Chit Chat Stocks - Fundamental Analysis: Red Violet (RDVT)

Episode Date: May 3, 2020

On this show we discuss Red Violet. Find out why Brett gave it a rating of 7.3 and Ryan a rating of 7.  --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome in. This is the Fundamental Analysis Show on Chit Chat Money. My name is Brett Schaefer and I'm here as always with Ryan Henderson and we're talking a small cap stock today. First one we've done in a little bit here. It might be one of the smallest companies we've done. Probably the smallest besides Turtle Beach Incorporated. The market cap's only $200 million. It is Red Violet. Strange name but they are a software as a service company with some, they're a little interesting. but Ryan is going to try to describe what they do and then the history of the company. Yeah, so Red Violet is cloud-based and they specialize in data fusion and analytics. So Red Violet transfers data into intelligence that allows their customers to make better decisions. And it says they provide mission-critical solutions to enterprises

and the use cases for those enterprises range from fraud detection to risk mitigation to due diligence and even marketing. So right now, from what I saw, they have basically two solutions, or their solutions go through two products, which is their IDI core and Forewarn. And so they generate revenue by licensing those solutions. And so you can either make money through the licensing fees on a transactional basis, which is based on usage, or you can do it through monthly fees or a combination of both. And their contracts are typically annual contracts or longer,

So it's not necessarily like a subscription, like a fixed cost type of thing. It is contract by contract. I think each one's a little different. I had trouble finding anything about the history because they're really young and they are really small. I did see that their CEO, his name is Derek Dubner, and he has served as the CEO and director of Red Violet since its formation in August 2017. he continued as the CEO of Red Violet as Red Violet was spun off of the original company Cogent so there was a spinoff some point down the road and then in 2018 they were still in development stage of the business but as they've hired out their sales staff they've transitioned

into a sales driven company and according to their shareholder letter their management team has built two different companies before this that were information solutions providers and they sold them for an aggregate of a billion dollars. So it appears their management team has startup success experience. So that's good. That's a good sign. They IPO'd in August of 2019. So they're a really young company. It looks like they were started in 2017 and IPO'd in 2019. So yeah, very young. Yeah. And the business might've been part of a smaller company, but yeah, the individual company started in 2017, which is only a few years ago, but I'll get into the Financials here market cap two hundred and five million dollars ticker is our

DVT and the price is nineteen dollars and nine cents and that is of May 2nd 2020 So as you can see really really small market cap almost into the micro cap territory Evia to sales is six point five and they are Unprofitable which means so they have no positive cash flow and no well Maybe the last quarter they had positive cash flow but they have no positive earnings. Uh, so you can't really get that PE ratio, uh, margin adjusted price to sales of 15.5. That is price to sales divided by sales growth and gross margin average company. That is a high growth stock. Usually their software base that

we've done averages around 45 to 50. So 15.5 is quite low. And that's probably because it's a micro cap and micro caps are riskier and no dividend and shares were up five percent this year which isn't crazy for how young they are especially with the ipo like this you know that's something to watch out for the shared dilution over the next few years here free cash flow margin negative 15 very very clean balance sheet total liabilities were less than half of their working capital they probably got a lot of cash from the ipo which is why they're uh so well capitalized right now that's the whole point of the ipo and then lastly not much debt if at all really all the debt they have is their operating lease liabilities and i bet they have some contracts

with their data providers and then stock-based compensation being so high uh recently ryan will get into it in the earnings is their operating cash flow is positive but their net income goes down to super negative so historically their free cash flow margin is negative 15 but they've actually been improving that but the net income line doesn't look that great even though on a cash basis they're uh you know pretty sustainable or getting close uh to you know sustainably breaking even every quarter yeah and so i think a lot of that sbc or that stock-based compensation has to do with the ipo related costs there was uh so this year they had 9.9 million in stock-based compensation the year four was only 0.7 million so i yeah they run a tight share only only barely

100 employees so right all right but i'll get into the earnings uh their full year revenue increased 86 percent to 30.3 million they had a net loss of 11.1 million and that included 9.9 million in stock-based compensation um and i i'm assuming that's related to their ipo they had adjusted EBITDA of $1.9 million versus negative $4.3 million in 2018. So they are adjusted EBITDA profitable. Take that with what you will. Gross margins went from 47% to 60%, which we'll talk about because they have sort of that fixed cost structure, which will allow them to grow gross margin at scale. Their full year operating loss was $11.2 million. General and administrative administrative expenses doubled because half of that was stock-based compensation.

So they include that stock-based compensation in their operating expenses. That goes into general and administrative. But yeah, operating loss is $11.2 million. They're almost operating break-even if you exclude SBC, but it is a real expense, so it should be included in there. Operating cash flow positive for the first time. They have roughly $12 billion in cash and cash equivalents. $12 million.

$12 million, sorry. in cash and cash equivalents at the end of the year. Their IDI core customers grew 40% year over year and their forewarned users grew 168% year over year. Those are their two main products. In the fourth quarter, revenue from existing customers grew 177%. So their retention rate and their expansion rate on existing customers is a lot stronger,

which, I mean, if you've- It's really strong. It's a really strong number. I mean, they're coming off a low base and maybe that's not going to repeat, but 177% is phenomenal. Yeah, and if you've taken Business 101, everyone knows it's less expensive to keep an existing customer or grow revenue from an existing customer than it is to hire out a new customer.

So pay attention to that number. That's really important, and that's probably what accounted for most of the revenue growth this year. okay next up is digging trenches which is the moat rating tough for the microcaps here uh so i'm gonna go with one uh you know a company this small uh within this large of an industry it's it's tough just because they don't have that big of the market right now and that just gives them less of an advantage uh you know word of mouth stuff like that network effects um they're just not going to have the moat at this size yeah you're definitely not investing for the moat at

this point either um i know on their 10k they stated um competition as one of their like first primary risk factors but they didn't say who or they didn't say they didn't name any they said some are larger and have far uh far more financial resources but they it was pretty vague so i couldn't really tell um it looks like they differentiate their service in a little bit in like a few different ways but it was kind of hard to tell without knowing who the actual competitors were yeah so let's get to the next section further reading what do you got yeah so mine is the actual tech so i honestly i couldn't tell you step for step what happens in the process so i understand that and i'm talking more specifically with idi core maybe forewarn as

well. But what is the customer going through? What's the entire process like? I understand that they're getting the data from their suppliers, which are typically credit bureaus. I think they have one primary data supplier as well, but I don't understand the entire customer value proposition here. And if you're going to be an investor, I think it's important to understand that entire process step-by-step. Yeah, I think I'll explain it a bit here. So they have all this data and they can basically vet potential clients for customers. So say you are a Forewarn user and Forewarn is specifically for real estate agents. So this one's more niche. IDI Core is for large enterprises that want to do various things. So it's on a case

by case basis. But Forewarn, you subscribe to that if you are a real estate broker or agent that is showing houses so there is a big worry of people like taking over houses or like assaulting someone things like that so using that you have the person and it's a little big brothery but you basically vet the potential client that's going to come over and be one-on-one with this person um so you can you know help the safety of them and then that can apply basically on a fraud basis for liabilities researching people for large organizations that are say you're a lawyer or the better business bureau working with a client you want to know their background idi core can combine all the data sources and they talk about how cloud fusion or cloud and

data fusion can help with that and that makes them the best option to vet people um and it is honestly a little creepy you know it's a little surveillancey but that's just the business and people have been doing a long time and red violet specifically is trying to do it cloud-based with apis and then they think that with their data fusion it's proprietary they have like a bunch of tech experts with it that that can separate themselves from the competition so what would be like an example of a business that would come to them because they have they say basically anyone health care law offices legislative and it's it can apply to anyone that's working with people that needs to recruit people.

It's really applicable to anything that you're working with a physical person. Okay, what's your further reading? Competitors, they didn't mention any in the 10K and I was reading through it and they didn't say any specific companies, but it's a large industry. And I think there's gotta be some large competitors,

possible acquisition candidates are, you know, to acquire Red Violets. People talked about Google potentially being able to get into this. Facebook could do it as well. Although Facebook probably doesn't have the reputation to be able to do something like this, but Google could definitely,

they have all the data as well in-house. So there could be, you know, anyone that has these data sets, these huge data sets that, you know, you can buy or have a contract with, those could be competitors. And there's also people that do things similar to the IDI core,

but they try to separate themselves because they're cloud-based. You know, the typical, like, growth story the last five years, someone saying they're cloud-based software as a service stuff like that okay what about future growth opportunities so i mean right now they just have two things you could talk about maybe they could do other stuff with these data sets um and that's probably their long-term plan for the next five to ten years but i just have the growth of idi core um and that is spelled idi and then

core um i think they need to change the name uh because it's really hard to understand their uh whatever parent company is red violet and they have idi core as a subsidiary it's tough to understand from the name what the hell they do but i guess it sort of makes sense so this is their flagship of their two products they claim that they have this huge data repository idi core provides intelligence to support debt recovery identity verification legislative of compliance, etc. So universities can use this, law offices, etc. Basically, you're vetting people with public data. It's kind of a pre-hiring surveillance. Again, a little creepy. Right now they have over 5,000 billable customers and there's definitely potential globally for

100,000 customers at least that are sizable. Yeah. The other product that they have is forewarned and so we got into a little bit of a debate off the show in terms uh so i i thought it'd be a night i thought it'd be a good idea for them to and i didn't realize forewarn was basically subscription based but i thought idi core could create sort of um a subscription in which the customers could come to them because right now for idi core they've hired i think it's a 43 person sales staff um like they said they've pivoted to a sales driven company and so those sales reps go out and they get these big clients and they you know it's basically a more expensive way of marketing you'd say but um i thought there could be a subscription online

where the customers come to them it sounds like that's not the nature of that business because it's very case by case um but forewarn does do subscriptions so and in my mind that subscription where a customer comes to them says here's my needs you can have them met because of their data repository that scales much easier in my mind because you don't have to hire out a sales staff to attract those users um and then having the massive contracts is fine for idi core but this way it allows the customers to find them easier um but i was thinking that the way they could do it with forewarn is they branch out into one different industry at a time i think right now it's just real estate um this way just real estate yep they would retain sort of that low marketing

spend because you could just enter each industry on its own. And then that sort of allows for network effect or word of mouth among the industry. And I think I'm pretty sure the numbers for forewarned users were going like 180% year over year. So if you can go industry by industry and one real estate broker, whatever, one business, I think it's a user, so it's individual. So a real estate agent says, okay, I use this to scan or vet who I was meeting with. Other real estate agents are going to come to them, use that same kind of thing. And it's important to do that by industry or else you're going to end up spending tons on marketing if you're entering a bunch of different industries at the same time. So expanding forewarned into

different industries one at a time. Yep. All right. Highlights and lowlights. it's what do you got so the fix the fixed cost structure is quite appealing um in terms of growing gross margins they said they could have 80 to 90 percent gross margins at scale if i'm not mistaken i think that was in their shareholder letter uh that was in a blog post uh but it makes sense so this wasn't someone that's associated with the company they said they could get 89 percent gross margin is that is because the data um doesn't scale so they have that contract and And if they get more customers, the gross margin will expand. And they already grew, what, from 47% to 60%.

So you can see they're scaling up rather quickly on the margin side. Right. And revenue growth is really solid. And it's even better from their existing customers, which, like we talked about, is always better to have that. It looks like they can also be profitable on an operating cash flow basis. Low light SBC was pretty high. I'd like to see that come down as a percentage of revenue. and then also they might have to spend time and money to educate the customer or educate the

market on what they do. And maybe it's different. Maybe I'm just really bad with tech, but it took a long time for me to kind of figure it out. Spending money trying to educate the market can be wasteful. And I'm saying that particularly in the forewarned case. IDI core, it's sort of big enterprise businesses, so they probably know what they're kind of looking for and they know what they're getting. But if you're trying to go to individual real estate agents, there's probably a lot of educating you have to do on the market. Other than that, I didn't find a whole lot of lowlights with the business. I know you did, which you can probably talk about right now. Yeah, I'll go lowlights first then. So I talked about again, they are business slash platform

agnostic as it goes for IDI core, which gives them a large opportunity, but no reason for someone to specifically go to them. They're going to have to go to their customers, which is going to cost more. So they're going to have to spend a lot of marketing, although they are only spending right now 25% of their revenue on marketing and getting 86% sales growth, which is a solid number. Hopefully that can continue because that will give them the margins they need. One customer does count as 15% of sales, which is something to look after. 15% of sales is a lot. They definitely don't want to lose that customer. But the big red flag I have in bold here is their ex-chairman.

What's his first name? I can't remember, but his last name is Bowser. Had to settle with the SEC over a blockchain pump and dump scheme. That is a huge red flag. He had to retire while the investigation was going on in 2018 from Red Violet's board. He is not one of the executive officers right now. But with the connection to the company, I mean, especially with a micro cap, that is something you have to be concerned about. Yeah, I guess it's a good sign that they removed him or he removed himself because, I mean, we just kind of witnessed something with Airbus, which was similar in that the CEO or management was a part of like the largest bribery scheme ever.

And then they hired from within. so i guess there could be some concern that maybe the existing management knew about this but i think it's good that the chairman is out now and not a part of the company yeah and let me just go over my highlights real quick uh let's see 65 of the revenue is contracted which means it's going to be more recurring uh and that's is growing over time which i think is a good thing and they talk about the two you know they talk about the tam on their 10k and they say it's 275 billion dollar big data slash analytics industry um that's what it's expected to be in 2022 obviously they're not getting saturated anytime soon here so there's just no concern

there but they're definitely not uh after a 275 billion dollar market it might be you know three to five billion dollars which is still a lot larger than they are right now uh but yeah it's just funny when they always throw out those tan numbers yeah that and i feel like everyone does that in either like their 10ks is basically here's the entire market um yeah uber six trillion yeah right um okay uh rating what do you have for the stock okay if there wasn't the sec investigation and uh some other concerns with the 15 one customer i would be pretty high on this um but we just researched it the other day so i don't know enough about it uh yet although i do have I think I do have a good grasp of the business after going over it for a few hours.

So I think it's going to be in the sevens range, probably like a seven three. It's going on the watch list, but that investigation, I need to do more research on that because if I'm investing in a micro cap stock where the ex-chairman was part of a pump and dump scheme, I do not want to be associated with a pump and dump scheme because you don't want to lose your capital. So it's going on the watch list right now. But if they can succeed expanding those margins with the valuation they are at with the EV to sales of 6.5, they should definitely be able to have an EV to sales of 10. And if they can grow their sales above 50% like they have, that could be an opportunity for the nice potential for growth for them to be $1 billion to $1.5 billion market cap.

yeah with micro caps it's hard to find companies that check every box especially and if they do then they probably aren't checking the valuation box as far as valuation goes it's it's not bad honestly a margin adjusted price to sales of 15 and a half and uh actual price to sales of what was it six and a half when they're growing revenue at a 80 something percent on the top line those are all relatively favorable valuations however you're right there are some big red flags that ex-chairman with the whole pump and dump scheme is a big one and you have to have faith in management especially from micro cap companies um i'm gonna go kind of in the same range i do like the financial structure of the business that fixed cost allows for higher gross margins at scale that's nice to

see and it looks like they're that recurring revenue or not the recurring revenue the revenue growth from existing customers is really attractive as well. So I'm going to go seven, but more digging. I could see myself possibly taking a position. Yeah, we're definitely going to keep this on the watch list. I'm going to be reading the earnings reports. I love that it's a microcap that the conference calls are so short and the earnings reports are so small that it's not really that hard to go over compared to a giant company like Amazon or something, but that's going to do it for this episode. Thank you guys for listening. Make sure to follow us as always on Twitter at chitchatmoney to help us give us suggestions

on the shows and email us at chitchatmoneypodcast at gmail.com. That is chitchatmoneypodcast. Oh, go ahead. This one came from an email. So thank you for the idea. We appreciate it. It's a really interesting company. Yeah.

If you have any ideas and you're not on Twitter, feel free to email us. Yeah, because we can help you and it helps us as well. This is another stock we add to the watch list. Email us at that email name. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Thank you guys for listening. We'll see you next time. it's an honor don't you wish you could just hit skip on the worst parts of your life you know the same way you can skip an ad i get it i'm siaya and i live in ice cove

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