2023-08-22 11:14:54 ET
Summary
- Mitek Systems is a leader in mobile capture and digital identity verification solutions for financial institutions, with a monopoly on the mobile capture market.
- The company's mobile deposit segment is growing at over 10% and its ID verification segment is expected to be cashflow breakeven in 2024, driving high growth and potential re-rating.
- Advances in artificial intelligence present a huge tailwind for Mitek, as AI improves its fraud detection capabilities and increases demand for identity verification solutions.
Introduction
Recent advances in Artificial Intelligence ((AI)) are the most significant innovation so far in this decade. The launch of ChatGPT by OpenAI caused widespread media attention. Many of us realized how good AI has become in many tasks including AI-generated pictures and videos that are confusingly similar to real ones.
This undermines that AI could be used to the detriment of others such as identity fraud/theft. Everyone can have access to any AI service provider like Midjourney or Adobe Firefly (ADBE) to generate hyperrealistic AI pictures and deep fakes, which are then used to open a financial account in someone else's name.
This presents a problem for the financial industry. Mitek Systems (MITK) offers a solution to this exact problem as it develops software that verifies an individual's documents, and checks for facial liveness including the voice. Mitek is an AI winner as AI-enabled fraud creates a huge demand tailwind for detection and protection. Any advances in that technology also make the company's products better. A good litmus test of whether a company seriously uses AI is mentions of the technology before the ChatGPT hype began. Mitek Systems first mentioned AI in its 2016 annual report .
Thesis Summary
Mitek Systems Inc. operates in mobile capture and digital identity verification solutions serving the largest financial institutions in the US. The banks profit from lower costs, while its customer benefit from higher security and much higher convenience. MITK has a monopoly (>90% market share) on the mobile capture market, which grows low double-digits, and uses this advantage to cross-sell its ID verification solutions which grow roughly 30%.
The stock trades at 12x NTM P/E, while the historical trough was 15x (outside of COVID). MITK is a buy for the following reasons:
- Its mobile capture business is falsely perceived as a melting ice cube because the number of checks issued is steadily declining - yet the dollar amount of checks is flat. In fact, MITK's segment is growing by >10% because the mobile check deposit market still has a long growth runway.
- Its ID verification business is a high-growth segment and expected to be cashflow breakeven in 2024. In the next three years the ID verification business will be responsible for over 50% of revenues and due to its growth rate should warrant a re-rating.
- AI is a big tailwind for MITK. The market for identity verification is already projected to grow 15,5% p.a., but recent advances in artificial intelligence could lead to upside surprises.
I believe MITK achieves an EPS of $1.27 in 2026 and using a multiple of 20x NTM P/E I arrive at a price target of $25.4 (20% IRR).
Business Overview
Mitek Systems has two business segments. The largest (60% of revenue) is its mobile deposit segment (also called remote deposit capture). Mobile deposit capture is a fund deposit process, which involves scanning the digital image and verifying checks then subsequently sharing it in the bank through mobile devices.
MITK sells licenses of its software to banks that implement it in their mobile banking offerings. Customers don't have to visit a branch to deposit a check. It's a simple 3-step process: open the banking app, take a picture of the front - Mobile Capture fills in the dollar amount automatically. This is highly convenient as the checks are often cleared within a few days . There is little incentive to use the old method which can be observed in the 85% retention rate . For customers, it is very important to have this technology implemented in their mobile banking offerings. Among a list of advanced mobile banking features, 84% of mobile banking users rated mobile deposits as "critical" or "important".
Mitek Systems & Cornerstone Advisors: 2022 Mobile Deposit Benchmark Report
For financial institutions (FIs) mobile deposits are an important part to implement cost efficiencies. According to Retail Dive , major banks save "$3.88 with each mobile check deposit compared to a teller deposit, with banks having saved an estimated $100 million in transactions costs as a result".
The second segment is identity verification (ID verify, 40% of revenue). Mitek's ID verification technologies make it possible for companies to verify an individual's identity during digital transactions, allowing them to reduce risk by detecting and reducing fraud as well as meeting regulatory requirements (Know Your Customer, Anti-Money Laundering). This is beneficial for the individual as it reduces friction in the users' experience with advanced data prefill and automation of the onboarding process.
