Description

What is the value of a recovery stock growing at a 10% organic rate before COVID with depressed EBITDA? 10x EBITDA?

What if this recovery stock was a leading software company with <60bps of share in a $10bn+ TAM? 15x?

What if this leading software recovery stock was launching a product that eliminates a key point of friction within its market, enabling TAM penetration to go from 20% to 100%? 20-25x?

What if in the 5yrs of turning around the business, the only missteps the management team had was a) believing COVID would end sooner than later and b) fumbling an equity raise which included issuing 6% dilutive warrants?

Let’s just cut 20-25x in half and assume 12x is the right multiple. At 12x VIQ should be worth $7.60 vs. a current trading price of $2.00.

Summary:

VIQ may have one of the better risk/rewards in the public market. VIQ offers a transcription service so customers can accurately transcribe conversations/recordings (e.g. a court reporter needs to accurately transcribe court proceedings). The US only TAM is ~$11bn. However, of that TAM, about 80% is never transcribed because it is not time intensive and costly to do so. VIQ has worked tirelessly to address this challenge and has introduced a product that eliminates a human editor altogether (the human is who makes sure it is 100% accurate). This product achieves ~95% accuracy for transcription services which should be sufficient to penetrate the 80% of documents that are not transcribed. Recent shortcomings aside, channel checks indicate the company has the best mousetrap in an industry dominated by mom and pops. In essence, VIQ is the leading player in a market where they have <50bps of mkt share with margins double its peer group, and yet the stock is down ~70% from the peak earlier this year.

While this CEO could do no wrong in 2018/2019 when he oversaw the doubling of the business with expanding gross margins from ~30% to the mid 40% range, he hit a wall in 2020. First, he kept trying to call a COVID recovery (business is negatively impacted by stay-at-home trends – think lower insurance claims when people are not driving OR reduced court transcriptions when proceedings are delayed, etc.). He overestimated the timing of the end of the pandemic which set the stock up for KPI shortfalls when Delta cases emerged. Second, the CEO told investors VIQ would list on Nasdaq and then pulled the listing because he believed the stock was underpriced. This decision coupled with growing risk of a guide down from rising COVID cases led to further declines in the stock. Finally, a month after pulling the equity raise, the CEO decided to issue equity and warrants because he thought he would be able to make some larger acquisitions. I believe consortium of investors approached him to do an equity raise. This group proposed taking down a big chunk of equity but would need warrants to provide this capital. At this point you could either believe the CEO is a complete fraud and his prior tenure at the company means nothing OR you could believe he was coerced into believing he needed issue equity with warrants to secure a more sticky, long oriented investor base.

This is the most important question. If you believe it is the former and disregard his track record, the 25% insider ownership, the innovation they have had to date, this stock is a hard pass. However, if you believe the latter then your upside is 4x-6x assuming management can hit what we believe are achievable numbers.

Now if it was just the equity raise, the stock would still hold in much better than it did. However, a large and very respected investor in the fund exited the position and publicly commented on the position in a less than favorable light. This manager is revered by the retail and the small cap investment management community, an honor earned through a very strong record. For a stock lacking institutional support (Canadian/expensive headline numbers/missing guidance and issuing equity) this was the final hammer in the coffin.

So where does that leave us?

During the Fall VIQ Solutions Inc. (“VIQ”) issued impressive guidance for 2022, implying $5-$10mm of EBITDA. However, this was predicated on closing one of their deals this year (“Auscript”). The problem is their Q4’2021 guidance also included the contribution from this deal. Unfortunately, the deal was late to close and management will probably once again fall short of Q4 guidance. However, we believe this is a timing error and at current levels, the shares are trading at 7.3x 2022 EBITDA and 2.7x our 2025 EBITDA estimate. The issue is that investors simply don’t trust management.

However, when one approaches the data and last quarter objectively, things look quite strong. First, the end market here is very sound and they have a proven technology that works. This is not a biotech where there is execution risk. The technology works, simple as that and is available today in the market. From the work done, I believe they have a great technology and customers love them. Second, they have developed an iteration of their technology that is eliminating a key area of market friction – the cost to transcribe. This should play a key role in driving penetration of their TAM and an accelerated growth profile in the years to come. To summarize, I think this is a successful leading product in a stable and growing market.

