(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long ID.V)
Investing in microcap companies is my passion. I've learned that dedicating my time to this segment of the market can lead me to outsized returns and a better understanding of the factors affecting a company’s success. Recently, I took my first self-paid site visit to do further due diligence on an investment of mine. I've done site visits in the past sponsored by sell-side brokers, but with most microcap companies, brokers won’t give them any love unless there’s a paycheck in it for them. So if I really wanted to know what Identillect Technologies (ID.V) was all about I would need to pay them a visit.
Image of Todd Sexton (left) CEO of Identillect Technologies, with Akshay D’Souza, Managing Director, Trading at Laurentian Bank Securities:
When we got to the office, we thought we might have uncovered a boiler room operation. This was Identillect’s listed office, but the name on the sign was not! When we opened the door, we were relieved to find a fellow suit greet us. It was the man we were there to meet, CEO of Identillect Todd Sexton. He was the first person we saw in this commuter town to wear a suit, aside from my friend and I who were ironically wearing matching uniforms (navy suit jacket with khakis and runners). Todd explained that he didn't want to spend the $500 it would cost to remove the last tenants name from the front window. I thought this was a valid reason. I’m all for conserving shareholder money.
CEO Todd Sexton is passionate about his business. He lives in San Diego but works out of his office in Lake Forest, CA (2hr drive) during the week. His day starts at 7:30am when he debriefs his sales team of six. His first task of the day is to get his team prepared to tackle a long day of making sales calls to promote the company's product, Delivery Trust. I'm told that each salesperson makes between 120 and 160 sales calls per day, obviously not an easy task. During our meeting, I couldn't help noticing the whole sales team standing while working. This is a successful sales trick that keeps energy high, and forces the whole team to see one another, busy trying to close deals.
The business of preventing privacy breaches is currently a $2 billion market in North America alone, and is projected to be a $5 billion market by 2019. In 2016, only 2% of all emails were encrypted. It has been suggested that by 2018, 9% of emails will be encrypted, rising to 50% by 2020.
Europe has taken a hard stance on accountability, making protection of all personal identifying information (PII) mandatory by May 2018. The fine for non-compliance can be as large as 4% of a company's gross revenue. Not only are companies in the European Union subject to this legislation, but also anyone who wants to do business with these companies (including North American businesses).
Legislation across North America will be harder to change as individual states, and governing industry organizations will need to tackle the issue. But we're starting to see inroads in some of the most vulnerable industries. HIPAA (Health Insurance Portability and Accountability Act; US law enacted in 1996) has already started enforcing data protection amongst its members. Recently, they assessed a $5.5 million fine to one of their members. The fine was for each email with PII data that was not encypted. Todd truly believes we will start seeing states introduce some form of legislation within the next year to make PII protection mandatory. The more often we see large data breaches, the more likely we are to see governing bodies forced into action.
The real estate industry is a good example of how one small data breach can lead to a large loss. Imagine you are selling a house. Your house gets listed, and on the public domain your house is listed and viewable online. After the home is sold, and before money and keys have changed hands, your agent needs to contact lawyers to transfer money between the buyer and seller. Now imagine someone has gained access to your agents email and password, and now has the ability to email their own wire transfer details to the lawyer. One hacked email address can lead to the loss of millions of dollars. In fact, this exact scenario happens on a regular basis. A collective of Century 21 real estate agents in Florida are making sure this never happens to their clients by being early adopters of Delivery Trust. Identillect's Delivery Trust plug-in ensures that private data is handled and secured at all times, with relative ease of handling for the sender and recipients. Todd sees the real estate sector as being the low-hanging fruit for his company. His desire is to present at more industry tradeshows, and he now knows exactly which ones to spend his time on.
It's still early to tell if Indentillect will be a winner in the large and growing encryption technology sector. But l like their chances with a strong and personally invested management team (18% ownership) with an award-winning platform-agnostic encryption solution. The recently announced completion of their warrant acceleration will give the company another $1.3M CAD; adequate funds for expansion capital and should be enough to get the company to profitability. It’s also good to see the large amount of shareholder support; over 80% of all issued and outstanding warrants were exercised.
Current cash burn is roughly $120k per month, and current net cash burn is closer to $60k. There is $400k debt in the company, but the originator is friendly, and has termed this out for another year. He has also participated in every round of financing for the company since inception.
The main risk I see right now is the uncertainty of the company landing a larger contract (think 5k to 20k users). It takes many months for a large organization to take action, so we can only be certain of the smaller organic growth that we have been seeing from the sales team. Historically, an average month would see gains of roughly 1,000 new users. I think Identillect can ramp up to 2,000 with an expanded sales team and increased awareness of the Delivery Trust brand.
You could label this a story stock at the moment. If you try valuing the company on current metrics, we would see roughly 6x current 2017 sales. This however, does not give the company credit for their 35% - 40% CAGR, which we expect to continue for at least the next five years. And we are not factoring in any large wins, where one larger contract could cut its valuation in half. On top of that, this company only has an enterprise value of $8M ($0.10 CAD). I would say that is not overpaying for a "story stock" which already has a decent SaaS recurring revenue base (~22,500 current users). The company charges between $6 to $10 per user, per month. So the magic number to break even is roughly 35,000 users given the current revenue mix.
With the recent infusion of funds, Identillect now has the resources to add a couple of new sales people, one more developer and potentially a product manager or customer service rep. Getting to profitability is what I want to see, as a long term investor that wants to see the risk-side of the equation reduced.
My takeaway from the site visit was a positive one. It gave me the comfort to invest more into the company through the exercise of warrants at 10 cents. There is still risk in achieving profitability with this company, but I believe Identillect has the pieces in place to get there.
If anyone has any thoughts or comments on this company, I would love to hear them.