KeyStone’s Stock Talk Podcast Episode 170
We are back with a packed show this week. Ryan will start by discussing a few great points made by legendary investor Howard Marks in his annual memos.
In our Your Stock, Our Take Segment, we answer two listener questions. Aaron will answer the first on Mitek Systems Inc. (MITK: NASDAQ) which has its core business centered around mobile check deposit software and is shifting to the digital identity and fraud prevention arena’s. The growth and valuations look attractive – enough so that we included it in our recently released US technology report – Aaron answers if it is a buy at present.
Brennan will then look into Block Inc. (SQ:NYSE) a global technology company with a focus on financial services – its well-known business’ include Square, Cash App, Spiral, TIDAL, and TBD. The stock is down 61% in 2022 and 76% since its highs last year. Is this high growth business finally a fundamental buy – we let you know.
Finally, Brett will update us on a stock we called a cautionary tale in our last podcast, Voyager Digital Ltd. (VOYG:TSX) – cryptocurrency platform that offers a secure way to trade over 100 different crypto assets using its easy-to-use mobile application. From its 2021 highs over $32, the stock has dropped 99% to close this week in the $0.30 range. Brett called it gambling in our last episode, a few short days later, the company filed for bankruptcy.
Welcome Aaron, Brennan and Brett.
Aaron is back…how was your Vacation.
Howard Stanley Marks is an American investor and writer. He is the co-founder and co-chairman of Oaktree Capital Management, largely thought of as the largest investor in distressed securities worldwide. He is considered a great investor and writer and his annual memo’s are must reads for investors around the world. As an aside, his book “The Most Important Thing Illuminated, published in 2013, an update to his original – The Most Important Thing, published in 2011, while not a beginners book, is a good read. Warren Buffett calls the book “a rarity, a useful book.” That recommendation was good enough for me.
Book by Howard Marks: The most important thing.
Billionaire Investor Howard Marks has published Memos for over 32 years.
Today, let’s look at three worthwhile points from his recent Memo’s to discuss. The first point I pulled is in relation to Microeconomics 101. The funny thing is, I did a speech on the essence of this topic earlier in the year. I will go over the points, then we can discuss. These are great points for any investor to take in, consider and apply them to their own investment strategy.
Point #1: Price & Value
When you look at a company, two factors will decide the success of your investment.
Price and Value.
No matter how great a company is, at the wrong price, it’ll be a bad investment.
As Marks used to say: “There’s always a price too high.”
At the same time, a lousy company could(!) also be a good investment at the right price.
Long-term investments, however, should have both.
Quality at the right price.
****DISCUSSION: Growth at a reasonable price.
Point #2: Two Schools
Origins are in a quote from Mark Twain who said,
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” –
Marks differentiates between people of the “I know” School and people of the “I don’t know” School.
“I Know” investors feel like they can know the future.
Investing, then, is easy.
You decide what’s going to happen and act accordingly.
“I don’t know” investors are aware of their inability to tell the future and stick to specific micro situations.
In such micro situations, they can actually gain a knowledge advantage over other investors.
“I know” investors also tend to be skeptics.
They generally focus on what could go wrong instead of what could go right.
Buffett’s discipline is unparrelled – to stick to his principles. To stay out of tech to a large degree, until he found value that he understoond – then made billions with his investment at Apple.
Point # 3: Macroeconomics 101
Cycles are the result of emotional decisions in the markets.
Marks describes a pendulum that shifts between euphoria and depression.
Most of the time, it’ll be in the middle – a healthy state.
But every now and then, it swings to the extremes.
The important thing to remember is the self-correcting nature of cycles.
Once the pendulum is at an extreme, it’ll swing back and eventually end up in a steady state.
This creates an opportunity for investors who are aware of this.
Discussion…it can be tough to know when the pendulum has swung back far enough….
How do you make money as an investor? The people who don’t know think the way you do it is by buying good assets – a good building, stock in a good company, or something like that. That is not the secret for success. The secret for success in investing is buying things for less than they’re worth.
What determines the success of the investor is not what he buys but what he pays for it.
You can overpay for the best assets and lose money. You can underpay for the worst assets and make money. The best of both is to underpay for the best assets. But first, you need to figure out the value in its relation to price.
Mitek Systems Inc. (MITK: NASDAQ)
Price: $9.20
Market Cap: $408 Million
COMPANY DESCRIPTION:
Mitek is a digital identity and fraud prevention company. The company’s core business is its mobile check deposit software. If you have ever deposited a check to your bank using your cell phone then you have probably used Mitek’s software. 98% of U.S. banks use Mitek’s technology and the company has deposited 4 billion checks with a total cumulative value of over $1.5 trillion.
