RDVT - Red Violet Grows But Employer Hiring Is Slowing

2023-07-19 19:35:13 ET

Summary

• Red Violet, Inc. sells a variety of identity verification software and services to companies in various industry verticals.
• Management has seen softness in the collections and real estate marketing verticals, as well as from large enterprise clients.
• Red Violet may be underfollowed by analysts, but it appears to be facing a slowing hiring environment.
• I'm putting Red Violet, Inc. stock on a watchlist for future consideration, but for now I'm Neutral [Hold] on the stock.

A Quick Take On Red Violet

Red Violet, Inc. ( RDVT ) provides a range of identity verification technologies to omnichannel-oriented companies worldwide.

As companies reduce hiring efforts, the effects may negatively impact Red Violet’s growth potential.

Although I’m Neutral [Hold] for the time being on Red Violet, Inc. due to my concern about a continued slowdown in hiring, I’m putting RDVT stock on a watchlist for future consideration.

Red Violet Overview

Boca Raton, Florida-based Red Violet was founded to provide software and services to assist companies in authenticating the identities of individuals in the United States.

The firm is headed by Chairman and CEO Derek Dubner, who has been with the firm since 2017 and previously was CEO of cogint and Interactive Data (acquired by cogint).

The company’s primary offerings include the following use cases:

• Due diligence

• Identity authentication

• Regulatory compliance

• Risk mitigation.

RDVT acquires customers through its direct sales and marketing efforts as well as through distributors, resellers and strategic alliances.

Red Violet’s Market & Competition

According to a 2022 market research report by Grand View Research, the global market for identity verification was estimated at $8.5 billion in 2021 and is forecasted to reach $34.0 billion by 2030.

This represents a strong forecast CAGR (Compound Annual Growth Rate) of 16.7% from 2022 to 2030.

The main drivers for this expected growth are a growing frequency of identity fraud and the increasing adoption of digital services by consumers and enterprises.

Also, the chart below shows the global identity verification market by industry vertical in 2021:

Major competitive or other industry participants include:

• Acuant

• Equifax

• Experian Plc

• GB Group PLC

• IDEMIA

• Intellicheck

• Mitek Systems

• Nuance Communications

• Thales Group S.A.

• TransUnion.

Red Violet’s Recent Financial Trends

• Total revenue by quarter has trended higher in recent quarters; Operating income by quarter has been materially variable as shown in the chart below.

• Gross profit margin by quarter has trended higher recently; Selling, G&A expenses as a percentage of total revenue by quarter have also moved higher in recent quarters.

• Earnings per share (Diluted) have produced the following variable (seasonal) results.

(All data in the above charts is GAAP.)

In the past 12 months, RDVT’s stock price has fallen 1.22% vs. that of the iShares Expanded Tech-Software Sector ETF’s ( IGV ) rise of 27.4%, as the chart indicates below.

For the balance sheet , the firm ended the quarter with $30.8 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash flow was $11.3 million, during which capital expenditures were $0.3 million. The company paid $5.5 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Red Violet

Below is a table of relevant capitalization and valuation figures for the company.

(Source - Seeking Alpha.)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

RDVT’s most recent Rule of 40 calculation was 20.0% as of Q1 2023’s results, so the firm is in need of improvement in this regard, per the table below.

(Source - Seeking Alpha.)

Commentary On Red Violet

In its last earnings call ( Source - Seeking Alpha ), covering Q1 2023’s results , management highlighted improvement in a leading indicator of customer demand, with new customer applications at a 12-month high.

However, during the quarter, management reduced headcount, from 187 to 170.

This is likely due, in part, to continued "softness within our collections and real estate marketing verticals. Both areas experienced slightly negative growth in the first quarter compared to prior year."

The company’s gross revenue retention rate was 94%, down from 97% in previous years, indicating a need to improve its sales & marketing efficiency.

Total revenue for Q1 2023 grew by 15.0% YoY and gross profit margin increased by 2.5%.

Selling, G&A expenses as a percentage of revenue rose by 1.7% year-over-year, indicating reduced efficiency, while operating income improved by 33.3% YoY.

Leadership did not provide forward guidance, either for the upcoming quarter or full year 2023.

The company's financial position is strong, with ample liquidity, no debt and positive free cash flow.

RDVT’s Rule of 40 performance has been only moderate and is in need of improvement.

From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below.

I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited "Uncertain" two times, "Challeng[es][ing]" three times, and ‘Macro’ once.

Analysts questioned company leadership about where the firm is seeing customer hesitation and management believes it is seeing some caution among larger customers.

However, the company has been continuing to build out its large customer sales pipeline.

Regarding valuation, the market is valuing RDVT at an EV/Sales multiple of around 5.2x on TTM revenue growth rate of 18.7% against a median SaaS Index implied ARR growth rate of 21% ( Source ).

The Meritech Capital Index of publicly held SaaS application software companies showed an average forward EV/Revenue multiple of around 8.8x on July 2, 2023, as the chart shows here:

So, by comparison, RDVT is currently valued by the market at a discount to the broader Meritech Capital SaaS Index, at least as of July 2, 2023 and given the firm’s growth rate compared to the median growth rate of other software companies in the index.

Risks to the company’s outlook include an economic slowdown that may be underway and lengthening sales cycles which may reduce its revenue growth potential in the near term.

For example, the drop in new non-farm payroll additions over the past year shows the potential for slowing economic growth affecting the firm’s forward prospects, as the chart below shows:

A potential upside catalyst to the stock could include better results in its collections and real estate marketing verticals or larger enterprise customers becoming less cautious.

The company is underrepresented by financial analysts and currently has only two analysts covering the stock, which may mean it is undervalued by the wider market.

Although I’m Neutral [Hold] for the time being on Red Violet, Inc. due to my concern about a continued slowdown in hiring, I’m putting RDVT on a watchlist for future consideration.

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