2023-07-18 13:07:53 ET
Summary
- Mitek Systems, a leading innovator of mobile image capture and digital identity verification solutions, is well-positioned to absorb the industry's projected double-digit growth over the next few years.
- Despite the risk of delisting due to late financial statement releases, the company's stock is undervalued and a buyback would likely be at a substantial premium to the current market price.
- Mitek's strong growth momentum, stellar profitability metrics, and high-quality business operations make it a recommended buy.
Investment thesis
Mitek Systems ( MITK ) is a high-quality business operating in the industry of digital identity verification solutions. The industry is projected to grow double digits over the next several years and my analysis suggests that MITK is well-positioned to absorb secular tailwinds. Recent quarters indicate strong growth momentum with stellar profitability metrics. There is a risk that the company can be delisted due to failing to comply with 10-K and 10-Q reporting but I think the risk is low because MITK has a legitimate justification of rotating the company's auditor. Even if the company will be forced to delist, I have a high conviction that the buyback will be with a substantial premium to the current market price because the stock is massively undervalued.
Company information
Mitek is a leading innovator of mobile image capture and digital identity verification solutions. According to the latest 10-Q report , the company serves more than 7,500 financial services organizations, leading marketplace and fintech brands around the globe.
The company's fiscal year ends on September 30. Mitek disaggregates revenue into two lines: Software & Hardware and Services & Other. Total sales are split about evenly between the two lines of business.
Financials
First of all, I want to emphasize that the company has changed its auditor, which is why Mitek submitted filings for late financial statements release. On June 13 the company received a delisting determination notice from Nasdaq due to non-compliance with the listing rules related to financial reporting deadlines. On July 6 , Nasdaq notified Mitek Systems of a stay extension. The panel hearing is scheduled for August 10. This relates to the latest quarter the full fiscal year. Still, we have plenty of the company's financial data to analyze, including the fresh earnings call of June 29 .
But let me start with analyzing long-term trends in Mitek's financial analysis, which are very positive. Revenue compounded yearly at a 25.5% rate, which means a tenfold growth over the decade. The gross margin has been consistently above 85%. Such a massive gross margin allowed the company to rapidly achieve operating profits, and currently, the operating margin is close to 20%. This, in turn, allowed to generate double-digits in the free cash flow [FCF] margin ex-stock-based compensation [ex-SBC] in recent years [FCF margin data unavailable for FY 2022 due to the late submission of full-scale financial statements].
The company fueled its stellar growth with substantial investments in R&D. About each fourth dollar generated in sales is reinvested in innovation. For me, it suggests the management's long-term commitment to building multiple competitive advantages for the company. Please also note that the SG&A to revenue ratio is relatively high at 45%, meaning there is plenty of room to improve the operating margin as the business scales up.
I would like to emphasize the company's stellar profitability metrics. I believe that profitability is the key metric for any business because the ability to generate free cash flows is the most important for shareholders expecting returns on their investments. Mitek has a stellar "A-" profitability grade from Seeking Alpha Quant , meaning its profitability ratios are substantially higher than the sector median.
High profitability enables the company to expand the gap with competitors by having more resources to invest inorganic growth or acquisitions. That said, MITK is well-positioned to capture the secular growth in the industry it represents. Grand View Research projects the identity verification market to compound at 16.7% annually. The company's stellar execution gives me high condition that MITK will be able to keep up with the industry's growth pace. That is a very bullish sign for investors.
On June 29 , the company announced record revenue and earnings for the full fiscal year 2022. From the quarterly perspective, the growth momentum is also strong, with a 17% YoY revenue growth. Non-GAAP operating margin comprised a stellar 28%. The non-GAAP EPS was flat at $0.22. Software & Hardware revenue increased 11% YoY. Services & Other revenue, which includes transactional SaaS revenues, maintenance, and professional services revenue, was up 23% YoY. I like the momentum strength across both segments. During the earnings call, the management reiterated its FY2023 guidance, with the expected 14% revenue growth. The non-GAAP operating margin is expected to increase 30% in FY 2023.
The upcoming earnings are expected to be released on July 28, with quarterly revenue at $37.38 million. This means a 15% YoY growth, which is solid. Despite the challenging macro environment, the company will continue to generate solid YoY growth over the next multiple quarters. Identity verification relates to security and reputation, and I believe that business will not cut back their expenses on it. Therefore, I expect the company to continue delivering strong earnings.
Valuation
This year, the stock underperformed the broader market with a 9% year-to-date price appreciation. The stock has a decent "B-" valuation grade from Seeking Alpha Quant . Current valuation multiples are mainly lower than the sector median and historical five-year averages. Thus, the stock is undervalued from the valuation ratios perspective.
To get more conviction, I want to proceed with the discounted cash flow [DCF] analysis. I use the elevated 13% WACC due to the small scale of the company. Earnings consensus estimates forecast double-digit revenue growth in the upcoming three years. For the years beyond, I incorporate a 10% revenue CAGR. For the FCF margin, I use the past five-year average, which is about 13.6%. I expect the FCF margin to expand by 50 basis points yearly.
The stock is substantially undervalued, according to my base case simulation. The business' fair value is about $790 million, which is 67% higher than the current market cap. Now let me simulate a more conservative scenario with 5% revenue CAGR and 25 basis points FCF margin expansion.
Risks to consider
The most obvious short-term risk now is the potential delisting. However, I think that the company has legitimate reasons why it failed to comply with reporting deadline rules of Nasdaq. Therefore, I have a high conviction that the company will be granted permission to stay public. Even if it is not the case and the company is forced to delist, the current stock price is significantly below the fair value. That said, it is highly likely that in case of a buyback, the company will pay a substantial premium to shareholders.
As a growth innovative company, MITK is under big pressure to deliver ambitious growth expectations from the public and especially investors. To do so, the company should constantly innovate and be efficient in allocating all these resources. It is a challenging task, but the track record suggests the management is able to succeed in the long term. The high uncertainty here relates to the length of the business's life cycle. We are living in an ever-evolving technological landscape, meaning there is always a possibility that MITK's technologies will be disrupted by new more efficient, and safe approaches.
Bottom line
To conclude, MITK is a "Buy". I have a high conviction that the company will avoid delisting because it has a justifiable cause for not filing the 10-K and 10-Q reports on time. The company demonstrates impressive revenue growth and the momentum is solid even amid the current harsh environment. Profitability metrics are stellar and the company has notable resources to fuel further growth both organically and with the help of acquisitions.
For further details see:
Mitek Systems: A High-Quality Undervalued Business