|Shares Out. (in M):||9||P/E||34||26|
|Market Cap (in $M):||300||P/FCF||34||0|
|Net Debt (in $M):||-30||EBIT||10||15|
|TEV (in $M):||270||TEV/EBIT||27||18|
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Intelligent Systems (“INS”) is an attractively valued financial technology provider that is likely to appreciate by 30%+ within the next 6-12 months as revenue and EPS growth pick up driven by account growth from the transition of the GM credit card business, other Apple initiatives like BNPL, and maybe more client wins. Failing that, I think INS shares can achieve 20%+ CAGRs from current share price levels over the next 3-5 years even with its existing client base, whilst maintaining a fortress balance sheet. I will explain INS’s key product, the CoreCard platform, and its uses, recent adoption trends, and then a few words on the key shareholder and valuation.
Modern software product with a moat
INS’s CoreCard platform is credit processing software for lenders, which tends to come with near unsurmountable switching costs. CoreCard’s software keeps track of monies lent, interest accrued, and repayments received. Whilst this may sound mundane, this is absolutely mission-critical software for lenders due to (a) the complexity arising from credit products, and (b) the regulated nature of the lending business. CoreCard’s software does not strictly speaking need to be tied to a credit card, it has much broader uses, e.g. SME loans, store credit, loyalty schemes, or prepaid multicurrency cards. Or BNPL. However, being able to handle credit and the associated calculation of interest rates is a KSP for CoreCard’s software because of the complexity of credit.
Today, lenders still use legacy software running on on-prem servers, most of which has been in use for 40 odd years, which also nicely underlines these products’ stickiness once implemented. CoreCard is a much newer product which is (i) easier / faster to customize, (ii) can process transactions basically in real time, and probably is (iii) cheaper to use overall, albeit the last point is a bit hard to quantify precisely. CoreCard’s software is available as a license, can be hosted on clouds, or you can choose to pay INS on a per-active-account basis for a more recurring SAAS-type billing model. However, unsurprisingly for most mission-critical software, most lenders have adopted the “if it ain’t broken, don’t fix it” attitude so far, but I think this may be changing.
Adaption runway led by GS & AAPL
The GS / Apple partnership with INS as leaked in 2018 was a game changer for INS and is likely to provide growth runway for many years to come driven by uptake of the Apple Card, other fashionable initiatives like BNPL, and hopefully more conversions from existing lenders. It was a big surprise to industry insiders that INS won the bid to provide the credit processing software to AAPL / GS, beating out incumbent providers (FIS, FISV, and GPN). Given the superiority of CoreCard’s software over incumbents’ offerings, it makes sense for new lenders launching new products to use CoreCard. However, the “you don’t get fired for buying [IBM]” mantra runs strong in the industry, resulting in somewhat slow uptake so far. However, I think this may be changing: GS won the issuer bank relationship for GM’s credit card business from Capital One earlier this year, and this will be CoreCard’s acid test: if INS succeeds in smoothly taking over the GM program, hopefully this will open the doors to more conversion business from established lenders.
Shrewd and shareholder-friendly owner-operator
I have not met the major shareholder and CEO Mr. Leland Strange, but based on everything I’ve understood, Mr. Strange is a fantastic operator with a deep understanding for the business. With Mr. Strange, nomen est omen, and his proclamations confuse street analysts. To me, however, they show his profound understanding for the software business and his clients, demonstrating realism as well as conservatism with regards to successfully growing CoreCard’s book of business. I agree with Mr. Strange’s assessment that in this industry segment, little can be won by hiring salespeople and running marketing campaigns. Being able to show results, i.e. adoption by blue chip lenders and winning over existing business, is key to driving CoreCard’s adoption given that the advantages offered by modern software solutions are pretty universally acknowledged. Overall, I am deeply impressed with Mr. Strange’s business acumen and given Mr. Strange’s track record, I am convinced that he will not squander INS’s hard earned cash.
High growth businesses are hard to value, but overall, I think INS is very attractively valued at 37x P/E LTM and 20x EBITDA LTM. Don’t get me wrong, these multiples don’t scream “cheap” but this is VIC, not CIC. Incremental margins should be 50-80%, so it won’t take too many years of growth to get to 10x P/E for an incredibly sticky piece of software. For what it’s worth, based on revenue multiples, INS trades in-line with FIS and FISV, but grows much faster. Furthermore, I think INS buying back shares at $37+ recently is also a great sign that INS shares are undervalued in the low-30s. Given somewhat easy comps in 2020 and resumed account growth from the Apple card and the GM program, I think INS is likely to display strong growth over the rest of 2021, which should hopefully remind the market of this company’s potential.
GM credit card transition failure
CoreCard’s reputation will suffer if the transition of the GM credit card business is not smooth. The company is well aware of this challenge and has been dedicated a lot of resources to demonstrate its competency in terms of execution, given the functionality of the CoreCard software is not in doubt. If they succeed here, I think it will significantly increase the likelihood that Amex may shift at least part of their account base towards CoreCard.
Inability to increase adoption
There are fintech lenders sprouting up, but overall, my view is that key to increasing adoption is winning over existing lenders as opposed to new start-up lenders. Lending is a tough business to start from scratch, and frankly, INS is focusing their bandwidth on winning over existing lenders. In darker times, INS was driving adoption by taking small stakes in fintech start-ups, such as Kabbage, in order to drive adoption, but Mr. Strange understands that there is a lot more money to be made if they can get another big bank to switch over to CoreCard.
Fintech is all the rage at the moment, and it’s always scary to be competing in a field when your competitors have easy access to near unlimited amounts of capital to burn. Based on everything I understand, it’s unlikely that anyone will be able to build a competing system in terms of functionality within the next 3-5 years at least. Having sold PaySys to First Data in 2001, INS still had access to PaySys’s COBOL code and knew the functionality well so CoreCard did not have to start from a blank sheet of paper. Yet, it took them more than a decade to get a competing product up and running, and this is even before the super long sales cycle kicked off.
Key man risk
Mr. Strange has been instrumental to INS’s success, although by now, he is obviously not the one typing up C++ code. As noted, he sold PaySys to First Data in 2001, so he and his team really know the space. Whilst he’s unlikely to jump ship at this point given his age, his loss would be quite a loss for INS shareholders.
INS has been attacked by short sellers in the past, but I am not too concerned with the allegations made. Mr. Strange took offense in those reports and issued a reasonable rebuttal, in my view. Valuation is debatable, and CoreCard today is clearly worth more than 2 or 3 years ago, but I don’t think INS is a fraud at all.
Technically, this is an existential risk for banks as we know them today, because banks may lose their role as custodians of cash and therefore an essential source of funding for their lending activities. At this point, there are too many open questions concerned the design and administration of CBDCs, but I think it’s worth flagging at least.
Hopefully none will materialize.
Last but not least, I want to give zipper a hat tip for flagging this one to me.
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No imminent hard catalysts, but there should be positive news (higher earnings, new partnerships) that may drive a re-rating within the next 6-12 months. Or the eventual sale of the business.
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