This is a continuation of my quest to go through all 100 stocks from the 2013 Forbes Best Small Companies list.

Upon first glance, if a stock is interesting but overpriced, I provide a quick rundown. Otherwise, if I come across something I like and the price is right, a full analysis and valuation report is provided.

My quick filtering method is simple and the same with every stock I look at.

  1. Just enter the ticker into the OSV stock analyzer
  2. Take a quick look at the valuation ratios
  3. Perform basic financial statement analysis
  4. Perform a quick reverse DCF

Just by doing this, I can decide whether to continue investigating the company or move on to the next.

The Forbes Criteria

For new readers, the methodology used by Forbes in coming up with the list is quite simple.

  • strong sales and earnings growth
  • publicly traded for at least a year
  • generates annual revenue between $5 million and $1 billion
  • stock price no lower than $5 a share
  • excluded financial institutions, REITs, utilities and limited partnerships

Introducing NIC Inc. (EGOV)

NICBuilding websites for Government

I last wrote about NIC in August and the story hasn’t changed much but it’s worth covering again because it’s a neat and simple business to own if the price comes way down.

There are certain investments where it takes hours or maybe days to fully wrap your head around the opportunity. These are complex investments with hidden assets and requires out of the box thinking and analysis to uncover the treasure.

These investments make headlines, are presented at investor conferences and subsequently analyzed by hundreds of fellow investors.

As much as I appreciate the hard work that goes into such investments, I still like the simple ones.

Investments where my head doesn’t ache thinking about it. Investments where I don’t have to constantly remind myself what the full thesis was every few months.

And, that’s where NIC fits in.

It’s a crappy name for a company and also adds to why it’s not widely followed or recognized.

Peter Lynch noted that companies with flashy names and bling bling tickers got more attention than the four letter acronyms most companies have.

  • BOOM (Dynamic Materials)
  • CASH (Meta Financial Group)
  • DNA (Genentech)
  • CAR (Avis Budget Group)

And then there is NIC Inc. (NASDAQ:EGOV), which isn’t the ticker. The ticker is EGOV.

What Does the Company Do?

The company builds websites for state and local governments. They also do work for federal agencies.

Their main bread and butter consists of building internet portals.

A portal site is a “specialty” site run by the government. Something like CheckIN Game which is run by the Indiana Department of Natural Resources. The CheckIn Game site is where hunters can register their harvested game online.

Now there are hundreds of these special interest government groups in the USA that can use a portal website to automate and increase efficiency.

The above web portals were created by NIC Inc. (NASDAQ:EGOV) by the way.

Having built several websites myself, none of the above websites are overly complicated. The major complexity probably lies in having to combine new web technology with the old and outdated systems and infrastructure that governments must use.

Obama’s website was/is a mess. If governments don’t use experienced and proven companies, any downtime will cause big trouble.

Why It’s Worth Looking At

1. The business is simple.

  • There is no inventory to deal with
  • No patents required to code a website
  • The government isn’t going to haggle with price as much as the private sector
  • Winning government contracts is awesome

2. The business also has a moat.

There are literally tens of thousands of web development agencies. There is no moat in being able to create websites. So NIC’s main business of making government portals isn’t the moat.

They have already entrenched themselves with a moat by signing up the government as their customer and already having built so many portals already.

NIC quickly established themselves and increased credibility and experience by taking 100% of the financial cost themselves in building the site.

The government doesn’t pay them anything. NIC gets paid by collecting a fee for the usage of the portals.

So every time a hunter goes to register his game, NIC pockets a small fee.

When you go to register your license, NIC gets a small fee.

When the number of these portals increase and more people use the internet to get things done instead of driving to a crowded office and waiting in line, NIC is there to benefit.

So when companies bid for a project, which company would the government choose?

  • A: a company that quotes a price and has no portfolio of government websites
  • B: a company that charges $0 upfront, has a large portfolio of successfully built and functioning government portals

It’s no wonder that NIC Inc. (NASDAQ:EGOV) has won every contract and renewal they bid for.

Always Consider the Downside Risk

1. Losing Major Customers

Losing the government as its major customer is an unlikely event, but it can happen.

Look at the mess If something like that was to happen with one of NIC’s sites, they are doomed.

2. Management Ethics

I’ve also got concerns about how ethical and shareholder friendly management is.

The SEC brought up an issue that the CEO back in 2011 that his personal commute using the company private jet was not properly being reported and recorded. The group of NIC executives in 2011 agreed to pay $2.8 million in settlement without denying or agreeing to the allegation made by the SEC.

If it gets to the point where the SEC is litigating, the management is already stepping on a fine line with the way they conduct themselves.

3. Security Concerns

Security breaches are also very real risks.

Government data that is either leaked, accidentally lost or stolen poses a real threat to NIC. Recently ExlService Holdings, Inc. (NASDAQ:EXLS), an outsourcing company, lost client data and the contract was promptly terminated which caused the stock to drop 20%.

If something like that happened to NIC, expect to see bigger falls.

Don’t forget to read the 10-K risk factors section.

Previously when talking about position sizing, I mentioned that random and unlikely events can happen and the best way to combat those is to use proper position sizing.

The Numbers

Cash adjusted PE of 39 and EV/EBITDA of 22.

Definitely not cheap.

The FCF growth in the table below refers to Buffett’s owner earnings which I include in the Stock Analyzer along with the regular FCF value.

When looking at the owner earnings, recent growth is strong and based on the contracts they own, it isn’t a one time peak or business cycle. The portal is all built so as time goes by the fees should increase.

CROIC is Cash Return on Invested Capital which looks at

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