Mitek is also developing its Digital Identify Verification technology. The company has multiple products in this market including Mobile Verify which provides real-time ID document authentication, allowing companies to verify the identities of current and prospective customers as a security measure. Digital Identify Verification is the long-tern growth driver of the company.
FINANCIAL OVERVIEW
Mitek is a highly profitable and cash flow positive software company with a strong track record of growth. In the most recent quarter, total revenue increased 21% year-over-year to $34.7 million resulting in a record second quarter for the company. Non-GAAP net income increased 49% year-over-year to $10.8 million, or $0.24 per diluted share.
Last year, Mitek grew its revenue 18% and non-GAAP EPS 19% to $0.76 per share. Mobile deposit revenue increased 11% to $75.5 million and ID verification revenue increased 32% to $44.3 million. The company has reported 8 consecutive years of revenue growth an average compound rate of 26% and 6 years of profitability.The balance sheet is okay with $62 million in cash and $132 million in debt. Mitek’s net debt-to-EBITDA ratio is 2.5 times which we would consider on the high end for a software company but we have no near-term concerns.
The valuation is very interesting with the stock trading at about 10 times trailing non-GAAP EPS of $0.91 per share.
OPERATIONAL OVERVIEW AND RISKS
Given the growth rate and future growth opportunities, the valuation looks very attractive…at face value. However, when we dig deeper into the company, there are some concerns that we have which is why we are still monitoring the stock and not ready to recommend it today.
Looking at the current operations, the mobile check cashing business accounts for 63% of revenue but it also accounts for 100% of cash flow and earnings. The Digital ID Verification business is where the long-term growth opportunities lie but as of today, that segment is still losing money.
In March of this year, the company closed the acquisition of a U.K.-based company called HooYu for US$130 million. This is a sizeable acquisition for a company like Mitek. The company expects that HooYu will be a transformational addition to the ID Verification business, but HooYu is also burning cash flow and the acquisition will actually delay Mitek’s target of net profit in the ID Verification business. Right now, Mitek expects that the ID segment will be cash flow positive by the second half of fiscal 2024.
The only thing making money for Mitek right now is the check deposit business and of course the usage of checks are in decline. Declining at about 3% to 5% per year. Mobile check deposits are growing but eventually they will start to decline at the same rate as checks generally. Long-term, Mitek knows it needs the ID verification business, but for us this business isn’t fully proven until it starts to make money.
Another overhang for Mitek is that there is a lawsuit. The United Services Automobile Association (USAA) has sued claiming that Mitek’s mobile check deposit software violates its patents. The USAA has actually gone after Mitek’s customers and received some very sizeable judgements. There is really no way of knowing where this legal action goes or how credible the claims are but its definitely an overhang for Mitek.
CONCLUSION
The financial performance, valuation and potential growth prospects for Mitek all look great. What we would need to see from the company is ideally two things. One would be some more clarity regarding the lawsuits and how this will impact Mitek. I don’t know when this is going to happen as these legal actions can drag on for many years. But at the very least, we would want to see the Digital ID Verification business transition into positive cash flow and start to become the primary source of growth and profitability for the overall company. This would validate the technology financially and also reduce Mitek’s dependence on its mobile check deposit business which is less of a long-term growth driver and subject to the legal issues.
For now, we sit on the sidelines but it’s a very interesting, cash flowing business and we will continue to monitor it closely.
Your Stock Our Take
—————–
Block Inc. (SQ: NYSE)
Current Price: $64.46
Market Cap: $38 Billion
What does the company do?
Block is a diversified technology company, co-founded and operated by Jack Dorsey (Twitter co-founder), with a focus on financial services. Made up of Square, Cash App, Spiral, TIDAL and TBD, the company builds tools to help more people access the economy.
- Square helps sellers run and grow their businesses with its integrated ecosystem of commerce solutions, business software and banking services.
- Cash App, allows individuals to send, spend or invest their money in stocks or bitcoin.
- Artists use TIDAL to help them succeed as entrepreneurs and connect more deeply with fans.
- Spiral (formerly Square Crypto) builds and funds free, open-source Bitcoin projects.
- TBD is building an open developer platform to make it easier to access Bitcoin and other blockchain technologies without having to go through an institution.
Key Points:
On December 1st, 2021, the company announced that it is changing its name from Square to Block, which acknowledges the company’s growth away from its original POS Square business.
On June 2nd, Square announced that it is working with Apple to enable Tap to Pay on iPhone within the Square Point of Sale app.
Block has made five acquisitions over the past four years – the most notable being Afterpay in January 2022 – an Australian Fintech company known for its buy now, pay later service (BNPL). And following the acquisition Square launched its first integration with Afterpay, providing BNPL functionality. The integration will enable Square sellers to offer Afterpay’s BNPL experience to their customers, helping them attract new shoppers and drive incremental revenue.
