|Shares Out. (in M):||12||P/E||0||0|
|Market Cap (in $M):||206||P/FCF||0||0|
|Net Debt (in $M):||-12||EBIT||0||0|
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This stock has been a somewhat material personal holding of mine for the past 9-12 months and I welcome any pushback on it from the community. The idea is somewhat speculative in nature, but I believe the risk-reward tradeoff to be compelling enough to warrant a write up.
Core Thesis Points
· Asset-light "data fusion" software business set to grow sales 60-100% in 2020 with growth well into the double-digits for years beyond that.
o I validate that these estimates are both reasonable and achievable by looking at how other competitive products have developed over time and RDVT’s sales force productivity trends
· Attractive fixed-cost business model resulting in rapidly expanding gross margins from ~60% today to almost 80-90% over the next 12 months
o Sustained positive free cash flow generation is also only a quarter or so away and set to ramp fairly dramatically over time as the business leverages its fixed cost base
· Highly experienced and well-incentivized mgmt. team that owns roughly 20% of the company and that have only been buyers in the open market
o Mgmt. even played key roles in the development of the industry that RDVT is in; 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 3-3.5x 2020 sales; other companies with similar qualities have fairly easily gone for a HSD multiple of sales. Using a normalized -- or “at scale” -- EBITDA margin figure (based on previous companies this management team has been involved with), RDVT is trading at only a M-HSD multiple of normalized 2021 EBITDA, despite the long growth runway ahead of it and its attractive economic profile.
o 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, mgmt. 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)
o Previous deals this mgmt. team has been involved with and simple multiple compression suggest that shares could be worth a multiple of where they trade today; additional upside possible from new product launches, increased visibility, and continued execution over the longer term
· Downside protection is available at ~$150m EV or roughly $14/share (~20% downside from current levels). This is seems like a fantastic risk-reward relative to the possible upside (~180-290% over the next few years, by my estimation).
o Downside protection level based on management’s previous sale of TLO to TRU. Given the very unique circumstances surrounding that sale (that I go into detail further below), I believe this downside protection level is appropriately conservative.
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 ~$30m in annual revenue (2019A) selling two software products that sit on top of the CORE platform – idiCORE and FOREWARN.
idiCORE is RDVT’s flagship product which has about 5.1K enterprise customers as of 2019YE (+40% y/y), and which I estimate did roughly $26m of sales in 2019. 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 per paying customer has been increasing over time to about $5.8K per customer per year at the end of 2019, vs ~$4.7K at the end of 2018 (+23% y/y)
RDVT’s other product, 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; this article cites a 2017 report in which 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 2019YE, roughly 31K agents across the country use the app (5K+ q/q adds each quarter of 2019), each of which pays ~$20 per month (my estimate based on certain sign up docs I’ve seen). I estimate that FOREWARN did about $4-5m 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 ~60% as of 2019. At a $50m revenue run-rate (which I model will be achieved within the next 4 quarters), management believes they will start approaching this 80-90% range.
Data Fusion Industry Background & RDVT’s Origins
Core to understanding the RDVT story and 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 ~$150m 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 Asher’s estate. To sort out the mess left behind, TLO entered bankruptcy court and Asher’s daughters were named co-CEO’s through the process. TLO was eventually put up for sale during the bankruptcy process (a key detail: 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, despite TLO being on the verge of immense profitability as it began to really leverage its fixed cost base), 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 auction with a $154m bid (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 ~$200m.
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. With an investment from the billionaire entrepreneur Phil Frost, 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 FLNT’s free cash flow, RDVT was ready to hit the ground running post 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 “secularly growing” would be apt descriptors. RDVT cites in their corporate presentation a $10Bn+ “Serviceable Risk Analytics” TAM and an incremental $88Bn “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.
This 2017 survey contains a list of some of the 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 (TRU): TLO is now a core product and growth driver of TRU’s USIS segment which did $1.6Bn in sales in 2019 and grew at a 12% CAGR organically 2016-2019. TLO was a well highlighted product at TRU’s analyst day earlier last year and mgmt. cited strong double-digit revenue and adj EBITDA growth over the last 3 years. Additionally, mgmt called out 25,000 enterprise customers for TLO and 130,000 users that use the product each month as of the end of 2018.
o “This growth story started for us in December of 2013 when we bought a business out of bankruptcy called TLO. We had a positive EBITDA, just about a year, maybe 13 months later, and it's been delivering strong double-digit CAGRs on both top and bottom line since then. And we turn that profit while making significant and still to this day ongoing investments in turning this from a bankrupt start-up to an awesome, stable, mature competitor in this space” -- TRU executive Tim Martin at the 2019 TRU Analyst Day
o “I might have had a hand in helping convince [Mark Kelsey] what a great business I left there, which, by the way, continues to be the fastest grower at [RELX Group], which I'm proud of… I think it's a big market there. The fraud market is big. It doesn't matter if there's -- insurance rates go up or down or sideways. People are committing fraud in new ways.” – TRU CEO James Peck at the 2018 JPM Ultimate Services Conference, referencing Accurint -- a competing data fusion product owned by LexisNexis/RELX Group.
