due in 30 days.

That $200 payment is a new account payable for that period.

Account Payable Effects on Cash Flow

A/P has a positive effect on a company’s cash flow. This makes sense because you’re foregoing payment now, with the promise of paying later. You can see it on Facebook (FB)’s cash flow statement below:

Every $1 of new A/P means $1 more you don’t have to spend today.

That said, those payments must be made over time.

Here’s a couple heuristics for gauging A/P figures:

    • Increase in A/P = more goods/services bought on credit
    • Decrease in A/P = company paying off prior debts faster than buying new goods/services on credit

Summary: A/P Helps Cash Flow, But Take Caution

A/P management is a great way to maintain high levels of cash flow. The less you have to pay out upfront, the better. That said, lookout for companies with ever-rising A/P balances on weak balance sheets. If a company doesn’t have the cash to pay it’s A/P, it could slip into default.

(Semi) Weekly Accounting Breakdown: Working Capital

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We’ve received a lot of positive feedback on the Cash Flow: It’s All That Matters series. So much so that we thought our readers would like a more regular installment of all things accounting.

The goal: Send weekly accounting lessons that you can read in less than five minutes.

We know learning about accounting is like watching paint dry. That’s why we’re breaking them into five minute bites.

Our first lesson: Working Capital Cycles

What Is Working Capital?

Working capital is your current assets minus current liabilities (CA – CL).

Current assets are things like:

    • Cash in the bank
    • Accounts receivables (money that needs collecting)
    • Inventory
    • Investments

Current liabilities are things like:

    • Accounts payable (bills you need to pay)
    • Short-term debt
    • Current portion of long-term debt
    • Unearned revenue outstanding (similar to A/R)

Apple’s (AAPL) latest 10-K reported $163B in current assets and $106B in current liabilities. This gives us $57B in positive working capital.

Positive & Negative Working Capital

Working capital has two forms: positive and negative

Positive: You have excess cash to pay for the daily operations of the business (salaries, creditors, suppliers, rent, etc.).

Negative: You do not have current cash to pay for daily operations but instead use suppliers and customers to fund expenses.

The Pros & Cons of Positive & Negative Working Capital

There’s benefits and downsides to both types of working capital cycles. Let’s start with positive working capital:

Pros:

    • You have a good cash buffer for unexpected expenses
    • Can fund growth and future opportunities with cash

Cons:

    • High working capital could be due to too much inventory or inability to reinvest in the business

Alright let’s shift to negative working capital:

Pros:

    • Fund operations through suppliers and customers
    • Generate cash from customers before you have to pay your current liabilities
    • Ideal for businesses with high turnover in product/sales

Cons:

    • Without growth, working capital eats away at profits
    • Lose money if customers don’t pay on time (i.e., higher A/R)
    • Doesn’t look good for bank funding/liquidity

Which Cycle Works Best?

The answer: it depends.

It depends on the industry you’re in and the growth trajectory of the internal business. Companies that enjoy negative working capital cycles include: Online retailers, grocery stores, restaurants and telecom companies (via financialexpress.com).

That wraps up this week’s accounting breakdown.

If you like this idea, let me know. If you hate it, still let me know. We’re always looking for ways to bring more value to you!

Red Violet (RDVT): Asset-Light Spin-off With Long Runway

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Business Description: RDVT’s platform (CORE™) stores 1+ trillion data records on nearly every individual in the US. Their data sources include MVA, property, criminal, court, and employee records. The proprietary, cloud-based platform funnels all the records into one, easy-to-query database. RDVT uses this technology in two products: idiCORE (risk management, debt recovery, fraud detection) and FOREWARN (individual background checks catered to realty professionals, see our homebuilding thesis here). 

Thesis: RDVT is a fast-growing, highly scalable data fusion company delivering 1+ trillion points of data to its customers at lightning speed. Their platform allows customers to assess risk and achieve a full-scale picture of any individual and business before meeting/conducting a deal. The company sports a fixed-cost model with 90% incremental gross margins. Management has a history of building similar companies, with two sales totaling $1B in the same industry. We believe the company can reach $190M in 2024 revenue with 40% EBITDA margins, giving us nearly 300% upside from current prices. 

History & Spin-off: The current RDVT team began developing the CORE platform in 2014 under the name “The Best One” (TBO). TBO received an investment from Phil Frost, changed its name to Cogint and listed it as a public company (under ticker CGNT). In 2018, the company merged with Fluent under the ticker FLNT. That same year FLNT decided to spin-out the CORE platform company (TBO/CGNT). Here’s what’s interesting: every single executive left TBO/CGNT to work at the newly spun-off company, Red Violet (RDVT). 

Fixed-Cost Model: The most attractive aspect of the RDVT thesis is their fixed-cost business model. In short, they pay a fixed, long-term contract on their data feed. It doesn’t matter if they generate $10M in revenue or $100M. Their cost remains fixed. This allows the company to reach 90% steady-state gross margins and near 100% incremental GM. As the business scales, they won’t have to spend as much on SG&A. This ramps up EBIT margins (in some estimates, reaches 40%). 

History of Value Creation: Dan Dubner and his executives were the early founders of the data fusion industry. They’ve built two companies like RDVT that sold for a combined $1B. RDVT is a spin-off of all the things that weren’t great in prior iterations of such data fusion technologies. We have a strong belief that management knows how to build, how to price and how to create value for shareholders. They own 20% of the company so incentives are aligned. 

Valuation: We’re assuming 45% annual top-line growth over the next five years — starting with $50M in 2020 revenue. At scale the company generates 90% GM and 40% EBITDA margins (based on their two previously sold companies). Given our assumptions, we end 2024 with $190M in revenues, $76M in EBITDA and $55M in FCF. Add back our $9M in net cash and we get a market cap of $578M ($50/share). If we assume a 17x exit EBITDA multiple (in line with historical sales), we get $700M in market cap ($62/share). That’s near 3x upside.

Risks: Data supplier concentration (receives 43% of its data from one provider), competing away margins, litigation risk from competitors (CEO is lawyer by trade), Data price increase leads to reduced margins.

***Disclosure: We currently have a position in RDVT at the time of this release***

Enlabs (NLAB): High Growth, Low Price

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Enlabs (NLAB.OM) offers entertainment through various products, including casino, live casino, betting, poker, and bingo under various brands. The company is also involved in delivering sports results and technical solutions in the online gaming industry. It operates in Sweden, Malta, Baltics, and internationally.

Thesis: NLAB is the Baltics market leader in the highly regulated, high barrier to entry and fast-growing online sports betting/gambling industry. The company commands 25% market share in the Baltic region and has its sights set on global expansion. NLAB’s growing earnings & revenues 30%+/annum while sporting 30% EBITDA margins. You can buy this business for 15x normalized earnings, well below industry/market averages. Management owns a decent chunk of stock and has zero debt. 

The Core Business: NLAB’s core business is Optibet, it’s online gambling/sports betting platform. It’s a capital-light, 80% gross margin business. The company invested a ton of money to create a new, proprietary platform that can seamlessly integrate into new countries and regulation standards. Think of it like plug-and-play for online sports betting. The core business should continue its 30% growth as the Baltic sports the fastest internet and highest mobile data usage per capita in Europe. 

Competitive Advantages: NLAB benefits from a first-mover advantage in many of its regions. Given the finite amount of betting licenses, the ability to move quickly within compliance is paramount. NLAB’s latest platform, along with its dominant market share in the Baltics create an easy choice for regulators when it comes time to hand out licenses. 

 

NLAB Risks 

Penetration Failure: NLAB fails to penetrate new markets like Sweden, Belarus and the US

No Relaxation in Legal Gambling: Countries fail to remove restrictions on legal sports betting/gambling

Cash-Burning Acquisitions: NLAB acquires companies that aren’t accretive to bottom-line, thus buring cash that could’ve been used to bolster core biz/platform

 

Valuation 

Scenario 1: NLAB continues its revenue/earnings path for the next five years. We’d get 2024 with $118M in revenues, $29M pre-tax profit and $24M in FCF: $5.58/share (196% upside)

Scenario 2: NLAB grows 2020 revenue 30% but 0% for the remaining four years. This gives us $56M in revenues, $14M pre-tax profit and $15M FCF: $3.05/share (62% upside)

Scenario 3: NLAB loses 13% per year in revenue, giving us $21M in revenues, $5.21M in pre-tax profit and $4M in FCF: $1.48/share (21% downside).