Recent Financial Results: (Q1, 2022) ALL IN USD$
- Revenue was $4.0 billion, a decrease of $1.1 billion, or 22%. This was primarily due to the decrease in Bitcoin revenue from decreased Bitcoin trading and volitilty. If we exclude revenue from bitcoin and the Afterpay acquisition, revenue was $2.1 billion, up 36% year over year.
| Q1 2022 | Q1 2021 | |
| Transaction Based | 31.1% | 19.0% |
| SaaS | 24.2% | 11.0% |
| Hardware | 0.9% | 0.6% |
| Bitcoin | 43.7% | 69.4% |
| Total | 100% | 100% |
While bitcoin revenue contributed 44% of the total net revenue in Q1 2022, gross profit generated from bitcoin transactions was only 3% of the total gross profit in Q1 2022. SO TOP LINE REVENUE FLUCTUATES WIDELY WITH BITCOIN REVENUE… BUT THE BOTTOM LINE DOESN’T.
- net income was $103.7 million or $0.18 per share, a decrease of 39.0%.
- Adjusted EBITDA was $195.4 million a decrease of 17.3%.
The decrease in profitability was due to an increase in operating expenses, including expenses related to the Afterpay acquisition.
Balance sheet – Cash of $4.8B; Leases & Debt were $5.2B. Providing net debt of $363M. It is also worth noting that Block had $149.0 million in Bitcoin on its balance sheet under its Non-Current assets.
Valuations:
Block trades with a trailing EV/Adj. EBITDA multiple of 35 times, a trailing P/FFO multiple of 30 times, and a P/Adj. Earnings multiple of 44 times.
Our Take:
Block is a diversified technology company, co-founded and operated by Jack Dorsey (Twitter co-founder).
The company’s legacy Square seller business has made a reputable name for itself as one of the best point-of-sale (POS) systems on the market. Plus, the company’s Cash App – which was developed in-house – has garnered great success with more than 44 million monthly transacting accounts (as of December 2021) across the United States and Europe. And in 2021, across the iOS App Store and Google Play in the U.S., Cash App was the number one finance app and the number four app overall, based on downloads.
The Afterpay acquisition is interesting which enables Square sellers to offer BNPL services as well as Cash App users to manage their installments through the app, which should support synergistic organic growth into the future.
Excluding the company’s highly volatile Bitcoin revenue, Block’s revenue compounded at a rate of 35% from 2019-to-2021. Plus, Block has a healthy balance sheet, and was able to generate a profit during the 2019, 2020 and 2021 fiscal years, on both an adjusted and GAAP net profit basis. But one thing to note is that GAAP net income has declined over the three years due to substantial share-based compensation.
Though management did not provide financial guidance, earnings and profitability are likely to decrease this year since the company’s first half of 2022 has been off to a slow start, and the next two quarters have tougher comparable financial results to lap from the 2021 fiscal year.
Considering the company’s quality name, tech diversification, healthy balance sheet, great track record of growth, and valuation multiples – the business is interesting! But the company is highly sensitive to an overall economic downturn and a reduction in consumer spending given its transaction-based business. And the company has exposure to credit risk with Afterpay’s BNPL operations and Square Loans (Small-Medium Business lending). Therefore, due to its anticipated weaker fiscal year, lack of concrete financial guidance, sensitivity to the overall economy and the necessity for the company to showcase its ability to chart back into GAAP profitability during the second half of 2022 – it remains a Monitor in our books.
Voyager Digital Ltd. (VOYG:TSX)
A quick catch-up from our last podcast’s segment on Voyager Digital:
Voyager Digital is a publicly traded cryptocurrency exchange that wrote a bad loan to three arrows capital, who defaulted—causing Voyager Digital to have liquidity and Solvency issues.
Since then, Voyager has declared Chapter 11 bankruptcy which allows for reorganization of the company. This leads us to Voyager’s current restructuring plan:
All equity is cancelled, so if you are holding the halted shares under this plan, they are worthless.
US Dollars are FDIC insured; this does NOT include any stablecoins, only standard American Dollars.
Customers will receive a pro-rata amount of crypto held, Three arrows Capital recovery, common shares of the new company, and voyager token. As of right now, the exact numbers of the amount that will be received are not stated but will likely be known in the near future.
Aside from Voyager’s stated plan, Kaj Labs, a blockchain developer, has issued a letter of intent of an offer of $250 million for Voyager’s remaining qualified assets, including; APIs, customer lists, branding and IP. If this sale goes through, it may fill the current hole in Voyager’s balance sheet or at least a portion of it, allowing customers to receive a higher amount of assets.
In summary, the equity is gone and customers are getting some of their holdings back eventually.
