2023-05-01 10:00:00 ET
Summary
- The Identity Verification market is projected to grow at 15%.
- Mitek is a leading player in the market and has a long runway ahead.
- Management started to repurchase shares to at least keep the share count stable after valuation multiples for Tech stocks colapsed.
- Mitek looks like a compelling investment at these prices.
The need for secure and reliable identity verification solutions has become paramount in today's digital age. With the rapid rise of online transactions, digital services and remote interactions, the importance of verifying the identities of individuals and entities has increased significantly for the security of customers and businesses alike. Traditional identification methods, such as physical IDs or documents, are susceptible to fraud, impersonation and data breaches. As a result, there has been a growing demand for digital identity verification solutions that leverage advanced technologies such as biometrics, artificial intelligence [AI], and blockchain to ensure the authenticity and integrity of identities in the digital realm. These solutions offer enhanced security, convenience, and compliance with regulatory requirements, making them indispensable for various industries. Mitek Systems (MITK) is a leader in this industry and is positioned well. Over the last decade, the performance has been underwhelming, with a total return of 113% compared to 212% for the S&P 500. The situation looked different until the tech bubble collapsed at the end of 2021 when Mitek posted peak total returns of 450%. Let's see if Mitek is now an attractive opportunity.
Identity Verification is a growth market
I aforementioned why the market is attractive in the introduction and the market is expected to grow at a fast clip. According to Markets and Markets, it is projected to reach a $15.8 billion size by 2025, a 15.6% CAGR, fueled by its increasing relevance throughout large verticals like Financial Services, Telecom or Insurance.
From a personal experience, over the last few years, I observed this change in more advanced verification requirements on websites and services. As the internet matures further and companies try to reduce fraud, the need for these solutions will increase. Government regulations are another tailwind. In Germany, for example, if you want to open a brokerage account, you must verify your identity. This used to be done over the post by mailing a copy of your passport and having around 3-8 weeks of processing time. This same process now takes about 5-15 minutes via digital solutions.
The industry is constantly battling bad actors who try to devise new ways to trick the system. This means that continuous investment in developing the solutions further is required, but it also enables continued new product releases or updates. Mitek's competitive advantage is its data flywheel: More data inflow allows better and faster learning of the algorithms, enabling better adoption and retention of customers, leading to more user data inflows.
Steady Revenue growth
Over the last five years, Mitek saw steady revenue growth, averaging around 15% per year. While this is impressive, EPS (27% CAGR) and Free cash flow per share (45% CAGR) grew much faster and more volatile.
This discrepancy was due to significant operating leverage: While gross margins stayed in the high 80s and only slightly improved (to be fair, there is not much to optimize at an 85% gross margin), SG&A margin declined from 60% to 42% and all profitability metrics improved significantly. EBIT margin grew from barely profitable (2%) to 22% and EBITDA increased to 31%. These attractive software margins could see further upside along the way.
An improving Capital Return Profile
Mitek matured quite a bit as a company over the last five years. We can see that the company continually diluted shareholders while margins were low. This led to a 28% dilution over the period, but we can also see that in early 2022 the company started repurchasing shares and keeping the share count flat. This timing is in line with the collapse of the tech bubble and shows reasonable capital allocation from management: Dilute while stock is a cheap currency, repurchase it once it is a good value. We can also see that Mitek made a large acquisition in early 2022 in a $126 million all-cash deal: Mitek bought HooYu , a leading KYC (know your customer) firm from the UK, to improve its portfolio. At the time of the deal, Mitek had a market cap of around $600 million, which was 1/5 of the company. This deal was financed mainly by taking on debt, as shown in Net Debt Issued.
A compelling Valuation
Over the last decade, Mitek hasn't been an excellent stock to own. After the stock tripled following the covid lows, we've seen a significant 61% drawdown, bringing the stock down to levels last seen pre-pandemic. The stock trades at a cheap multiple of 10 times forward EBITDA compared to the median of 17 times and trades at a 5.8% FCF yield. Let's look into the stock further with an inverse DCF model.
Frequent readers of my analysis will notice that I adjusted my inverse DCF models a bit: I focus more on Owner Earnings now, which I define as:
FCF + Growth CapEx - SBC +/- Net working capital changes
I believe that this approach is more accurate than using just free cash flow for multiple reasons:
- Stock-based compensation is a real expense and should be accounted for.
- Growth CapEx could be returned to owners instead.
- NWC Changes can skew FCF in the short term and should be adjusted.
Using this framework, we can see that Mitek is very attractively priced and does not require a lot of growth to project above-market returns, especially if we consider the projected market growth rate of 15% for identity verification solutions.
The biggest risk I see looming over the stock are continued legal complications with USAA (United Services Automobile Association) regarding patent infringements. The complications have been going on for a while (see this press release from Mitek in 2014). In May 2022 Mitek won the latest round in a patent fight regarding Mitek's mobile banking solution.
Mitek looks like a compelling investment at these levels and I am considering opening a position.
For further details see:
Mitek Systems: An Undervalued Player In The Booming Identity Verification Market