Prescience Point Initiates InnerWorkings, Inc. (NASDAQ:INWK) at Strong Sell. The value oriented short biased research firm, believes that the company is violating GAAP. They think the company which is currently trading at around $10 a share is worth closer to $5. InnerWorkings is compared to a previous short recommendation of the research firm, Boulder Brands. They accuse InnerWorkings, Inc. (NASDAQ:INWK) of deceiving both investors and the SEC.
For the fiscal year ended 31 December 2012, InnerWorkings, Inc. revenues increased 26% to $797.7M. Net income increased 17% to $19.1M. Revenues reflect United States segment increase of 20% to $649.1M, International segment increase of 61% to $150.3M. Net income was partially offset by Selling, General and Administrative increase of 24% to $143.6M (expense), Gain on sale of investment decrease of 70% to $1.2M (income).
A brief summary of the main ‘red flags’ can be found below followed by the full document in scribd.
We believe shares of InnerWorkings, Inc. (NASDAQ:INWK) are grossly overvalued and poised to collapse by as much as 55%. We believe the company is inflating its revenues in violation of GAAP principles by misapplying gross revenue accounting, placing it in violation of its credit agreement. The SEC has inquired about IW’s gross revenue treatment, and we believe management’s response was incomplete and/or misleading. We note that Groupon (Nasdaq: GRPN) – which has many connections with IW, including a common co-founder, former board members, and the same auditor in Ernst & Young, Chicago – violated GAAP principles in the same way and was forced to restate its revenues. Similarly, we believe InnerWorkings will be forced to restate its historical financial results. Furthermore, IW shares many of the same bad qualities we profiled in our previous reports on The Active Network (Nasdaq: ACTV or “Active”) and Boulder Brands (Nasdaq: BDBD or “Boulder”). Similar to Active, we note IW was also formed through dozens of questionable acquisitions – but IW structures them with opaque contingent payment terms that artificially boost EBITDA and EPS, even when its deals fail! To be clear, we believe IW has been able to inflate its EBITDA and EPS by converting acquisition earn-out payables to earnings. Similar to Boulder, where we spotted prior failures of management and trouble at the Board level with numerous departures, we note that IW had 4 out of its 7 board members either resign or decide not to run for reelection in 2012. IW also appears to be overstating its revenue opportunity: our research shows that IW has penetrated 25% of its North American market opportunity (80% of revenue), while having claimed a penetration rate <1% – a harbinger of waning organic growth. Follow the $$: IW’s gross margins and free cash flow have been declining for several years, and its CEO began selling stock just weeks after announcing an expanded relationship with its biggest customer! We believe IW’s financial statements fail to reflect its true financial condition, that management is misrepresenting IW’s growth prospects, and that IW’s stock has an intrinsic value today of $5.00/share.
InnerWorkings appears to be Inflating its Revenues and Misleading both the SEC and Investors
- At the heart of IW’s revenue shenanigans are its misapplication of gross vs. net accounting. We have reviewed its customer and supplier agreements, and conclude IW’s revenue recognition policy is a blatant violation of GAAP principles, as corroborated by a 3rd party accounting expert. IW bears no inventory risk as it never takes title to goods, and makes suppliers provide a full warranty for its products. This directly calls into question if IW is the “primary obligor” in the transaction and carries “inventory risk,” which are foundations of its argument for applying gross revenue accounting.
- The SEC already issued a comment letter in Oct. 2012 which questioned, among other things, the company’s use of gross revenue accounting. Our findings will be of interest to both the SEC and IW’s creditors. IW has borrowed money from banks on the basis of its financials being stated in accordance with GAAP, which, based on our research, is not the case.
InnerWorkings Mischaracterizes its Market Opportunity and Uses Murky Accounting for its Acquisition Roll-up Strategy
- IW lures investors with its “huge” opportunity to crack the “$500bn” printing market. We believe IW’s addressable market figures are as inflated as its revenues and neglect to consider the impact of print capacity.
- Most of IW’s revenue has been acquired through aggressive deal structures that contain little upfront cash payments, and earn-outs paid over 3-4yrs to retain and motivate owners/salesmen. This allows IW to artificially boost current earnings, by moving significant deal costs away from the income statement and deferring them into future periods through the cash flow statement. Furthermore, IW can manipulate its earnings by setting targets very high and booking income for failing to achieve targets. IW’s deals are becoming more desperate as evidenced by the acquisition of Productions Graphics, a European firm of questionable quality acquired in late 2011, that already is struggling.
Follow the Money: InnerWorkings’s Financial State Looks Increasingly Fragile
- Looking beyond IW’s above market revenue growth, we find a company with declining gross margins and free cash flow. IW just lost business from its largest customer, yet the CEO began selling stock a few weeks after IW announced an “expanded” relationship with the same customer. Where there’s smoke, there’s fire. IW had two directors resign and two decide not to run for reelection in 2012 (3 were on the audit committee).
IW’s Founder Has a History of Over-Promising and Under-Delivering to Shareholders
- IW’s founders have used the same playbook of over-promising their ability to disrupt a big market opportunity with a proprietary technology in the past. As detailed previously by both Barron’s and Fortune articles, IW’s founder Eric Lefkofsky (also a co-founder of Groupon) has a history of burning investors with failed expectations. One of his prior ventures, Starbelly.com, promised to transform the apparel industry, but rapidly went into bankruptcy. Fraud lawsuits followed claiming its software never worked as promised. Ironically, IW touted its PPM4 technology, which has been quietly swept under the rug. However, a recently disclosed patent lawsuit could cost the company up to $56m.
Sell-Side Analysts Are Seeing None of These Major Issues and Incorrectly Valuing IW’s Stock
- Sell-side analysts incorrectly believe IW’s stock price is worth $16.00, indicating 45% upside. They are incorrectly evaluating IW’s revenue growth and market opportunities, and overlooking the numerous red flags we will highlight.
- Given these risks, we believe IW should be valued closer to its commercial printing/diversified business products and services peers at 8-12x 2013 earnings and 5x-7x 2013 EBITDA, which would result in a stock price closer to $5.00/share.