Note: Ackroo trades on the Canadian Venture exchange as AKR.V, and OTC as AKRFF
Finding that next ‘home-run’ idea is no easy task. Most of the time that ‘home-run’ idea usually comes with just as much downside as upside, and as many value investors would agree, what’s the point of buying something without a solid margin of safety? Finding a ‘home-run’ idea with limited downside? Well that’s a whole other level of rare.
Some investors looking for that next home-run idea will venture into the micro-cap space to find these opportunities. Let’s be real for a second though: the micro-cap space is usually very sketchy. Overly promotional management teams, companies with junk products, and a few fallen angels. Yet every once in awhile, you stumble across something that makes you do a double take. Not all micro-cap companies are as bad as you think.
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Meet Ackroo, a formerly overhyped start-up that turned into a broken, cash burning machine that left a lot of previous shareholders with pennies on their original investment. Fast forward to now, and you have a company that fired the previous management team, drastically reduced headcount, and has positioned itself on verge of breakeven, all on a barebones budget.
Even with all this change, the market still views Ackroo as broken, with nothing positive on the horizon. Yet, with profitability likely less than a year away, it’s pretty easy to see a path to multi-bagger potential without overly aggressive assumptions.
What $6 million of cash burn looks like, or 150% of the current market cap.
Before we get to where Ackroo is going, let’s recap to how it got in this position. Ackroo is a SaaS based provider focused on selling its cloud based gift card and loyalty platform into the retail and hospitality markets across North America, with a focus on the SMB segment (small to medium sized businesses). Essentially, the SMB segment is very underserved and very fragmented when it comes to the loyalty market, since most of the big players in the space only focus on enterprise accounts. This was Ackroo’s opportunity. Original shareholders ate that up. What’s better than a sticky, recurring revenue business within a highly fragmented market? Investors love consistency and predictability.
Pre-money valuations for the company were around $19.5mm (current market cap is about $4.3mm). So what was the problem? Ackroo wasn’t making any money. The company burned through cash like no other as they tried to build a big salesforce. Things just kept going downhill from there as the company was constantly running out of money.
During this time, the company hired Steve Levely, who happened to stumble across Ackroo because he was trying to build his own loyalty and gift card offering to take advantage of the underserved SMB market. In May of 2014, the board appointed Steve as the CEO with the goal of becoming profitable of selling the company.
The biggest issue for the new management team? Raising money. No one wants to invest in a company that’s already burned through millions of dollars. Luckily, they were able to raise some money in a few private placements to keep the lights on. The management team also decided to fire the whole sales force and switch to a referral only model, which dramatically reduced costs, and if you think about it, what other choice did they have with a barebones budget? Since then, they’ve made a few acquisitions and secured a few partnerships to increase their scale and improve their offering.
Like I mentioned earlier, Ackroo is a SaaS based provider focused on selling its cloud based gift card and loyalty platform into the retail and hospitality markets across North America, with a focus on the SMB segment. Their platform provides the processing of gift card and loyalty transaction at point-of-sale, gives merchants important administrative and marketing data (this is important, think big data), and also allows customers to access and manage their gift card and loyalty account. It’s a very, very fragmented space, with a lot of different players and a lot of different offerings. My big question at first? Where’s the competitive advantage/moat? To be honest, there really isn’t much of one.
Let’s think of where Ackroo fits in for a second. You have well known names like Square that have a loyalty and gift card offering as well. Why can’t they out-compete Ackroo? Well, Square focuses on very small businesses with only a few locations. They also charge a much higher transaction fee (~3%) than a typical enterprise payment processor would charge (sub 2%). Yes, that 1% is a big difference. Ackroo often works with companies with many locations. Companies like that don’t work with the Square’s of the world because of the high fees, and the infrastructure needed to handle all their locations. They also prefer third-party providers like Ackroo because Ackroo’s platform can support any sort of point of sale environment and because it allows merchants to use which payment provider they’d like. Payment neutrality is key.
So what about they big guys? Why doesn’t First Data come up with their own loyalty offering for the SMB space? They certainly can, but it’s not worth their time and resources. They instead have offerings for big enterprise accounts which will actually help move the needle when it comes to revenue and profits. Instead, companies like First Data and Global Payments will partner with Ackroo, and have their salesforce sell Ackroo’s offering into their current customer base.