· Clear/Thomson Reuters (TRI): Clear is one of a handful of products TRI sells in its Legal Professionals & Corporate segments, which together do ~$3.5Bn in sales and grow in the ~MSD area organically.
o “The CLEAR investigative business is in high demand from federal and local security agencies and police forces. It is an area in which we plan to continue to invest and is growing double-digit. Given the must-have nature of these products, it's no surprise our retention rates are quite high, with revenues generated on a subscription basis… [The Legal Professionals market] is also a historically stable market, even during the downturn in 2008.” – TRI 2018 Investor Day
· 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:
1) There is a very real and 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
2) This market’s growth appears to be secular, not cyclical, and should show durability for years to come – demand for using data to analyze business risks and to prevent fraud will likely not disappear even in a recession scenario
3) While RDVT only sells two products today, there is ample demand to expand into adjacent data fusion applications over time
Fundamental Estimates and Valuing the Business
This simple table summarizes my base case outlook on RDVT’s fundamentals and possible valuation ranges for the stock over the next couple years. I go into further detail on my assumptions below.
As mentioned earlier, RDVT mgmt. has given barely any forward-looking guidance thus far except for one sentence in their 8/29/19 press release for a $7.5m capital raise that suggested that mgmt. believes revenues could grow 100% or more in 2020 (~$60m+). My conversations with management suggest that they will not need to raise any more money in the future, and my model suggests the same.
· idiCORE Assumptions
o idiCORE will likely end 2019 with ~4.6K customers on average through the year, up +1.2K 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 RDVT will continue to add roughly 1.5K enterprise customers per year through 2022. As a cross-check, recall that TLO launched about 10 years ago and currently has ~25K enterprise customers – or roughly ~2.5K new customers adds per year. This suggests to me that my assumptions here are adequately conservative and not unreasonable.
o Average revenue per idiCORE customer in 2019 will be about $5.5K, up about 24% y/y vs $4.4K in 2018. I assume this metric can continue to grow at a ~25%/year clip, bringing avg revenue per customer per year to $6.9K in 2020, $8.6K in 2021, and $10.7K in 2022. Is this reasonable? Again, I refer to TLO as a cross-check: TRU’s USIS segment (in which TLO sits) does about $1.6Bn per year. If I assume $250-500m of USIS segment sales come from TLO, that would imply ~$10-20K in annual revenue per customer per year across TLO’s 25K customers base – about 1-2x what I estimate for RDVT in 2022. My diligence and discussions with certain businesses that use TLO suggest that this price range is roughly in the ballpark of what the actual cost of TLO is per year.
· FOREWARN Assumptions
o Average # of FOREWARN users for 2019 was roughly 22K – a roughly 16K vs ~7K users in 2018. I assume this trend holds in the near term and average annual FOREWARN users increase by +15K in 2020 and +10K in each 2021 and 2022. Note that RDVT is still in the early stages of growth with this product and has announced several large wins with this product in the past few months.
o 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 $50m in 2020, $76m in 2021, and $110m 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 4Q19, each sales rep was able to generate ~$700k in annualized sales while costing RDVT about ~$150k 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 $7.5m growth capital raise to hire new reps at $150k/rep and let’s assume that sales rep productivity increases to ~$1m/rep within the next 12 months (it increased from ~$450k/year to $700k/year through 2019). This would get us to a sales force of almost 75 reps, each pulling in $1m in annualized sales by around late 2020/early 2021 (takes 3-6 months for a rep to get to full productivity). This math would suggest that my estimates of $50m sales in 2020 and $76m in 2021 are directionally achievable.
As previously mentioned, RDVT’s mgmt team previously sold Seisint to LexisNexis for 7x sales and 17x EBITDA when the business was doing $115m in sales and $45m in EBITDA (~40% EBITDA margin). Using these externally validated multiples on my fundamental estimates for RDVT in the coming years would suggest the equity could be worth somewhere between $50-70/share over the next few years (~180-290% total return from current levels).
Additionally, I view TLO’s sale to TRU for $150m as a relative valuation floor (a $150m EV would suggest a $14/share price for RDVT; ~20% downside from current levels) given the unique circumstances around the deal (Asher’s death and the dilemma of the company being on the verge of operating profitability vs the estate lawyers’ fiduciary duties).
Looking at risk-rewards here, the tradeoff seems fantastic: risk ~$4 to make a possible ~$30-50 over the next years.
Risks To The Thesis
· Supplier Risk
o 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.
· Litigation Risk
o RDVT recently settled a lawsuit it had with Transunion in July 2017. As with any business, especially those in competitive markets, litigation risk may arise in the future. On the plus side however, RDVT’s CEO is a lawyer by training and is a good person to have at the helm in this regard.
· Getting Google’d
o It does not leave me that 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. In my discussions with management, they did not seem too worried about this risk.
· Retaining Talent
o 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.
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