Third, the corporate governance snafu can’t be swept under the rug. One can postulate why they did what they did (as noted above), but this is a stain that they can’t remove. However, this is a management team that has been doing exceptionally well prior to COVID and the management team and Board are heavily invested in the company (Insiders here own ~25% of the company). They are not in this business to clip an annual salary. Fourth, I believe the company is likely to beat expectations going forward. If we start with their 2021 revenue ex M&A and add-in their deferred backlog of ~$4mm, Queensland contract of ~$5.5m/yr, M&A contribution from TTA and Auscript of $14mm, we are already at $55mm of sales for 2022 without assuming any organic growth. We believe management guidance of $50mm+ of sales is conservative. Assuming some organic growth, it would not be surprising to see VIQ pushing closer to $60mm of sales in 2022.

Assuming VIQ can achieve their 2022 EBITDA margin guidance of 10-20%, that implies EBITDA of $5-$10mm+ on a sales figure that could ultimately be conservative. That implies the stock is trading at 5-11x EV/EBITDA for what could be a LT double digit CAGR software business. Assuming organic revenue growth in 2022-2025 of 10% (market growing 6% and assuming some market share gains) and incremental margins of 55%, the company can generate $20mm of EBITDA in 2025. When taking into account the company will only have 70bps share of the industry in 2025, it’s reasonable to see how this type of business commands high multiple. At 10-20x EV/EBITDA, the shares are worth $7-$13/share. This would also suggest 3-6x EV/Sales, a deep discount to NUAN, a large peer that just got bought out at 13x EV/S. If you hate the management team and believe this growing earnings stream is only worth 10x EV/EBITDA, then the IRR here is 51%.

Overall, I have a hard time finding a name where hitting numbers and achieving growth in-line with what they saw pre-covid leads to 3-7x of upside. 

Company Overview:

There is another VIC write-up on this name that provides a good overview of the business as well as real-time thinking on the stock, so it is worth reading this write-up for additional background information.

VIQ provides a leading transcription service in an ~$11bn TAM in the four verticals they partake in. A typical workflow starts with VIQ capturing content using either their own hardware for audio/video or a third-party solution (think a recorder in the court room capturing voice from the judge, the defendant, the plaintiff, the lawyers, etc..). Subsequently, the recording is fed into a proprietary solution called aiAssist which figures out a) which speech engine to use (they typically leverage the commodity offerings from Google, Speechamatics, etc.), b) layers in software to make nuanced changes to the transcription (this is where machine learning comes in), c) figure out which human transcriber to offer this to and d) ultimately recalibrates the data to improve on “b” and “c.” Historically, aiAssist would get the end product to ~80% accuracy at which point the human transcriber/editor takes over and puts the final adjustments before delivering the ~100% accurate final version to the client. Putting accuracy aside (see below), one of the biggest advantages that VIQ has is that the company is one of the few to provide an integrated solution where the recording, transcribing, editing, saving/cloud, distribution is all provided under one roof.

It is important to note that while VIQ does not provide the speech engine (This is provided via APIs from Google, Microsoft, Nuance, Speechamatics) the aiAssist is a software layer that sits on top of this commodity offering. What aiAssist does is a) figure out which speech engine to use (e.g. Google may be deemed more accurate for a Spanish Judge), b) can break up the recording into portions to be better transcribed by the engine/API, c) can break up the recording between multiple parties to be fed through different engines (e.g. judge may be run through Google while plaintiff run through Microsoft). Once it works through the engine, aiAssist makes the necessary edits to pick up various nuances in the recordings in addition to highlighting key parts for the human editors to spend time on (i.e. may highlight a part in red because they want a human check and may highlight a part in green where they deem no human check is required). Overall, the engine improves the speed, accuracy and then uses the data to recalibrate/get better.

The evolution of aiAssist has enabled VIQ to take turnaround times from 3-4 days before to 3-4hours currently (before First Draft – more below). By leveraging this improved process in combination with their full transition to the cloud (in 2021 cloud was 100% or workflow from <20% in 2019), VIQ was able to expand gross margins from ~30% to nearly 50% before COVID/M&A (when they do a deal it pressures margins because they typically buy a 20-30% margin company).

TAM / Market Opportunity:

When looking at the TAM, I focus on the US. While VIQ has a global presence, the US market alone is sizeable enough for significant stock appreciation. Right now, VIQ focuses only on evidence-based verticals of law enforcement (interrogations, narratives, statements), insurance (interviews, witness statements, claims), judicial (court reporting), legal (lawyer case notes) and has recently gotten into media. In those verticals, the TAM is ~$11bn. The TAM is calculated assuming every recording is transcribed at the going market rate (cost per page/minute * minutes/pages). However, only 20% of the market is currently transcribed and ~80% is recorded and not transcribed (i.e. a court recording is saved on file, but not transcribed because it is not worth the transcription cost). In that 80%, many times judicial hearings are not required to be transcribed but required to be recorded and saved for 100 years.