Ackroo’s niche is really within some of these bigger businesses with many locations that prefer to have a third party provider of loyalty and gift card solutions, which can work with many different payment providers. Ackroo’s direct competitors are more like companies such a Datacandy which have a similar offering, which a few differences. For example, Datacandy looks cheaper upfront, but they’ll charge you for any additional services you request. Ackroos allows merchants to add on most additional features at no additional cost. Datacandy requires merchants to request customer spending data reports from them, Ackroo’s platform is completely do-it-yourself so you can generate reports on your own. Again, I don’t think any of this can be called a strong competitive advantage. The real selling point to investors is the consistency of the recurring revenues and the stickiness of the business.
Ackroo really has three different types of revenue: the recurring revenue which is the SaaS fee they charge merchants every month, the lumpy, seasonal revenue they’ll get from things such as when merchants do big gift card campaigns around Christmas, and then the truly one-time revenue they’ll get from initial set up fees, etc. Obviously, the recurring revenue is every investors dream. Pretty predictable and consistent every quarter, with only about 2% attrition in Q2 as well. That revenue is quite sticky as well. Once you’ve integrated software like this into your platform and get used to it, the monetary and psychological switching costs get much higher. Steve and his management team believe they’ll be able to hold onto their accounts for upwards of 9 years.
The Future and The Upside
Now for the fun part. The common bullish argument is that Ackroo should trade at a similar multiple of revenue like other publicly traded comps, which are currently averaging around 4x – 6x revenue. Ackroo currently trades at 1.6x pro-forma revenue. So you can do some quick math and slap a nice 4x multiple on Ackroo, and you get yourself an easy double. I’m not going to argue the whole higher multiple of revenue angle without a good reason. Again this is a stock that has burned investors in the past. There has to be a REASON for investors to give Ackroo that 4x revenue multiple. I think that reason comes once Ackroo hits breakeven and posts some profits. The question obviously, when does that happen?
First and foremost, we have to understand the revenue growth. Unfortunately, Ackroo does not do a very good job separately recurring vs one-time revenue or organic vs acquisition based revenue. Let’s tackle the recurring vs one-time revenue dynamic first.
Ackroo lists revenue as either “Subscription and Service” or “Product”. At first glance you’d think the former is the recurring revenue part of the business, but if you look at the past few quarters of “Subscription and Service” revenue, you can see it’s quite lumpy. That’s because the “Service” piece is very lumpy in nature, and is not what you consider recurring monthly revenue. After talking with Steve, the company really has more a of a 60/40 split between recurring and one-time-ish revenue, with about a 5% fluctuation for seasonality during times like Q4. Therefore, that 60% of revenue is the type that is nice and easy to project every year, and should be relatively consistent.
Now what about organic vs acquisition based revenue? It can be very deceiving to read a press release and see the big growth numbers the company has been posting. That is mainly because of acquisitions. Unfortunately, the company doesn’t breakout each, mainly because I believe there hasn’t been much organic growth over the past few quarters. Before I get into the math I want to make one thing clear, I do not think it’s bad to see little to no organic growth here. This was a company on the verge of bust with an extremely limited budget that is only using referrals to grow. I honestly wouldn’t expect them to be growing rapidly now. Yet, I expect this is going to change big time over the next few quarters.
One thing to point out here: the recurring vs one-time revenue is my estimate based on my talks with Steve. Essentially, I estimated the proportion of recurring vs one-time each quarter based on the 60/40 split I mentioned earlier. I used that to back into the company’s true organic growth number, which as you can see, really hasn’t moved much.
At the end of May, Ackroo acquired Dealer Rewards Canada, which added about $53k in recurring monthly revenue, and gave the company a nice boost in organic growth thanks to the upselling of some other features. Over time, that RMR has increased to $59k. The only other organic boost the company has really experienced has really been on the one-time side, thanks to higher than normal marketing campaigns run by some of Ackroo’s merchants in Q2 2016.
How about going forward? Let’s assume a really bearish scenario: No acquisitions, and only enough organic growth to offset attrition. What does the company look like over the next few quarters?
Ackroo should start getting revenue contributions from both it’s acquisition of D1 mobile and Loyalint/Fidelint, which will help boost revenue. D1 is expected to contribute about $100k a year, with Loyalint/Fidelint contributing recurring monthly revenue about about $15k (not assuming any additional upside like the Dealer Rewards acquisition). By the end of 2017, again with literally no acquisitions or organic growth, the company will hit about $2.66mm in revenue.
