Chit Chat Stocks - Mitek Systems (MITK) | Not So Deep Dive

Episode Date: December 14, 2021

Mitek Systems is a software company that specializes in digital identity verification solutions. The company serves over 7,500 financial service organizations by allowing users to perform mobile deposits. Mitek commands roughly 98% market share in mobile deposits. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Mitek Systems. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Special promotion through the end of 2021: Subscribe to 7investing with the code "chitchat" and get $50 off your annual subscription: https://7investing.com/subscribe/ Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (3:14) Industry | (10:08) Management & Ownership | (12:18) Valuation | (15:46) Earnings | (17:13) Balance Sheet | (20:08) Our Analysis | (21:36) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chitchat Money. Let me explain, because we always forget to do this, what this show is. So we're just going to go through the

basics of a company in about 30 to 45 minutes. Typically, it'll take about 45 minutes, but we're going to cover the basics of the history, what they do, basic financials, earnings, different business lines, future growth opportunities. And this is really the first time we're looking at a company. So we're looking at the basic SEC filings. We're looking at their earnings presentations and their conference calls and trying to get an overview for anyone to get inspired maybe to learn about it more. I hope that explains it correctly. We have Brad on the show as always every other week. Brad, have you heard of Matek Systems, the company we're talking about today? No, not at all. First experience with it. Yeah. We're in the small cap realm here. I think

the market cap's around $750 million, so a lot smaller than what people are used to. This isn't the Shopify's or the really popular stocks of the world. Hopefully, this can put another company on someone's radar if they're interested. I'm going to let Ryan introduce the company, but first, we need to talk about our sponsor for the Not So Deep Dives, Potential Multibaggers. The aim of the potential multi-bagger service is to find stocks that can go up 10X over the next 10 years or compound at 26% per year. And so far, their track record has been very stellar. So they've picked Cloudflare at $39 a share, Upstart at $128 a share, although that one's very recent. They picked Square at $75 a share, Roku at $113 a share. Very strong track record for the potential

multi-baggers picks. Ryan, you have something to add? Also, if you're interested in learning about, I guess the way Chris looks at businesses shameless plug for ourselves. He recently came on and talked about upstart with us. And it gives you a glimpse into his sort of process. Yes. He's been on the show multiple times. If you want a promo kind of what he does behind the paywall you can go listen to those, see if you're interested, but potential multi beggars does a deep research about the companies behind

the tickers they own for every pick. You get five articles together about 20,000 words, but spread over several weeks so you can keep up, help researching together, really bridging the gap for someone that may not be an expert in finance, may want some help if they want some picks for stuff that's not an index fund and they just want some help along the way. So if you want to become a multi, you should go to Seeking Alpha and look for From Growth to Value, Google it, or go to at From Value with no capitalizations on Twitter. All right, Ryan, do you want to introduce Matek Systems and talk about the special promo we're doing for

7investing? Yeah, we've mentioned this before if you're a recurring listener, but we have sort of a holiday promo code with 7investing where you can use chitchat and you get $50 off the annual. If you aren't familiar with 7investing, they give seven racks a month and it's great research. It's a great way for us to kind of find new ideas. At least that's the way we use it. So go ahead, check them out use code chit chat get 50 off without further ado let's get to my tech and is it my tech or my tech uh i don't know i i am entirely unsure it's it could be my tech we're gonna go with my tech i think yeah m-i-t-e-k ticker is m-i-t-k for anyone that doesn't know since it's kind of a hard spelling on here yeah but uh my tech systems is the leading or a leading

provider of mobile capture technology and digital identity identity verification solutions and i I know that's kind of a lot of tech lingo, so I'll kind of dive into what it is, but they serve more than 7,500 financial services organizations, and it's pretty much just two business lines. So I'll go through each of them, but it might be more than that 7,500 institutions figure. It's just they haven't reported their second 10K, which is when they usually up the figure on it. So once they get that out, it might be a little bit more.

But the first part of their business is mobile deposit. And so this accounts for 67% of their sales, and it's the older part of their two businesses. So today, when a customer wants to deposit a check with basically any financial institution, I believe, you can open a banking app, scan the front and back of the check, and have it instantly deposited. In most cases, that's Matek's mobile deposit technology at work. And so they have sort of, they say it's AI or machine learning, but they can capture it. They can scan that check and they can instantly deposit the specified amount.

And 90 of the top 100 banks, U.S. banks use them. And I think it's somewhere like 98% market share within mobile deposit. So this really is their, I guess, entire industry. And in exchange for the service, Matek collects a fee on each check deposited. It used to be around $0.50 a check, but has since increased to around $0.85 per check. And the bank will usually front this cost. They don't pass it along to the customer. And if you're wondering, why don't they just pass it along?

