Paradigm Report For Simon | Investment Thesis Route1 is a Canadian technology success story a long time in the making. The company has world-class IP (that is now patent protected) but has historically struggled to execute on significant sales opportunities. A new management team and board have refocused the company on several high-value opportunities, one or more of which are on the verge of being realized after months of trialing, testing and approvals. We believe Route1 could announce a multi-million dollar contract win with the U.S. Navy before year end. This could serve as a springboard into other U.S. Department of Defense (DoD) agencies which, when combined, represent an opportunity several times the size of the Navy. The blue sky potential is significant, with the current valuation, while it has increased significantly over the past six months, still only reflecting partial value for the Navy opportunity alone. Highlights - Route1 is likely on the verge of signing a landmark contract with the U.S. Navy, which should open the door to much larger opportunities in other U.S. government agencies that combined represent over $160M in potential annual EBITDA.
- The company has completed a remarkable turnaround in just over a year, with an almost fully reconstituted senior management team and board.
- Fundamentals continue to improve, with Route1 set to reach cash flow break-even and profitability for the first time ever beginning in Q3/FY10 (Sept.).
- Trading at 8.8x our FY12 FD EPS, which assumes a risk-weighted U.S. Navy contract award, we believe the shares are undervalued.
- Significant upside exists to our estimates, which assume that Route1 deploys one-third of the U.S. Navy opportunity and receives no other major awards.
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| Valuation and Conclusion Overall, we believe Route1 is on the cusp of generating significant market interest as a successful turnaround story that is primed to deliver explosive growth in revenue and earnings with the signing of potentially several marquee government clients. The stock has had a spectacular run already in 2010 (up over 250%); however, we believe there is more than double remaining just based on one contract scaled back to a conservative size. Using FY12 FD EPS (the year in which the U.S. Navy contract is fully deployed) and applying a 20x P/E multiple, we calculate a target price of
.60 per share and, as a result, we initiate coverage of Route1 with a Speculative Buy rating. |
Management and Board Shuffle Has Re-energized Route1: In a process that began in mid-2009 and was completed in February 2010 with the appointment of Tony Busseri as CEO, almost the entire board and management team was replaced. Since then, Route1 has re-invigorated its sales momentum with key accounts, repaired damaged relationships and signed new commercial agreements (notably teaming with Hewlett-Packard [HP-N, NR] on the U.S. Navy opportunity).
Technology Has Significant Validation: Route1’s technology has been certified for use by the U.S. Navy and the Department of Homeland Security (DHS), which requires the highest level of security and operational effectiveness.
Several Major Catalysts on the Horizon: We believe the company could announce several major contracts before year-end, including a commercial agreement with the Navy Reserve that would add tens of thousands of subscribers, potentially increasing the company’s subscriber base by a factor of almost 7x.
Big Upside from U.S. Government Agencies: Outside of the 300K potential users at the U.S. Navy (we assume 100K in our forecasts), other U.S. DoD reserve forces when combined with DHS represent over 1M potential subscribers (and 5M–6M subscribers in the ultimate blue sky potential).
Key Financial Milestones Set to be Reached: We anticipate that the company should be cash flow break-even during Q3/FY10 and potentially report its first-ever profitable quarter in Q4/FY10 or Q1/FY11 at the latest.
Strong IP: Route1 owns all the related IP and recently received a U.S. patent covering its MobiKEY (June 2010, U.S. Patent No. 7,739,726) and MobiNET (October 2010, Patent No. 7,814,216).
Recurring Revenue Model: One of the most attractive features of the business is the recurring nature of service revenue (~$25 per month per user), which provides strong visibility and contributes an extremely high gross margin (over 90%).
European Bank and Reseller Agreement: Route1 has been working with a major European bank for some time (~315-user trial ongoing), which could lead to a significant opportunity for secure on-line banking transactions. In addition, the company recently signed a reseller and hosting agreement with Fox-IT, which we believe requires the sale of 25K–50K keys to maintain exclusivity.
Earnings Leverage and Upside: There is significant leverage in the business model, as adding incremental users to the network requires virtually no cost (Route1 has indicated that for every 25K additional users, EPS of
.01 is generated). Support requirements for the Navy contract are in place and there is no material compensation associated with the sale. Significant upside to our forecast exists, as we only assume Route1 deploys to one-third of the Navy potential over the two years (and adds no other agencies or new clients outside the U.S. Government).