Note: RewardStream trades on the Toronto venture exchange as REW.V but can also be found by searching CVE:REW , CVE: CA:REW or REW:CN
It always blows my mind to see the amount of misunderstood companies in the microcap space.
Usually it’s combination of a lack of coverage, not many investor relations resources, and misleading financials.
But that’s usually where you can find some of the best opportunities thanks to a little bit of information arbitrage.
Like Ackroo (see what I wrote on them here), there’s a good deal of information arbitrage surrounding RewardStream: a fast-growing SaaS provider of referral marketing software.
RewardStream went public back in August through a merger with an old publicly traded mining company, Musgrove Mining. For awhile, things were going quite well. The market clearly saw the growth potential in RewardStream and the stock traded between about $0.32 and $0.44 a share, at a hefty market cap valued at 8x (!!) Sales.
Since then, things haven’t looked so hot:
So what happened? It could be many things, but there’s two that stand out in my mind:
#1) Selling Pressure From Previous Shareholders – The old shareholders of Musgrove Mining, the company which RewardStream merged with to go public, were given shares of RewardStream after the merger. I wouldn’t be surprised if the pressure on the stock was related to them selling out.
#2) Misleading Financials – If you looked at the stock, you’ll notice the decline started to happen right after August. What happened in August? The company released its Q3 earnings. If someone were to talk a quick glance at the numbers, this is what you would see:
Looks like no growth.
You think to yourself: What the heck is going on? The company must not be executing. This could be a busted growth story!
But that’s First Level Thinking: “Market sees a company that on the surface looks like it’s not growing, sell, sell, sell!”
We need to be Second Level thinkers though.
For those that haven’t heard of the concept of Second Level Thinking, I’d definitely recommend a book written by one of the great investors, Howard Marks, which discusses that concept and much more.
Second Level thinkers always understand that there is more to the story, and that you need to think beyond what the current view in the market may be.
As a result, that quick glance at revenue is enough to dissuade potential investors.
What if I told you the company was actually growing the top-line at 30%, without any significant contribution from the e-commerce portion of the business which is highly likely to accelerate growth even further, thanks to integrations with Shopify, Magenta, and WooCommerce?
Surprising? Let’s dig in further.
RewardStream has actually been around since 1999. Yet over the past year or so, there have been significant changes to the business that will likely drive growth going forward.
Previously, RewardStream was both a loyalty and referral software company that operated by selling its software using a licensing model and selling the software directly. It also primarily focused on enterprise customers like telecom companies and credit unions for reasons such as the high customer satisfaction and the use of word-of-mouth referrals already driving the credit union business.
The company has made two major changes though: it quit the loyalty business because of lower margins, and switched to a SaaS model to really push into the e-commerce market.
Both of these are extremely important for reasons I’ll discuss in a little bit. But first, let’s get into the business.
RewardStream offers referral marketing software that companies can integrate into their ecosystem to drive additional growth. They make money in three main ways:
Launch Fees – What they charge enterprise customers up front to get set up with their software
Monthly Fees – This is the SaaS aspect of the business, or the monthly fee they charge for access to the software
Success Fees – They take a portion of the revenue customers earn from successful referrals (~5%)
It’s a very, very competitive and fragmented industry, so it’s important to understand how their software fits in the mix. To learn about the software better, I decided to get a demo, which resulted in an sales rep reaching out to me and setting up a live demo.
My first impression? This is a much more advanced, customizable solution compared to some of the basic options out there (upViral, ReferralCandy, etc).
I’ll spare you the details, but their offering had much more functionality and options compared to some other alternative software platforms. They personally reach out to each potential customer and help set up a RewardStream account for you to track your referrals. You can tell they wanted to create a more customized for their customers to make sure it’s successful and that they’ll get a nice revenue kicker from success fees later down the road (see what I wrote earlier).
Why else is this important?
The more they can help potential customers get set up and integrate their product into their ecosystem, the stickier the business will be. It’s much harder to switch to a competitor once your business is already fully integrated with RewardStream’s product. In the earlier stages I’m sure this is more costly for them to do (via sales reps) but over time, I’m sure they’ll be able to streamline the process.
More than 80% of their revenue is recurring.
Like most software businesses, it’s very sticky, and the initial high touch aspect certainly helps.
It’s still in a very competitive industry, with competitors offering similar solutions.
What do we need to focus on here then?
The key with a business like this is their ability to keep executing and growing.
Is their product better than most of the other options out there? Probably, but there are certainly competitors with similar offerings. If you head over to their website, they show you plenty of examples of how their software has helped their customers too.
At the end of the day, there’s no massive competitive advantages in an industry like this.
There’s big time execution risk.
The business will definitely need more capital before it hits breakeven.
So where’s the opportunity for investors right now?
One of the biggest problems these small companies have is getting people to notice them. Not many people care about companies that are sub-$50mm in market cap, let alone sub-$10mm in market cap. It takes awhile for investors to even find these names, or pop up on their screeners.
So when do they start noticing a company like RewardStream? There’s two big catalysts:
#1) – A clean QoQ revenue comparable, without the inclusion of any loyalty or source code revenue.
#2) – Once the company starts posting some big growth numbers.
Remember this chart? This is your advantage. Information arbitrage opportunity #1.
Because if you look deeper, the company’s revenue is really broken down like this:
And the what investors should be looking at is this:
But maybe the market’s greedy. Maybe it wants more growth.
This company seems like it’s all about e-commerce. Why shouldn’t revenue growth be even higher?
This is information arbitrage opportunity #2, and I think a big misconception around the stock.
In reality, there is little to no contribution from the e-commerce arm yet. Pretty much all historical revenue has essentially been coming from its bigger enterprise clients.
In fact, next quarter should be the first quarter the company should actually see some of the impact from the e-commerce side, albeit potentially small at first. This is a big reason why the company could be at a key inflection point.
The company only fully released access to its first big e-commerce plugin on the Magento platform on August 16th. Q4 should be the first quarter investors start to see the partial impact from Magento and being available to all 230,000 of Magento’s merchants.
How about since then?
On Sept 28th, the company announced it has integrated its plugin on the WooCommerce platform and made itself accessible to Woo’s 1.7 million merchants.
On Nov 2nd, the company announced it has integrated its plugin on the Shopify platform, although only in testing mode for now (I checked, it’s not on Shopify’s plugin list yet). Once it’s been fully integrated, that will make the plugin accessible to Shopify’s 300,000 merchants.
My point? The market has yet to see the growth RewardStream can achieve on the e-commerce side.
This is a business growing at 30% without any contribution from e-commerce. Imagine what they’ll grow at once they have contributions from e-commerce.
When does the market wake up?
Well Q4 (fiscal year ends on Sept 30th) will only have a partial impact from the full roll out of the plugin on the Magento platform, but they did land two referral marketing programs for Hawaii’s leading provider of telecommunications services. It might take another quarter.
In Q1, we should really see some serious impact from both Magento and Woo, in addition to creating referral marketing programs for iPromo.com and Scholar’s Choice.
If the market hasn’t woken up by then, Q2 should do the trick. Q2 will represent the first clean QoQ revenue comparable to pop up on screeners, and we should see the impact of Magento, Woo and hopefully Shopify.
So how much recurring monthly revenue can they get from these platforms? If we stay conservative and assume a 0.25% penetration rate on Shopify and Magento and a 0.1% penetration on WooCommerce (smaller merchants) at $49 a month, that’s about $1.8 million in extra recurring revenue a year, not including the ~5% success fees they get on referrals as well. That’s only 3,025 stores. The company could easily end up passing that number.
The common argument now is why would someone touch something valued at 4x revenue?
That’s a completely fair argument because the market has yet to see clean, strong revenue numbers from the company. Yet as I discussed earlier, that’s about to change over the next few quarters.
At a minimum, it shouldn’t take long for the market to start to notice and at least revalue the company back where it was in August.
Longer term, it’s all about execution risk. The market wants to see them growing fast and get closer to profitability.
Can management execute long-term? Again, it’s way too early to tell, but they do have a management team with experience in the space.
Their advisory board consists of maybe executives with strong marketing backgrounds, including the COO of Leadpages and a VP over at Points International.
CEO Rob Goehring has an extensive marketing and entrepreneurial background. Previously, he was Chief Marketing Officer at Tio networks and was also a co-founder of Contigo Systems, which was sold to Vecima Networks for $200 million.
How long does it take until they’re profitable?
It’ll probably take about $10 – $15 million in revenue until the company can stay consistently profitable. That will require at least $4 – $5 million more in capital, which $3 million could come from options and warrants that can be exercised in the ranges of $0.30 to $0.50 a share.
Luckily, we only need to focus on the next few quarters for now. As we start to see the performance of e-commerce and the markets reaction, it’ll be worth revisiting.
Yet with the market soon to see cleaner and stronger results from the company, it may be worth it to get a head start on the crowd.
Article by Alpha Tree Group