Now more importantly, how about the historical costs?
Note: I removed non-cash expenses like amortization, and stock comp in my EBITDA calculation
As you can see, EBITDA loss has dramatically shrunk. Let’s focus on a few things here:
First off, the Dealer Rewards Fee. Essentially because of the way that acquisition was structured, Ackroo bought the Dealer Rewards Canada customer base, but did not buy the Dealer Rewards software platform with it. Why you ask? They literally just didn’t have the money to. Again, Ackroo is doing all of this on literally as bare bones budget. They now need to move the Dealer Rewards customers over to their platform. While they are transitioning them, they’ll receive all the revenue but have a pay a 40% licensing fee while those customers are still on the Dealer Rewards platform. This is added into COGS, and as you can see, is the main reason for the drop in Gross Margin. Management expects to have the subscriber base fully transferred over by the end of the year, thus eliminating the licensing fee for 2017.
Next up, Admin and R&D expenses. Both should be slightly lower going forward. You’ll also notice the Sales & Mktg expenses pretty much disappear as the company operates on a referral only model.
Let’s take a look at how things shape up for 2017:
So what do we notice?
The Dealer Rewards licensing fee should disappear in 2017, with the exception of one big dealer who I think they will have trouble moving over by the end of 2016. Either way, you can see the improvement in Gross Margin after.
Assuming a similar SG&A expense level and even with no acquisitions or organic growth being included, the company should be EBITDA positive for the first time likely in the first quarter of 2017, thanks to the licensing fee disappearing. Yes, I know, I know I’m not deducting stock comp, but I’ll explain later.
Additionally, you have a company that is darn close to having a breakeven quarter by the middle of 2017, without accounting for ANY growth.
But let’s be real for a second: Ackroo has got a strong pipeline of new deals expected to come in from the First Data partnership, and there’s a good chance they make another acquisition as well during the year. Take a look at what happens when we make some more realistic assumptions:
Note: I removed non-cash expenses like amortization, and stock comp in my Net Income calculation to better show the companies true CASH Net Income
What are the assumptions here?
About $100k in revenue from organic new deals, thanks to the First Data partnership. Very conservative assumption here.
$300k in revenue from a random acquisition the company makes during the year. (Acquired at 2x revenue, financed with debt at 10%). Pretty conservative as well, considering the acquisition of Dealer Rewards Canada contributes over $700k in revenue a year.
Now all of a sudden we have a company that’s profitable and would be trading at 16x 2017E earnings, which would be ridiculous for a company whose growth runaway is just opening up.
What’s key here is now the market has a REASON to place a 4x growth revenue multiple on the company. Using the projected 2017E revenue of $3.34mm, that’s a market cap of $13.36mm, which is about a triple from the current market cap today.
But that’s not even the best part. Remember, Ackroo’s big issue has always been raising capital. No one wants to lend to a company that has a history of burning through cash. Now that Ackroo has turned profitable, it becomes very easy for them to find financing for future acquisitions. The capital markets all of a sudden swing open and Ackroo is in a good position to roll-up the very fragmented industry it’s in.
Now in 2018, things can get very interesting, let’s take a look:
This time I just added an additional $100k from organic new deals thanks to the company’s partnerships and a larger acquisition similar to Dealer Rewards Canada. Now all of a sudden we have a company over $5mm in revenue, that is nicely profitable (even after an increase in SG&A from a boost in headcount), and much better positioned to grow. Using the same 4x revenue multiple, we have a company worth 4.5x more than it currently is today. Again, who knows how fast the company decides to roll up the market once the capital markets open up for them. This can all happen much more quickly than I even expect.
Wrapping It All Up
A series of prior mistakes by an old management team, a very negative market perception, and lack of coverage on Ackroo have created the perfect lollapolooza of pessimism to cause some serious mispricing on a name that is in a strong position to take off quickly over the next few quarters. Once the market actually realizes how close to breakeven Ackroo is, I wouldn’t be surprised the company is instantly re-rated to a 4x – 6x revenue multiple like other publicly traded comparables. The end game for Ackroo? I wouldn’t be surprised to see the company acquired in a few years like a larger player such as First Data for a hefty premium on its revenue base, thanks to the extreme stickiness of the business model.