Description

I. Executive Summary

AudioEye (ticker: AEYE) is a niche SaaS business growing at 100%+ rate with expanding gross profit margin, strong logo retention rate, an efficient go-to-market strategy that trades at ~7.5x revenue run rate.

AEYE reported its results on August 13, 2020 that demonstrate that execution continues to be strong despite COVID-19 headwinds. Thus, I think the opportunity is very actionable.

II. Why Does This Opportunity Exist?

There are several reasons why this opportunity exists:

(1) Small cap (~$145M)

(2) Limited sellside coverage (B. Riley and National)

(3) Very under the radar among buysiders (no investment pitches on major investment buyside websites).

III. Capital Structure

On a fully diluted basis and using the T-method to account for stock options and warrants, AEYE has ~$145M market cap. Below I provide a detailed breakdown of the capital structure:

IV. Valuation at a Glance and Upside Potential

AEYE is trading at ~9.1x EV/LTM revenue (LTM revenue = ~$15.9M). MRR as of June 30, 2020 was ~$1.6M which is equivalent to a revenue run rate of $19.2M which means that AEYE trades at ~7.5x run-rate revenue.

Given that AEYE has been growing revenue at an astonishingly high rate, this multiple is too low. For context, I provide the y-o-y revenue growth rate for the last 6 quarters:

1Q 2019 = ~72.8%

2Q 2019 = ~97.2%

3Q 2019 = ~85.8%

4Q 2019 = ~ 100.2%

1Q 2020 = ~ 114.6%

2Q 2020 = ~ 116.9%

Furthermore, the growth rate has been accelerating over the past three quarters.

In the next 3-4 years the revenue run-rate should get to ~$50M (from current ~$19.2M). At that time the gross profit margin could reach ~75% and the company will have strong FCF. Thus, revenue multiple of 7x – 9x is likely to be appropriate and may be quite a bit higher. Even holding the multiple constant, this should lead to ~150% price appreciation in the next 3-4 years.

V. What Does AEYE Do?

The Americans with Disabilities Act (ADA) became law in 1990. One of its provisions requires public venues (e.g., movie theaters) make themselves accessible to people with disabilities. This is an excellent piece of legislation that has made life a bit easier for many people. What has probably become an unintended consequence of the ADA is that digital properties (i.e., websites) are also subject to its provisions and thus must make themselves accessible to people with disabilities (e.g., visual and hearing impairments). In a way, the ADA requires “digital ramps and rails”.

AEYE provides SaaS to its clients to make their websites digitally accessible.

VI. Customers’ Motivation

Customers are generally motivated by these factors:

(1) Fear / concern of being sued for violating the ADA.

(2) Desire to do the “right thing”.

(3) Expanding their audience and gaining potentially incremental demand from people who can now access their websites.

While AEYE management talks a fair bit about #2 and #3, I tend to think that #1 is in fact the primary driver. Thus, I view AEYE is a compliance solution that many customers view as a necessary cost of doing business.

The company provides this industry data about lawsuits and names a few particular companies that were sued.

Source: AEYE Investor Presentation.

VII. Customer Segmentation and Go-to-Market Strategy

Complexity of a customer’s website defines customer segmentation and go-to-market strategy.

1. Enterprise / Direct Channel

Big companies have complex websites and manage them in-house. This is “direct” or “enterprise” channel for AEYE that requires direct selling via company’s own salesforce.

Within the enterprise / direct channel, the complexity of the website also varies, and that complexity determines pricing. On the low end, AEYE can charge $8K to $10K / year. On the high end, AEYE may be charging $60K to $100K. Websites that fall in the middle carry a price of $10K to $60K.

AEYE discloses some of its enterprise clients and many of them are very established businesses / brands. See the image below.

Source: AEYE Investor Presentation.

2. Indirect Channel

Smaller companies have simpler websites and they outsource managing their websites to content management system (CMS) providers. CMS providers manage a multitude of websites on the same platform. Typically, a CMS provider serves a particular industry or vertical and its clients have very similar websites’ design / layout. A good example would be a CMS provider that serves car dealerships of a particular car brand. Car dealerships would have dozens websites but their needs are highly similar and those sites look very similar too because a CMS provider uses a template.

AEYE sells its SaaS to such smaller companies via CMS providers. For CMS providers it is an opportunity to sell an extra feature for a cut. CMS providers generally get ~40% of the price paid by an end customer while AEYE gets ~60%. These numbers of course can vary depending on particular relationships.