While the market itself is attractive and growing at a healthy rate, VIQ is on the precipice of rolling a solution that could unlock the other 80% of the market; FirstDraft. FirstDraft is a recently launched solution that circumvents the human editor.  While the human editor is used for near 100% accuracy, FirstDraft is used to get it to 90%+ accuracy. Given there is no human involved, this product carries significantly higher gross margins (80%+). More importantly, it unlocks the 80% of the market that is currently not being transcribed. For example, a court may not want to transcribe a court proceeding because they don’t want to pay $1,000 for a 100% accurate transcription but may be willing to pay $400 for a 90%+ accurate transcription. What makes this more appealing is that this will be offered as part of a bundled solution in 2022. This shift to a subscription like business model will look like this:

-        Old Model: Client has a pay as you go offering. They have 100 hours of recordings and 20 hours of recording that are required to be transcribed throughout the year which ultimately end up in 10,000 pages of transcription and costs $5,000. They pay VIQ as they go  

-        New Model: VIQ offers a subscription service to the client. For $6,000, the client gets up to 20 hours of recordings to be transcribed with 100% accuracy and the other 80 hours of recordings (that they did not subscribe before) the client can transcribe for free with ~90% accuracy.

Competition / Differentiation:

One common pushback is that the speech engine is not owned by them (owned by tech/FANG). However, that is a true commodity, and it is the software layer on top that makes all the difference (see above). In the speech engine realm, the larger players all provide this as an ancillary service. All the large speech engine providers offer a very similar service taking audio and transcribing it into a large file/meta data. However, they excel at different things. For example, Speechamatics may be better at transcribing certain accents and certain verticals (i.e. legal) whereas Google may be better at transcribing media and more consumer verticals. Nonetheless, the large players are unlikely to go downstream:

-        First, the upstream players provide one large file output with meta data. There are no application layers to view, edit, distribute, archive. The likes of VIQ convert this meta data to an application that a customer can use. It took VIQ 10yrs to bring this product to the market so it would take quite some time to create a cohesive and comprehensive application layer on top of the data.

-        Second, if they go downstream, they will piss off their customers because they would be competing with them. It may not be worth it. No one has looked to do this outside of Nuance. In Nuance case, they tried to focus entirely on one vertical specially in the health market (which is easier to transcribe than a court proceeding)

-        Third, the downstream market is extremely fragmented as decisions for this are done branch by branch (i.e. all the police departments in Austin are free to choose who they use on the transcription front). Such fragmentation makes it difficult for larger player to allocate time and resources.

The only true competition VIQ has is vs. other transcription providers. In the US, the market is extremely fragmented, and the competition must go court by court or county by county as noted to grow. Additionally, many times large companies have a handful of these vendors (i.e. the claims department at Geico may like VIQ but the customer service department may like “Company ABC”). However, the size of fragmentation does depend on the region. In law enforcement, the market is very fragmented in the US vs. being consolidated in Australia (4-5 large enforcement agencies) and somewhere in-between in the UK. In courts, US is fragmented and more concentrated outside the US (see the win rate for them in Australia). While the fragmentation is a challenge to scale, the size of each contract is also small; smaller deals could be $50-600K/customer. While barriers to entry are not significant, barriers to scale are indeed very significant. VIQ is exceptionally positioned competing in an industry of this size with the fragmented competitor base.

I believe VIQ differentiates itself on 4 fronts. 1) They are one of the few to offer a vertically integrated solution. Peers either do transcription only and then use someone else for recording or cloud or the customer itself does that on their end. 2) The company’s turnaround times are already the fastest in the industry (peers take 3-5 days) and FirstDraft will only elevate their competitive advantage. 3) When a customer uses multiple providers, they are winning the most complex contracts. For example, VIQ is the only one that can accurately transcribe a recording with 5+ parties speaking. Funny enough, they were the ones chosen to transcribe most of the Trump v Biden debates. 4) This is an industry where brand equity is important, and the company is the leader in the space.  They do business with seven of the top ten insurance companies and recently won a $30mm+ contract to provide services to Justice Courts in Queensland.  Such business success increases the likelihood of future success in RFP negotiations.

Overall, the company is very inexpensive on 2022 numbers and has a leading product in a market that over time should see substantial adoption of its services.  When factoring in the growing success of AI based transcription services coupled with the enormous market penetration opportunity, I believe the risk/reward is quite attractive.

Disclosure: At the time of publication, the author of this article holds a position in VIQ. This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a long position in the company covered herein and stands to realize gains in the event that the price of the stock increases. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use.  Any projections, forecasts and estimates contained in this report are necessarily speculative in nature and are based upon certain assumptions. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections presented. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

Strong execution on earnings and cash flow in 22/23