Post by
TallerCraig on Feb 24, 2021 8:46am
Timing the Inflection Point in Growth – Loaded Up into Q2…
I don’t write down my thoughts much, but I think this is the best opportunity I have seen in a raging bull market especially with SaaS names trading 10, 20 even as high 50x Revenues in a while.
You have to be really choosey with your exposure and one of the only places I am finding value in small cap tech is in these revenue mix shift stories. These stories have fast growing, highly profitable SaaS style revenue streams hidden within the total revenue of the business growing anywhere from 20-50% YoY which as they grow, they become a larger and larger percentage of total revenue of the business to where the market take note and re-rates the business accordingly which tends to happen when that growth driver within business gets to aprox. >50% total revenues. You can find a whole bucket of these at reasonable prices in small cap tech right at that inflection point. (MTLO RW DSY ROI IQ BEW SEB).
I think DSY is at that inflection point today – Independent Label Revenue up 38.8% YoY (55% of Revenue)
I am going to make the case that we are coming out of transitory pricing adjustment period for the major Label division which is now coming to an end in Q2 that understated the underlying growth in the core platform, in the mean time a fast-growing Independent Label business has gone from single digit growth to growing revenues and Sends over 40% YoY within that same 12-month time frame now representing close to 55% of revenues.
Bear with me;
KPI Driver - Sends
We need to hit on Sends before we talk revenue because this is a key point in how I derive my confidence in the underlying growth rate of the platform which will ultimately drive revenues.
The Independent Label is clearly on fire, with sends up 46.4% YoY in Q1 but total sends for the platform were still up 25.5% YoY in Q1. The key point here is that that even within the Major Label you are still seeing Send growth through the pricing adjustment. As a result, when we come out and start lapping the pricing adjustment starting next Q you are going to have revenue growth starting to track the growth in Sends Activity again.
Adjusting for a 3-5% point lag for trial activity on the platform you are going to be having Revenue generating Sends up call it 20% and revenue growth tracking that number starting as early as next Q.
Growth Drivers
It was a conference call or two ago where there was a single line that got me all fired up. The new(er) management team were asked about growth, they said they were not brought in to grow this business single digits. They are going for it! I love that attitude especially when you already have a profitable business with 25% of market cap in cash and a 90%+ gross margin profile. Each incremental dollar of revenue they bring in is just so profitable.
I think there is incredible growth potential in the foreign Language content and global expansion of the business but the key thing for me is that the core Major Label business with Universal and Sony Music side is still growing.
I believe there is massive growth potential to increase the wallet share on the Sony music side with management is beginning to hint at.
On the Independent label side this is where I think the blue-sky opportunity is. They have recently brought in an executive based down in Miami to grow the Spanish Language and to make a push in South America which is an entirely untapped market for them.
They have recently made the investment into the technology so it can be used in Spanish, German, Japanese & French ahead of this push into foreign markets so the technology on the backend is already primed to onboard these new customers.
So, if I look at the current Revenue mix of 50% US, 45% Europe & 5% Other more or less there is massive opportunity to grow out the business internationally.
If they get this global expansion right, you could easily see compounded 20%+ growth rate for some time as they gain more of a global footprint. Seeing that over the last two Qs we have seen global growth pushing up to 40% I think they are off to a very good start.
Financials
FY21 Revenue – $4.4M USD ($5.7M CAD)
I believe they can grow Revenue for the remainder of the year at a 20% clip driven by Independent Label Revenue to continue to drive growth at a 30%ish clip while the Major Label returns to a mid-single/low double digit growth rate.
The power of these platforms come from the profitability these businesses have. Most SaaS businesses run anywhere from a 60-80% gross margin profile but these pure platforms have no content costs and minimal maintenance and run with gross profit margins north of 90%.
FY21 EBITDA - $900K USD ($1.15M CAD)
I think its more about revenue growth vs EBITDA growth right now because they are making their big push in global markets but I would just like to point out that last Q on a sub scale revenue base they still managed to put up 22% Operating Profit Margin. Given the global opportunity I would be alright with them spending more money to really go after that global market for that margin to come in a bit as they ramp up S&M and R&D spend as they try to capture more share.
Balance Sheet – $3.1M USD ($4.0M CAD) Cash 0.38/share
With no debt and closing in on 0.40/share in cash there is a massive margin of safety to the business, I think the NCIB over the last year was a great use of cash, whether from this point on they want to continue to pursue the NCIB (as a believe the stock is significantly undervalued) or pursue some smaller tuck-in M&A strategy to gain more of a global footprint or add a complimentary offering I am all ears. This management team has proven over the last year to have a good pulse on where the business has to go.
On Valuation
These Tech/Software style platforms trade at massive multiples in the market and most of them are losing piles of money every year as they try to scale. I believe that DSY is one of the rare ones where it has the same Tech/Software and platform economics but also has the profitability which many of the other names don’t have. When you add on the reacceleration in growth that is about to come out of DSY that is where I think were are going to start to see the re-rating in multiple.
So If we assume the platform style businesses trade anywhere from 8-10x Sales and some lower margin SaaS style businesses trade for around 5-8x ARR. I am going to be a little more conservative and use Gross Profit Dollars instead of Sales and give it a valuation range of 6-8x EV/Gross Profit. (I think I am being conservative because there was a Comp in NameSilo the Domain business that just sold for 10x Gross Profit that had tax and growth problems)
So in FY21 I get to a Gross Profit Figure of $4.1M USD ($5.3M CAD) then back out the 0.38/share in cash I get to a valuation target of 3.25 – 4.20/share or 3.70/share at the midpoint or 160% upside.
In Conclusion
These are the exact type of names I am looking for, these backend niche internet SaaS/Platforms that are trading at massive discounts with great unit economics and clean balance sheets for a large margin of safety in comparison to these sexy and overhyped front facing consumer SaaS companies trading at over 20x Sales with lesser economics.
This is the exact moment, if you can time the entry into these investments right as the growth begins to inflect higher you get the massive re-rating in valuation. Over the next 18-24 months the business could grow 50% yet you get a 100-200% move in valuation. That is what multi-baggers are made from…
LONG