The typical price per site per year that AEYE gets (i.e., AEYE’s share) is massively lower than price for the enterprise customers. However, these websites are a lot simpler and as a consequence easier to maintain.

The beauty of the indirect channel is that AEYE can reach a very large number of potential customers in a very cost-efficient way without building a massive salesforce.

As of June 30, 2020, AEYE had 20 indirect channel partners.

3. Customer Count

In the Fall of 2018 AEYE had ~700 indirect customers and ~150 direct customers.

To the best of my knowledge, AEYE has not provided a customer count for each channel since then and we only know the aggregate customer count which was ~20K at the end of 2Q 2020. The majority of customer growth has, of course, come from the indirect channel.

VIII. TAM and Growth Runway

There are of course many millions of websites around the globe. Many of them may never become compliant with the ADA. However, it is also quite clear that the penetration of digital accessibility solutions is very low and is probably in low single digits. Importantly, the litigation activity in the space seems to be only increasing (although at decelerating rate). Continuously rising importance of the digital experience was only accelerated by COVID-19 pandemic. This article titled “The push to make websites accessible for people with disabilities as COVID-19 outbreak continues” is a good example.

Thus, given (1) low penetration, (2) rising importance of digital, and (3) existing legislation, AEYE can be able to grow at a very high rate for a number of years.

IX. Key Operating and Financial Metrics

AEYE has a strong logo retention rate of ~95%. This is very solid given that many indirect channel clients are mid-size businesses that can be closing, merging, etc.

Gross profit margin has shown a remarkable improvement and increased from ~54.5% in 1Q 2019 to 69.6% in 2Q 2020. With gross profit margin already just shy of 70%, I think the margin can expand to 75% or even higher over the next 2-3 years.

As any rapidly scaling SaaS business in the early stages of its life, AEYE’s S&M and G&A as % of sales are high: 32.3% and 48.4% respectively in 2Q 2020. Both metrics have been declining over the past several quarters.

X. Management and Key Actors

Carr Betis is the Executive Chairman. You can read his bio here. He owns ~9.5% of the shares.

Todd Bankofier was CEO for a few years but was moved to Chief Revenue Officer on September 19, 2019. In my view, Todd Bankofier was good at building AEYE’s salesforce but he probably lacked SaaS DNA and experience. He subsequently left AEYE.

While AEYE was looking for new CEO, AEYE announced that “Executive Chairman Carr Bettis has assumed operating responsibilities and will continue to do so until a new CEO has been appointed.”

On March 2, 2020 AEYE appointed Heath Thompson as Chief Executive Officer. Based on this resume, Heath Thompson has a lot of technology background.

However, on August 13, 2020 AEYE announced that “Heath Thompson has moved from CEO to strategic advisor and has a continuing role to advance the Company’s mission and to acquire customers for AudioEye”.

This time David Moradi became Interim CEO; he was also appointed Chief Strategy Officer. David Moradi would continue to serve on the board of directors. David Moradi is the founder of Sero Capital, LLC. In the past he held investment roles at several investment firms, including Soros Fund Management and Pequot Capital. Per the most recent proxy (April 7, 2020) David Moradi beneficially owns ~33.1% of shares and ~47.5% of shares on an as-converted basis.

Another recent appointment (also August 14, 2020) is Khurrum Malik who is taking a role of CMO. Khurrum Malik has “held leadership positions at Microsoft, Facebook and Spotify”.

Sach Barot has bee CFO since May 2019.

CEO changes and lack of “permanent” CEO today is a concern. On the flipside, if AEYE has grown revenue and customer base so well despite CEO changes, what can AEYE do with a strong CEO in place?

XI. Risks

Competition

AEYE appears to have a robust solution that is more comprehensive than what others offer. However, competition and technology obsolescence are risks.

Influence of a larger shareholder

David Moradi and / or Sero Capital own a very large percent of shares outstanding and may have high influence on the future of the company.

XII. Catalysts

1. Continuous revenue growth

2. Reaching positive FCF. Currently AEYE is guiding that it would reach positive FCF in 2021.

Disclaimer

Presented recommendation and analysis is an opinion of the author. The author and / or affiliated entities are long AEYE shares. Various factors may influence or factor into the analysis or the opinion. The author does not assume any obligation to update the analysis or recommendation.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst