Part V - Bringing the threads together and looking for the CatalystI trust everyone had a great weekend and returns with wits sharpened to make money.
To summarize:
Part 1 :
- LiveTiles is an enterprise Software As A Service (SAAS) company in the "intelligent workspace" vertical.
- It has 4 related products : Design, Bots , Hyperfish and LVT Intelligence. The LVT Design product supplies a cloud based portal to organizations' intranet. Every employee enters the organization's intranet through this portal which puts LVT and its products at a central function as organizations move to the cloud and increasingly seek data, ease of use and increased efficiency in the workplace. LVT is well placed to offer add-on software services and has seized this opportunity by adding 3 products in 18 months. 2 were developed internally and 1 was acquired.
Part 2:
- The management team is led by 2 founders who are proven entrepreneurs who sold their first company to Rhipe.
- Their development team is exceptionally good at UX (User Experience) and UI (User Interface)
- The senior management includes a number of very senior former Microsoft execs. The company is well embedded within the MSFT ecosystem and knows and understands how to sell SAAS product within that ecosystem. MSFT is a customer and is bringing referrals to LVT because LVT's UX and UI expertise helps MSFT get customer traction with its Sharepoint product.
- LVT has made 2 acquisitions which have brought further management strength including Brian Cook, founder of Nintex (which he sold for 100s of millions of dollars) and the Wizdom team in Europe. Interestingly, all of these senior credible entrepreneurs have chosen to take LVT stock as consideration for the sale of their companies.
- The company has grown very rapidly and circumspect investors will want to see proof that LVT has the operational skills and financial controls to manage this growth.
Part 3 &4 :
- Rapidly growing SAAS companies go through three stages :
- Stage One : Early Stage Accelerating Growth, characterized by increasing cash burn
- Stage Two : "The Inflection Point". Accelerating revenues catch up with accelerating costs. The rate of cash burn reaches a trough and inflects and starts to decrease . Investors can see a path to cash flow break even .
- Stage Three : "Cash Positive" Operating cash burn continues to decrease until the company reaches cash flow break even and organic is self funding.
- The valuation rises significantly when a company reaches Stage 2 provided it is still growing rapidly. Stage 3 is often accompanied by a more mature growth phase where valuation depends on TAM (total addressable market)
- Valuations at Stage 2 range from 35X recurring revenues (see Workday example) to 12X revenues. The key variables are (i) Rate of Growth (ii) Operating Margin and (iii) TAM.
- The TAM for one product, LVT Design, on solely MSFT clients alone is as follows. There are approximately 200 million Sharepoint users. The average seat price for LVT design ai $1.20 per month....so Sharepoint TAM is approx $2.9 billion. (We would be thrilled if they achieved 15% penetration = $435 million), Then there is LVT Design for other platforms including AWS etc, Hyperfish and Bots. This is easily a $5bn TAM company. This allows for a valuation towards the upper end of the valuation matrix.
- Operating margins . From their July 2018 Investor presentation, we can deduce that LVT in 2018 was a business with approximately 23% operating margins. This may be unduly conservative because early stage growth companies typically have lower op margins than when they reach stage three...but lets be conservative and use 23% for now. This is towards the lower end of SAAS on a valuation matrix.
- The rate of growth remains a key variable when LVT reaches the cash burn inflection point. Overall, it seems conservative to use a valuation of somewhere between 10x and 15x recurring revenues PROVIDED that LVT can demonstrate that it has reached an inflection point in cash burn.
Part V : When does LVT reach cash burn inflection? What will ARR be at December 2019?Here is LVT's cash burn profile for the last 2 calendar years, 2017 and 2018. It is the classic stage one Early Stage growth profile with accelerating cash burn. Cash burn increased from a quarterly burn rate of -$1.6 million in March 2017 to a quarterly burn rate of $11.2 million in September 2018.
$'000 |
| 3/2017 | 6/2017 | 9/2017 | 12/2017 | 3/2018 | 6/2018 | 9/2018 | 12/2018 | 3/2019 |
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| 1 | Revenues | 700 | 970 | 1,070 | 910 | 1,460 | 3,430 | 2,410 | 4,090 | ? |
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| 2 | OpEx | 2,350 | 2,650 | 4,230 | 6,200 | 6,700 | 10,800 | 13,600 | 13,900 | ? |
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| 3 | Cash Burn | -1,640 | -1,675 | -3,160 | -5,311 | -5,245 | -7,427 | -11,188 | -9,843 | ? |
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So the question is, has cash burn reached an inflection point? Will it steadily decrease from December onwards? Have we reached Stage 2?
On the plus side we can clearly see revenues starting to catch up with expenses as revenues jumped to $4 million in the December quarter. However the inflection point always needs a couple of quarters at minimum to warrant being defined as a "trend".
It is the view of this commentator that cash burn in March quarter will be more important to LVT than ARR. March is always a soft and volatile month in software sales. Software sales forces make a big push in the December quarter to make their annual targets (and bonuses) and companies are trying to complete purchases by year end. As a result March can be all over the place, so its difficult to forecast the growth in ARR.
However, March and June will be important observations point in terms of determining whether LVT has passed an inflection point in terms of cash burn.
Let's look at revenues first: In the December quarter revenues benefited from September's N3 license revenue which arrived in October. I estimate that this added a bump of $300,000 to the Dec quarter revenue. However the increase from December 2017 to March 2018 adds $550,000 (Its a recurring subscription model , so without allowing for churn, the revenues in March 2018 will occur again in March 2019 + any additional subs won since then). If subs roll forward from Dec into in the March quarter (remember some of the jump in December will be annual licenses ), the revenues would be a net $250,000 higher in the core business. Lets call that our conservative assumption, a net revenue increase of $250,000.
The waters are somewhat muddied by Wizdom who will contribute both expenses and revenue. Overall Wizdom's performance consideration is based on remaining EBITDA neutral but we have no idea if there is any seasonal nature to the revenues. If March is a soft license quarter like it is in many other software companies then Wizdom might be cash negative in the March quarter. But we are setting a high hurdle for LVT's management. We want them to prove to us that they can manage costs as well as growth, so lets assume for the conservative case that Wizdom is cash flow break even.
Then we come to LVT's core expenses.The CFO stated in the December quarter press release that they hope to save $2 million in op ex in the quarter. This would amount to reducing headcount and other expenses by $ 8million per year. I commented earlier that reducing a cost base by 15% in a growing company is extremely difficult to do, especially in one quarter. I acknowledge and admire the objective but I want to be realistic in my expectations. I will say a quiet "told you so" if cost reduction is 5% and expect them to do more in the June quarter. I will be impressed if they do -7.5% on cost. I will acknowledge that management have excellent operational management and financial controls if they weed out 10% of costs in one quarter. If they take out the full $2 million (15% of costs) without hurting R&D and marketing and without damaging morale in one quarter then I will doff my cap, eat humble pie, admit I was wrong etc. and I will acknowledge that LVT has genuine six sigma management hiring quickly for growth and then weeding out 8 /10 who are not making the grade. Again, see my earlier posts as to why my experience is that this is very difficult to do.
So Four Scenarios:
1. Cash Burn does not decline further. We have not reached the inflection point. LVT continues to trade in a volatile manner between 30 and 45...while investors "wait and see". I confess I would be disappointed,
2. Cash burn declines by $1.25 million to around $8.25 million. ($1 million of cost cutting -7.5% and 0.25m of revenues) Its in the right direction. Look to June for further confirmation and accelerated decline in cash burn. Stock trades 40-50. It has upside. Call its base case -
3. Cash burn declines by $ 2 million to around $7.7 million. We have definitely passed an inflection point. Market can start to ascribe successful SAAS multiples to LVT Call this base case +.
4. Cash burn declines to less than $7 million. This would be vigorous indication that company has passed the inflection point in cash burn having peaked at -$11.1 million in September. Market would see a clear path to cash flow breakeven in early 2020.
What is the upside?
If we see a clear path to ARR of $50 million some time in 2019 and $100 million in June 2021 and apply 10-15X revenues to that recurring revenue,
Then we should see a market Cap of $500 million - $750 million before the end of 2019 and a market cap of between $1 billion and $1.5 billion by June 2021.
Dependent on having passed the cash burn inflection point by June this year, lets use a mid point of $625 million as a market cap by year end.
Now lets figure out the right number of shares:
| Number of Share at June 2018 | 519 million |
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| 1 | Add HyperFish Performance Consideration | + 6.8 million |
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| 2 | Acquisition of Wizdom | + 50 million |
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| 3 | Capital Raise in Feb | +45 million |
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| 4 | Management Incentive Shares | +32.6 million |
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| 5 | Final Cap Raise | +45 million |
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| 6 | Wizdom Performance Consideration 2020 | +30 million |
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| 8 | Fully Diluted Share Base | 728 million |
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I assume one further cap raise, even if company has clear path to cash flow break they will do a final cap raise because this management is conservative and will never allow their cash to decline to $7 million. They will always want opportunistic and secure cash at bank (this is a personal opinion, the company have never said this but I look at their style)
Hence a base case target price would be 85 cents a share by the end of 2019. This is full of assumptions and opinions. Everyone would have to come to their own view based on their own valuation assumptions. Our view is HIGHLY DEPENDENT on a clear demonstration in the March numbers that cash burn is continuing to decline.
If cash burn is not declining as fast as base case then the target would be lower. If either ARR is higher or cash burn is declining faster then the target could be higher.
Blue sky scenario (and please take this with a grain of salt). If LVT saw ARR of $60 million by December 2019 or March 2020, and cash burn declining faster than base case then we might ascribe 15X to $60 million and end up at $900 million by 728 m shares = $1.25 per share.
If you ignore management incentive shares and disagree with my final cap raise assumption then you would be using 650 million shares (Many analysts ignore fully diluted shares in their valuation). If the share price is at 85 cents by January 2020 then the Wizdom performance consideration would only be 17.3 million shares (The virtuous cycle of a rising share price!). Combined this would raise the base case target price from 85 cents to 98 cents but we prefer to stick with 85 cents.
Please bear in mind that we own shares and any views are tainted by this. Always remember to do your own work and use your own assumptions....but it would be great if you shared.
Obviously if LVT gets to $100 million by June 2021, then the market cap will be north of $ 1bn but we are not looking that far ahead.
At 45 cents buyers will be absorbing any stale owners left over from the Feb 2018 placing. It is obvious that the Feb 2019 placing has been fully absorbed.
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