This is such a cheap solution compared to opening a branch and having to have an operating branch in order to collect checks or to have an ATM, to install one or to use a third-party ATM and have their fees. this is the cheapest solution by far. And it also helps with security and ID verification, making sure it's the person that's actually doing it. If you don't have that as much, the backend on figuring out, I don't know, you can lose a lot of money if someone's doing fraudulent activity and this can help with that. And then I guess the second part of the business is the mobile verify, which I think Brett partially just alluded to. And this accounts

for 33% of revenue, but it's much younger and it should be a bigger part of the business moving forward. And so Mobile Verify helps banks make sure that people are who they say they are. And so if someone is applying for a loan or opening a bank account or anything that could be, I guess, costly or sensitive material, something that someone might pretend to be someone else for, let's say, Matex verification algorithm can scan their ID and authenticate that it's really them. And they built this part of the business largely through acquisitions. And so i think the the process i guess is that they have this installed customer base with a lot of banks and then they can kind of cross sell this this verification feature to them um and it's a this

industry that the verification side is growing pretty quickly because uh fraud i guess is getting deep fakes are getting more advanced and so they're they're trying to find the technology to combat it and they're paying up for it well it's not just deep fakes i guess mainly in general people trying to fake identities online and with people, yeah, with stuff moving more and more online commerce, everything, interactions, stuff like that. If everything's going through online, if you're doing all your financial transactions through the digital world, then it's a lot easier for people, at least right now, to, I don't know, have a lot of fraudulent activity. So it's growing quickly. And it's very costly for them too. Banks have huge expenses if people are able to pretend

to be someone else. But I'll get into the history a bit. So Matek Systems was first founded in 1986 and the company's headquartered in San Diego, California. For the life of me, I was digging maybe for like an hour to try to find history and I couldn't find anything. I have no idea who the founder was. I saw that they started as sort of like a tech software company and they kind of pivoted, I guess, since. But they've been public pretty much their entire life. So after being founded in 1986, I think they went public in 87. And interesting note, they lost more than 94% of their value in the dot-com crash. Still alive today. So if you bought the dip, congrats. But other than that, from what I could find, the only other notable historical items for the

company were basically lawsuits and acquisitions. So they settled a dispute with USAA in 2014, but that feud doesn't seem to have ended yet. In 2018, USAA sued Wells Fargo and then PNC Bank for patent infringement of their mobile deposit capture technology, which was supplied to them by Matek. So if you're thinking like, how does a lawsuit between USAA and Wells Fargo pertain to matech wells fargo could seek to be reimbursed by matech and so there is sort of that legal uh i guess downside um if the suits go through but it's it's been a decade almost of kind of legal fights with usaa um yeah they're pesky they seem like kind of one of a little bit of a patent troll type deal you know yeah it's i guess that's possible um so and that is it's important to

the investment actually. So it's not like this is some tiny lawsuit. So I think keeping up with that is if you're an investor, it is important. Yeah, definitely. And just for reference, if you look at their, they basically restarted the business in like 2010 when they came out with this mobile check ID stuff. So it's almost like it was a new team around then. If you look at their revenue per share numbers and stuff like that, it was totally collapsing before 2010. And then they kind of restarted this new business model and now they're almost a whole new business. And so it's almost like the business is only 10 years old, but it's kind of in the shell of what this company used to be from the 80s.

But I'll go over the industry and competition quick. Very simple. They have mobile check deposit industry and then the digital identity solutions. Mobile check deposits is very easy because as Ryan mentioned, they're basically a monopoly with this market. So just look at their revenue. That's kind of what the market size is. A lot of people have argued that this is going to be disappearing.

However, they're actually growing that revenue, at least when we were looking at for the recent quarters. But there is that worry that that is kind of a declining industry and you can kind of see the path maybe over the next 10 to 15 years of that business going away almost entirely. It's like the decline in checks, the decline of checks and circulation is being offset for Matek by the amount of checks that are being deposited through digital solutions instead of like physical. So at some point, you could probably say that checks will go out of the way, but it hasn't happened yet. So that market's still going around for them. But the identity verification market is probably the one that people are most interested in from a TAM perspective. And that is estimated to be Biomatech themselves. I'm sure they use third-party solutions, but this is their own

TAM estimate of about $7.6 billion that is projected to grow to $15.8 billion by 2025. And then management claims with their ID R&D acquisition that their TAM is going to expand to $23.5 billion. Again, those are kind of just numbers that are thrown out there, but you can kind of tell it's a very, you know, it's not a large, like super large industry, but it's a big industry and the needs are growing quickly from all the customers out there. And then their competitors, they have plenty of them. There's Jumio, there's IntelliCheck, there's IDNow, and then there's a ton of smaller

competitors. Jumio and IntelliCheck are two of the bigger ones. But Matex Systems, I believe, is the largest one in this industry, at least right now. And there's lots of other small startups than Matex Systems, like Joe Quire, like IDR&D, which we'll talk about later. And management does talk about this as being part of their strategy. Explicitly, like on every conference call, they say that their acquisitions are something they're trying to do to fortify their identification solution process. All right. Management and ownership. Brad, do you want to hit that up that for us? Yeah, for sure. So Max Kamekia, he is the current CEO and president since November 2018.

He's got a 76 percent Glassdoor rating, not a whole lot of reviews. So take with it what you will or take from that what you will. He was a former CEO of Illuminate Education, which is basically SAS meets education. And then he was the CEO for a couple of other companies that he fostered a few years of profitable revenue growth with and margin expansion with. The companies are Interwoven and Acceleris. But other than that, not a ton of notable experience. But the experience he does have, he was successful with a few very lucrative exits and that profitable growth I talked about. The CFO for about five seconds was, and I thought this was interesting to mention, was Susan Repo.

Um, so she was the, she looks like she, it looks like she was the CFO from June to July of 2021. Um, there was a news release and then nothing. Yeah, go ahead, Ryan. I was going to say it to have a CFO with the last name repo is a very good investment omen. Uh, cause hopefully they'll buy back stock. Yeah. But repo repo operation, you know, that's, you know, organized crime. I don't know. It could be a double-edged sword. Isn't repo short for repurchase? Yeah, but yes. Yeah. I think it's also short for repo operation all right well anyway continue brad sorry yeah but so she was there for 30 days and then now uh she's not she's not the cfo anymore but she is a board member um so

she's still around she was uh the former cfo of tesla finance and the vpa finance and corporate treasurer at tesla so i know a bunch of a bunch of people just just perked up a little bit hearing uh hearing the name tesla either loving it or hating it it depends on who you are yeah Polarizing for sure. But the current CFO is Frank Tarullo. I'm guessing on some of these pronunciations, so I'm sorry if I'm incorrect. But he was the former COO of a company called Adara and then a few more companies he was the CFO of that he fostered a lot of lucrative hypergrowth, just like Max Karnecchia. But then the CTO is Stephen Ritter. Right now, he's been there since March 2016. He's the longest tenured executive or important executive

that I found. He came as a senior director of engineering at McAfee. And he's been, like these other people, the executive at a lot of other firms that are private and tiny that I've never heard of. But in terms of ownership, it looks like there's been quite a few leadership teams for this company over their long history. So kind of unsurprisingly, it looks like directors and executives on their own only have about 3.4% of the common stock overall. They do have some handsome options packages. Max, his share count can go from 120,000 shares to 170,000 with the options packages that he already has in place, and he'll get more if he succeeds. And then it looks like, which stands in contrast to insider ownership, about 70% of the company

is held by institutions without a lot of accumulation or selling activity. It's pretty typical for a company that's about 40 years old and has had a lot of different leadership teams for institutions to accumulate ownership over a long period of time and for current owners or current executives not to have a large stake. So nothing super concerning there. Right. That's a good overview of the management and ownership. I'll hit valuation quick. Pretty simple. Market cap is $784 million. So it is a small cap. Ticker is MITK. However, enterprise value is definitely relevant here. They do have a lot of net cash on the balance sheet. My calculation was that enterprise value is about $678 million. I was just using some basic

stuff. You could maybe come up with your own number. It's probably around there, maybe a little higher, maybe a little lower, depending. But I'm going to use enterprise value because they are cashflow positive and the cash they have, it doesn't sound like, especially because they're able to be cashflow positive while investing for the identity solutions segment. That cash is definitely available for shareholders whenever they want to. but EV to sales is about 5.7. EV to gross profit is about 6.4. So as you can tell there, gross margins are extremely high, which we're going to get into next. And then EV to operating cashflow is approximately 18. So pretty standard multiple there. Lots of potential dilution though

from the convertible notes they have in the balance sheet. Fairly easy to understand those. If you look at the SEC filings, you can get the details on those. I'm sure Brad will talk about that a bit too. And they actually haven't granted any options for this year as of June 30th. And they have granted 808,000 in restricted stock units. And if we look at their shares outstanding, they have about 44 million. So decent dilution, that's probably coming. And they've had some dilution in the past. So I think I would expect that to be a slight headwind. But Ryan, do you want to hit earnings? Yeah. And they just, as I mentioned, they just reported their full year earnings, but they haven't filed their 10K yet. Maybe it comes out before this, I guess,

gets published, but just keep an eye on it because there wasn't a cashflow statement on their earnings release, but it will be on the 10K, obviously. And so full year revenue was $120 million and that's up 18% year over year. And they break it into software and hardware revenue and then services revenue. But if you go into the 10K and you key in how much comes from mobile deposit and how much comes from verified, they do give those numbers. So that is something that's important. They do hide it, but it's important to look for. And then they have 88% gross margins in aggregate, but the software and hardware revenue has 96% gross margins. And then the services side isn't terrible. It's just not quite as high as that software and hardware revenue that

they have. And if you think about it, if you just think about the business where they're basically signing on with a bank, providing that capture technology, basically it's being used by customers with their phone. There isn't a lot of input costs to that. Basically, they've got to sell to the banks and that's about it. So naturally it's pretty high gross margin. And then they had about $37.4 million in operating cashflow for the year. That's a 55% versus a year ago. That's about 31% operating cashflow margins. And then judging by last year, there's typically minimal capex. So free cashflow should be close to operating cashflow. They do spend about 10% of their revenue on a stock-based compensation. And they raised a $135 million convertible note

at a little under $21 a share, which is due in 2026 for reference. Find my text stock price right now. It's 1750. Okay. So I guess there's probably a good chance that converts. And so there will likely be some dilution down the road. Other things, as far as earnings go, net income is minimal. I think they are probably writing off some of the acquisition costs, which I guess just helps with minimizing taxes. Yeah. I guess it's hard to tell. You probably have to dig. I didn't confirm any of that, but it's definitely, they have quite a few non-cash charges. There's also a buyback that they announced. So it's- They did a tiny, tiny amount. They did like $190,000 worth. So it's authorized for 15 million,

but they've only nibbled thus far. So I don't know. I'm sure we'll talk about that later, maybe in highlights and lowlights. But Brad, do you want to talk about balance sheet and liquidity? Yeah. So cash and then also really liquid investments where they keep most of their liquidity is 227 million. As we talked about a little bit, cashflow from operations is 25.6 million over the first nine months of the year. 8.5 million of that is stock-based compensation. So notable needs to be mentioned, but not egregious or anything like that, not Snapchat or to that degree. But 120 million, as we kind of talked about, outstanding and convertible senior notes. So that's based on the market cap, 15% possible maximum dilution. And that looks to

be their only debt aside from a $10 million credit facility. So this $120 million, they actually issued $155 million, and then they paid off some more expensive debt. So it looked like a savvy move to me. And then the conversion does actually have an interest rate of 0.75%. Sometimes we see zero interest rates like we've seen in some other growthy stock convertible rights deals, but they, and they do have some pretty handsome conversion rights as Ryan talked about. Um, but, but yeah, not, not nothing crazy on, on, on 0.75%, but, but not zero. Like I was sort of expecting it to be, but, but again, nothing crazy. Yeah. It's interesting. They would choose to do convertibles since they're already fairly profitable, but maybe they wanted the balance sheet for the

acquisition strategy they're doing. It's kind of hard to tell. Um, all right, let's hit the ad break. this episode is brought to you by La Quinta by Wyndham here you are miles from home and ready to start your vacation good thing you're staying at La Quinta by Wyndham they have free high-speed wi-fi to stream all your favorite movies and in the morning get fresh waffles with their free bright side breakfast or squeeze in a workout at their fitness center either way you're ready to conquer the day. Tonight, La Quinta. Tomorrow, you triumph.

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be enabled in the panoramic wi-fi app restrictions apply all right welcome back next up we have anecdotal evidence this one is tough because anecdotally like you're not actually interacting with my tech systems or my tech systems whatever it's called you just you are but you don't know a lot of the times like you're not the brand isn't them uh but let's kick things off with brad uh what are your thoughts anecdotally on this business you have any uh i guess i've used my bank of america account to deposit checks and that that's been pretty cool and convenient not having to go um to to an actual place to do it and just being able to do it from home but that that's that's the extent of my anecdotal evidence i don't even know if matech and bank

of america are are in or contractually partners but it seems like it based on the 90 market share for the check deposit thing. Most likely, yeah. I think they probably are. How about this for a question? What type of pricing power do you guys think they have? I guess we'll start with Brad and go to Ryan for the mobile check deposit.

Yeah. So kind of like we've alluded to a little bit, it seems like Venmo and Cash App and really laser fast money wiring and things like that are maybe a little bit more convenient than having a physical checkbook and having to convert that physical experience

to a digital experience via the picture. But it seems like that can all kind of happen on a smartphone to me. And I think we're getting close to that point. So in terms of pricing power in that environment, I think it goes away, to be honest. And it kind of becomes, how do we make our experience more affordable

than this other experience versus more convenient than the current experience? but that yeah that's kind of how i see it that's an interesting point you would think they're kind of locked in but with the industry dynamics of a lot of people kind of leaving the check world sort of like us i'm sure none of us have really deposited checks at any sort of frequency you might argue that they don't have that pricing power just because they at some point say bank of america says no you know what we're just going to put everyone and say let's switch you to zell kind of deal like we're going to try to toss you on there but some people i don't think made that

some people are probably hesitant to switch from checks it's kind of a there's some friction there i don't think any bank i don't think any bank is going to eliminate the ability to accept mobile checks no but they might that's yeah stupid but they might they might try to get people off of them if matek raises prices too much or just lean on them far less heavily um so which eliminates the pricing power from attack i mean they've raised it by like they've raised prices by like 11 percent annually since 2015 and banks haven't seemed to bat an eye i don't i doubt they're going to be able to keep that up but i mean they i if they're if they're using this as kind of a cash cow and this is eventually going to go away i mean why not juice it as much as you can i don't think

that's a terrible strategy if they're saying it's going to go away in like a decade the banks have such i mean the bank's alternatives are so costly so it's like yeah i don't know you don't want to you don't want to ruin your relationships with the banks if you're trying to cross sell their uh their verification solution but um i think there's probably some room to gradually increase prices um i guess as far as anecdotal evidence goes for me i've used my bank i'm pretty sure uses the technology that my tech supplies um and i don't think i'll ever go to a branch to cash a check or if you do you i mean i have like once in the last few years and you just get you're like why am i here yeah and i'd also say like it's i prefer instant deposit and just

bypassing the check process to begin with so that may be indicative of uh the mobile captures future anyways but yeah all for my anecdote i'll go to the identity verification which is their big growth opportunity that they talk about which it is they don't have to just talk about it it is but i think the double digit growth projections of that industry check out um you're going to need it more just to get it in the financial institutions and the government institutions and whatever, that seems pretty easy. But I believe there's a lot of optionality too, in other ways that this ID verification stuff could be very useful. Two that come to mind for me are, and it might be a little bit different because you can't just do the clunky stuff

with this, but online dating, there's definitely a need for that where, no, I have not, but you know that people always talk about it this isn't personal but though you know i've always uh people uh i don't know that's kind of the big knock you know for when people don't tend to care they still go on the apps but a lot of times people talk about the worry that they're getting catfish and stuff like that so and then also airbnb i think it's a very easy one where people want to just confirm that this is a real person i'm interacting with who they say they are that one i mean that that that that's a pretty easy fix too yeah i think uh based off what i'm hearing that uh tinder already has some sort of verification thing yeah they released something

i'm not sure who they're partnering with but yeah i can i can personally say that yeah yes yes they do yeah yeah well they announced that recently actually or they rolled that out recently yeah let's go to future growth opportunities uh brad you want to go first yeah so so tinder really no No, I'm just kidding. But I actually see what you're saying. It didn't occur to me until you said that. So that was a cool idea. But in terms of future growth opportunities, so I'm taking the really easy and obvious one. So they operate in the digital banking niche with these identity functions and the mobile check stuff and all that. And digital banking, to absolutely nobody's surprise, is a rapidly growing sector, poised to yield, based on where you look, 15% to 20%

Kager through 2030. So it's a really good space to be in, especially the identity part. We've talked about how the mobile checking might not be super durable. It is very lucrative right now, but it might not be in the very, very distant future. I'm not talking about next couple of years, but by the end of that planning period, I just talked about by like 2030 or something like that. But yeah, FinTech, it's a great space to be in. And they are definitely a monopolistic, uh, or they've, they've taken sort of a monopolistic niche within this mobile banking, um, world. Yeah. All right, Ryan. Yeah. I like that one. And it kind of digital banking, I think is just a good tailwind for them generally. Um, especially within verification,

uh, for me, it's, I mean, the future for the business is pretty clear. So I guess like there isn't that much of a future with like the mobile deposit business. I mean, it sounds like it's very profitable, so hopefully it'll be a cash cow that they can maybe reinvest, but yeah. Right. I just don't, I don't see like decades worth of growth there. So, I mean, verification is, I guess, the future. And when you talk about identity authentication, at least from what I know of the business, is that IntelliCheck has the most accurate solution because of their relationship with the DMV. Yeah, whatever that organization is called. It's like some North American licensing organization. And so I should, I guess, caveat this by saying that we are IntelliCheck shareholders. So this is going to be sort of a biased take. But I think they could acquire IntelliCheck and bolster their authentication accuracy.

Because if the stats are correct, IntelliCheck has like a 99% accuracy on fraud detection and Matex is around 80%. Well, IntelliCheck does have 99%. It is unclear exactly what Matex is because they don't really, it's a bit of a black box. But if it was that high, they would probably brag about it. So it's definitely not as high as IntelliCheck. Yeah, I guess it seems weird to me that the acquisition hasn't happened because Matek has shown a willingness to acquire companies and IntelliCheck trades for like half of Matek's cash balance. And Matek said, I remember in the recent conference call,

let me pull up the exact notes here. I got to get the note sheet. Sorry, continue. Go ahead. It just seems like a pretty logical acquisition and this would tie them up. I mean, this would, And I think they have 20% to 25% market share within verification. Matek does. So if they just gobbled up IntelliCheck, I think that's one way to just pretty much win the market. And it's a market that is compounding at around 15% revenue across digital verification anyway. Yeah, here is… It seems like a logical acquisition.

Yeah, it sounds like they would be better together than not. Here's the direct quote from the Commerce Call. in fiscal 2022, we expect to invest further in strategic acquisitions to accelerate our innovation in the fight against fraud. It sounds like they've reached out and they said that they've reached out to other people that they haven't like made a connection with yet or made a deal with yet. So it sounds like they reach out to all these companies. So, you know, they probably talked to IntelliCheck and plenty of others like IDRD, which is actually my future growth opportunity. they acquired a company called IDR&D in June, I believe was the name.

Terrible name. Yeah. Tough to say. This is basically a bolt-on acquisition for the ID verification market, and it's really supposed to help with their capabilities. It was a $49 million acquisition, so pretty sizable compared to Matek Systems' market cap. But to explain what IDR&D is, it's hard to get the niches of all these identification stuff. It's hard to understand, but the company is an expert in facial and voice biometric capabilities, which help against deep fakes and synthetic voice stuff. So I guess that's a pretty rising... There's a lot of fraud that people do with that type of technology. So it's hard to exactly identify what Mitek will do

with it. I think it'll just all come together in their solution that they sell to customers, but it should help with their overall capabilities as they try to get better and better and better Yeah. I mean, they group it into one product in their investor documents. So they just call it mobile verified, but I think there's like a bunch of different capabilities within it. There's like document scanning versus ID scanning, facial recognition, that kind of thing. Yeah. They do break it out on their actual website, not their IR page. They have all the technologies there. Again, it's a bit of a black box that kind of just give you an overview, but it goes through, I think like seven or eight different things they do.

All right. Highlights and lowlights. Brad, what'd you like and dislike about this business? Yeah. So I'm considering it a financial technology company. I think that's pretty safe. So I really like its model within that FinTech landscape. So most FinTech companies are extremely consumer facing in nature. They offer the exact same services and they compete on price. And SoFi, I own SoFi and SoFi's ability to compete on price is why I like it. But that's an irrelevant aside. But the space is very commoditized. So by being an ancillary supporter of the industry, you actually get to enjoy this sector growth without having to spend an absurd amount of money building brand awareness. And you can kind of ride this

tide that lifts all boats without really having to commit a lot of resources behind it. If you have a good product, which it seems like based on their market share with their original check deposit thing is really working. But in terms of lowlights, it seems like most of their executive positions kind of function like revolving doors. So there's not a lot of continuity from the team. We study other companies where they've had executives, at least like a CTO or a CFO that's been there for a decade. And especially because this company is several decades old. I was hoping to see that. So that was a little bit not concerning, but notable to me. And then Ryan was talking about how difficult it was to find information

on the founding story and the history of the company. I also found that concerning. I would have liked for it to have been a much easier time locating that information. And it's probably nothing, but by it being so difficult to locate, it just makes my mind go to, okay, why is it so difficult to locate? And yeah. That was a bit of a yellow flag for me. Is it's like, what, was there something wrong with this guy? Like, why is no one, why can't I find out who the founder was? I mean, it probably isn't that big of a deal because the business is totally different than it was in 1986, but.

It's like a new business in 2010. Yeah. It's just, it just kind of rubbed me the wrong way. Highlights for me though, they have a huge installed base of banks and financial services companies that they can cross sell to. So they kind of have their footprint or their foot in the door with a lot of those customers, which when, when I'm looking at, when I read a company like IntelliCheck's conference calls, it's a sales oriented business. And that's their whole goal is to sign on as many customers as

they can. Matek seems pretty similar. They have a pretty high marketing spend. Yeah. Right. And, and Matek already has the foot in the door, whereas they don't have, they don't have to start from square one. Like IntelliCheck may have to with some of these institutions. And then they get a lot of cashflow from their deposit business. So that's kind of, I guess, a cash cow that they can kind of milk to fund their other business. And then low lights for me, though, the written checks in circulation, I remember reading that they are declining by three to 4% per year. At some point, the transition to digital deposits is no longer going to offset that decline. I don't know when that's going to come, but that's-

Well, it could be like cigarettes. It might be longer than we think, but who knows? yeah who knows and maybe there's a high floor maybe there's just like people that still use checks forever but um or use them as rolling papers for cigarettes too never know yeah there we go there you go double double uh opportunity in the declining industry right there anyway so i guess the other low light that i have is that i don't like the overhang from usaa and if you're like rolling your eyes like oh that's not that big of a deal like wells fargo um they pay they They have to – I don't think it's been paid yet. Or they have to – okay.

They have to pay $300 million to USAA, and I think they're still fighting it in court. But $300 million, if Matek's on the hook to reimburse some of that, that's a huge chunk of cash relative to Matek's market cap. They'd be able to pay it because they'd probably just take out some debt, and they'd be able to pay it, but it would be a big loss. But it's like the fact that this has happened multiple times now makes me feel like this is USA is like pesty and they're not going away. Yeah, it doesn't seem like it, I guess, is just a low light for me. It's frustrating. Yeah, it's definitely an unfortunate risk that they have going. Could be low, low risk, but I'm not sure.

Because of my lack of understanding of most legal issues, I don't like when there's legal overhang with companies. Yeah. All right. My highlights, I think the asset life model gives them the potential to be really, really profitable. They're already at, well, cashflow margins can be tough because of the stock-based compensation can make those harder. But I think their cashflow margins could get to 50% fairly easily. And there's a durable tailwind from the industry that should be around really forever.

Now, they could get disrupted by a better technology company. So one of their competitors, what's it called? Jumio. Is it called that? I always think of Jumia. That South, the African Amazon that everyone hypes up a lot, but it's Jumio, I believe, IntelliCheck, those other ones out there, maybe a bigger fintech company that could disrupt them. But either way, the industry is durable and their actual overall profitability is massed right now

because they said that their identity solution segment is still operating in the red and they think it will be through 2023, but they have that, that still has great unit economics. Like we said, 90% gross margins, low lights for me. I don't like the convertible notes if they didn't need them, need them, excuse me. I got a cough, excuse me. Um, and won't go big. Like if they do the convertible notes and they won't go big on buybacks, I don't know why they didn't do standard debt. Uh, because it's not like they're, I don't know, they could pay this stuff back. It's not like they don't need it. Uh, and I didn't like how low the price was and I didn't like how they do the warrants in conjunction with it because if you do the warrants why not just do a higher price

it was a lower convert it was a pretty low conversion price yeah so but it's fine but it's just a bit of a low light for me it might not have been when they wrote when they did the convertible because i think matek has had a really good year yeah it could have been lower than but either way like if you if you have the funds from your cash flow like i just don't i don't know that's a bit nitpicky. It's not terrible. And then the other lie for me is there's no clear data on how well their stuff works, which leaves investors like us without the relevant information. You don't know exactly how well it works. They talk about AI, machine learning, and all that good stuff and about how they have the best product, which I don't think they do, but it

sounds great, but there's no data that I'm getting. Maybe we just missed it, but that's kind of a black box. And then lastly, small one, they have customer concentration with three customers at over 10% of revenue. I think that's fine, but whatever. Anyone that supplies to banks is though. I mean, you're going to have, I think probably JP Morgan, Wells Fargo and Bank of America. There you've got your customer concentration. Well, that's true, but it might mean that the pricing power might not be as high. Those banks are well-funded. It's probably They don't want to even care if Matek raises their prices, but I still think that gives them less leverage in negotiation with the banks. All right, bull case.

What do you think would go right here, Brad? Yeah, we've talked a little bit about this or maybe a lot of it about this, but I think it's the clear bull case that the mobile check business that we're talking about is able to kind of decline at a snail's pace instead of very rapidly and is able to continue feeding projects for acquisitions and for internal R&D and for this ID section of the business to allow them to seamlessly transition from mobile check to something with a much longer runway. And I mean, they've done it successfully already once. We talked about how the company basically reinvented itself in 2010. So they are capable of pivoting when they need to pivot and figuring this out. But that's really the case that I see that new projects and the ID business can allow them to compound at a 15% clip while this, or more than a 15%, 10 to 15% clip, let's go with, for the foreseeable future as kind of the digital or the early erosion of this mobile check business is slower than I think it's going to be.

The thing that's wild, and this is kind of, I guess, the bull case, too, is we keep talking about like, maybe this decline is slower than we expect. It's growing. The business is growing, which is shocking. Well, the pricing power. Yeah. And just the conversion to digital. I think those two things are massively outweighing just the decline of checks in circulation. So I guess if that business remains steady and they're able to sell this verification technology to most of their partners, I mean, the ultimate bull case is that the business stays steady and they win the verification market.

And it's like north of 50% market share. I think they'd have to make some acquisitions to make that happen. Oh, yeah. Well, maybe. Well, they're at 20, 25% right now. That definitely would be a big hurdle to gain that much market share. I think if anyone is going to win, I think they have the easiest chance to be the leader in that industry. Yeah, they are the leader right now.

I think they're the biggest. Don't quote me on that, but I think they are. there's a very, I guess, there's a very feasible path to north of 15% revenue CAGR, like Brad mentioned. Yeah. And yeah, I'll hit mine.

It's similar. I think if ID solutions can grow at a double digit rate and then margins expand, returns should be adequate if you think they deserve kind of a 20X earnings multiple. They're right around there right now.

So it's not one where you're worried about, well, you're not hoping really for multiple expansion. That could be great. But you're not worried about multiple compression like a lot of the high growth stocks we look at are. And by earnings, you mean cash flow. Sure. Yeah. I'm just, that's, yeah. Intertwine those. That's the same number to me. Bear case, Brad, what do you got?

Yeah. The bear case to me is the continued evolution that this business model needs to make and the continued spend that they're going to need to make, I think, to do other things beyond the verification market. um if if it's as competitive as actually ryan's going to talk about competition there so i won't i won't talk but but it is a competitive space um so i i don't know if it can they can be a one-trick pony there and just and see a couple decades of growth solely from that business and and as you have more of these transitions and evolutions and um and new and brand new management teams um there's no guarantee that they're all going to be successful um and and And the bear case is that this pivot that we're all foreseeing is not as

successful as the one they had in 2010. Yeah. The management part leaving, like, I think that's something I didn't write down, but that's definitely one. That could be a bear case too. If they got that turnover, you never know with new management, they could totally botch it. All right, Ryan, what do you got? I guess there are like the bear case for me is that the verify or the verification market ends up staying really competitive and Matek is

able to win a lot of customers or they spend a lot of money trying to win customers and it just isn't that great of a return on their spending. The other part, there's a pretty technical aspect to this business that, especially in the verification side, I don't know. I don't really understand the nuances of whose technology is better and what are banks willing to have? Would they take an 80%, I guess, accuracy rate on fraud detection? If that's their cutoff, then maybe Matek's the big supplier for them. Do they require a 99%? You would think the more the better, but I guess I just don't necessarily understand

the industry dynamics within verification all that well. The other thing that shocks me is that I would have thought that check, like mobile deposits with checks would be like a super commoditized like function but they have i'm surprised they got to 98 market share and the only other competitor is i think usaa has the other two percent uh so they must just be sour they lost huh but i think they were partners though back in the day i don't know it's kind of weird that they like split up i don't know the history on that but yeah i don't that that just i guess that surprised me the bear case for me is that they're, they just don't succeed that much within verification.

Yeah. That's mine too. I'd say that, you know, the, the ID stuff, they just get disrupted. It's hard to tell whether someone like that could come up, Brad, you wrote down here, someone like Galileo and plaid, like, do you think you know more about those types of businesses? Do you, have they said anything about that? Or is it just kind of like a thought that that's something they could easily go into?

I know, I know Galileo is, actively building products for legacy bank workflows and to make those easier. They haven't announced any of the details of what that's going to look like, but they are building B2B products for legacy banks. So I don't know. I didn't mention it because I'm not positive if there's going to be any overlap at all, but there could be. Yeah. That could be a threat. It also could be a tailwind as they bring everyone, right? I would think so. As they bring everyone online, make that easier. Yeah. I think the big question is whether Matex has, and I use this term like every show, a defensible position within the ID market because that industry is growing so

quickly. All right. More or less interested. Let's wrap things up. Brad, what are your final thoughts here? Yeah. I think I'm more interested. And it's not more interesting because I'm ready. I'm super excited about the company and ready to buy it right now, but just because, I mean, we talked for 45 ish minutes and nothing really concerned me all that much. Um, aside from all the management turnover, a little bit, a little bit, um, queasy there, but, but I think more interested in a company I'm going to keep an eye on and maybe dig into a little bit more, uh, because it's really, I mean, it's not ridiculously priced for a company that, that, uh, some that we do think or it seems like we think in compound at 15 for a long time yeah yeah ryan yeah any small

cap that has basically completely won their market automatically makes me more interested well completely is maybe not are you talking about checks checks okay yeah yeah that it shows me that they can go into go into a market and win over customers and to have that that big of a guess I guess, customer footprint is also pretty impressive for a smaller company like this. So I am more interested. There's a part of me that's just hesitant to get super excited about it. And I'm not sure what that is. Maybe it's my lack of understanding. Maybe it's the name. The name's weird. Yeah. That could be part of it. Maybe it's the USAA overhang. Maybe it's that I just like, I don't have, I don't feel like I have a huge edge in like, oh, what verification

technology is the best yeah maybe that maybe that doesn't matter though yeah i'm more interested too i mean yeah there is a few things where you're like why is it trading in such a cheapish multiple like oh you know is it that easy that they're going to compound this id market at 10 to 50 a year if so that's great but i think yeah i'm definitely more interested if margins can expand and the the revenue can keep growing in id you know you got some good returns there so i think the opportunity there's potential um now while we wrap things up while we also were more interested this is not a stock recommendation show so obviously do your own research we have not researched it fully there could be things we missed but that was kind of the first look

we took at this business um and we have to choose the stock for next week or in two weeks which may be overlapping with the holiday period so timing could be different but ryan what is your choice here so we got a listener recommendation we've had a few so we're gonna i think we should all try to use those um uh someone emailed the show by the way our email is chitchatmoneypodcast.gmail.com if you want us to do any shows or anything like that we leave it in the show notes so you can see it down there uh and he said he wants to he wants us to look at zoom info uh and uh revenue is growing apparently 30 percent and they've got oh he's giving he's given the pitch 40 free cash flow margins. We got some we like. Thanks for the rec. We're going to do that one

for two weeks from now. All right. That's great. That's going to do it for this episode. Thank you all for listening. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time. Bye.