Mitek Systems serves 7,800 FIs, among it the largest US banks.
Mitek Systems Investor Presentation
Mobile Deposit Market Overview
Mitek is the market leader in its core business with a market share of >90% .
For 40 years, people have been saying that checks would disappear - yet they still account for 7% of all consumer transactions . A good way to think about the payment system is to use the analogy of a highway. Lanes (i.e., payment methods like cash, checks, credit cards, etc.) are added to the highway but never taken away. The dollar amount is flat since 2012.
The market is growing and there is still a lot of white space to capture for MITK. According to a survey from Cornerstone Advisory in Q3 2022, the percentage of consumers who used mobile deposits increased from 40% to 53% . My expert network estimates that over 50% of checks are remotely deposited for the big banks and only 3-4% for credit unions.
Mitek Systems & Cornerstone Advisors: 2022 Mobile Deposit Benchmark Report
Allied Market Research expects this market to grow by 6% p.a. driven by new consumer habits due to COVID and high customer retention as mobile is gaining market share. MITK is even able to achieve a higher growth rate as they can increase prices because:
- Higher costs are marginal as the costs of a branch are much higher than mobile deposits. In addition, the price increases are often not passed through to the consumer as banks want to incentivize the adoption to cut costs.
- MITK has a >90% market share and there is no incentive to switch providers.
- CEO Max Carnecchia said that contracts have been " poorly negotiated ".
Huge AI tailwind for Mitek's identity verification
AI is going to be very beneficial to Mitek's business in two ways. Advances in AI make MITK's products better at detecting and preventing fraud. However, AI also enables fraud and makes it easier to implement.
A study from the National Council on Identity Theft Protection showed that between 2020 and 2022 almost 50% of U.S. citizens were victims of identity theft. The most common forms of identity fraud included account takeover, (actual user's information is misappropriated), starting a new financial account with a victim's information, and information theft (i.e., Social Security identity theft). The graph below shows that these issues have been steadily increasing over the past decade and even accelerated in recent years. Mitek estimates it costs companies a staggering $43 billion .
National Council on Identity Theft Protection
ID theft and fraud is a serious issue and MITK is in a prime spot to tackle this issue. The market for ID verification is expected to grow at a CAGR of 15,5% until 2029 to a size of $24 billion. Note that these numbers are before the ChatGPT breakthrough which arguably has increased the market size.
Gartner expects the market penetration to be at only 20-50% - ergo a long growth runway is ahead for MITK.
Mitek Systems Investor Presentation
MITK can grow its segment above market rate in three ways:
- It can leverage its monopoly market status and cross-sell its ID verification solutions.
- It is expanding outside the financial industry and winning reputable customers like Adobe, DocuSign (DOCU), Turro, and others.
- It adds additional use cases for existing users such as re-verifying the same individual after establishing a relationship (i.e. change of phone number, address, etc.).
MITK has been working with artificial intelligence since 2016 way before it was a "hype" on the stock market. There are key considerations when evaluating AI winners/losers. One of these is the data set available to the company. "Garbage in, garbage out" - good data is crucial as AI functions solely on data. MITK has access to data (ID cards, passports, driver's licenses, etc.) that only the government might have when it comes to this industry. Furthermore, it has processed several billion checks with insights into additional personal information and consumer habits. This is helpful when it comes to detecting abnormal behavior. In other words, Mitek Systems has a historical dataset in a unique area, which is difficult to approximate using other companies' datasets, resulting in a big moat.
Growth & Valuation
The mobile deposit segment is far away from being a "melting ice cube" growing over 10%. ID verification is MITK's high-growth segment and is becoming a major part of the company's revenue.
This translates to growth in the bottom line.
It is hard to find an exact comparison for MITK, however, there are several related companies in both segments. The table below shows that MITK is severely undervalued, despite having better margins and growth rates.
* EPS for MITK is adjusted for litigation costs and other one-time effects; n.a is for values that went deeply negative (Company Filings)
What is the correct multiple for a profitable monopoly with 20% growth rates? Whatever you think, I doubt the current NTM P/E multiple of 12.8x is correct. The historical trough (outside of COVID) was at 15x, while the 10-year-mean is 23.6x. In the next three years, I believe that MITK will re-rate to 20x. With ID verification becoming the bigger part of Mitek's revenue (>50%), there could be further upside in the multiple.
Catalyst 1: Delisting Risk Eliminated
On June 13, 2023, MITK received a delisting notice from Nasdaq because it did not timely file its 2022 annual report and subsequent quarters. The reason is its auditor Mayer Hoffman McCann P.C. resigned in May 2022 and the transition to the new auditor, BDO USA LLP , took longer than expected. This move caused confusion specifically because McCann has been Mitek's auditor since 2007. First of all, both auditors made clear that the delay was not due to a result of misconduct. After talking to the management, it became clear that the decision was an update. In 2007, MITK had a market cap of only $10 million and was listed OTC. Of course, a company at this stage is not going to have access to a top-tier auditor (no offense to McCann). Now with ambitions of a >$1 billion business it makes sense to upgrade to a U.S. Top 10 auditor.
Mitek has time until October 13, 2023 to regain compliance. They already filed its 2022 annual report on July 31, 2023. This shows that the company is very serious about Nasdaq's listing requirements. In MITK's most recent earnings call for Q4 2022 , CFO Fuad Ahmad said that it would only take a couple of weeks to file the quarterly reports after the annual report.
What happens in the case of a delisting? The stock still will be tradeable, but OTC. In that case, I expect forced selling as passive investors/ETFs and other funds cannot hold OTC securities. It is hard to tell the downside in such a scenario, but a 50% drawdown shouldn't be a surprise. However (!), this does not equate to a deterioration in MITK's fundamentals. On the contrary, this presents me to double down on my position which I am ready to do. Mitek can relist on the Nasdaq without the typical waiting period as long as all initial listing standards are met.
Catalyst 2: USAA Litigation Win
The second catalyst is a win in the United Services Automobile Association ((USAA)) litigation.
Little back story : In the 2000s, USAA, which serves military personnel, and Mitek Systems, were business partners that developed mobile check deposit technology together. They had a contract dispute and parted ways. This led to a lawsuit in 2012 which was settled in 2014. Under the terms of the settlement, the parties agreed to dismiss their claims against each other. They also acknowledged that distinct patent rights exist for each of them.
Nevertheless, USAA has been asking banks that use Mitek's mobile capture technology to pay for a license since 2017. Many banks ignored it, so they were sued. In two instances USAA was successful and won $218 million and $300 million from PNC and Wells Fargo respectively. Since it relates to mobile deposit technology, Wells Fargo demanded indemnification from Mitek.
However, in all of the lawsuits, Mitek was not mentioned once. In fact infringement only occurred after banks altered MITK's products. To eliminate any worry of indemnification, MITK sued USAA in 2019 seeking declaratory judgment that its software does not infringe four USAA patents. At first, it was dismissed (in April 2021), but the Court of Appeals for the Federal Circuit (by Circuit Judge Richard Taranto) said the case needed "a finer parsing of the issues".
It is important to put USAA wins in a juristic context as they won in a patent-plaintiff-friendly court in Marshall, Texas. It is known to be the Mekka for "patent trolls" . Moreover, Mitek launched its mobile deposits product in January 2008 and filed the first patent for it in August 2010, while USAA launched its competing product in 2009. Also noteworthy, is the decision of the U.S. Patent Offices Trial and Appeal Board (PTAB) USAA v. PNC that three of USAA's patents on mobile check deposit technology are invalid (USAA's patents '571, '559 & '779). This could be used to overturn the decision of the $218 million fine. A PNC spokesperson said that PTAB would not have granted these patents had it been aware of all facts.
The court battle between MITK and USAA likely takes years to play out. In the worst case, Mitek must pay indemnification which could be a significant amount, or the litigation could have a fallout effect, and the customer retention declines as well as the growth of new customers stalls.
Yet, I think Mitek is well positioned given it launched the product and filed the patent first, prior settlements, not being at fault for the bank's patent infringement, USAA's recent court setbacks, and the fact that indemnification would be a precedent, and such things are hard to push through.
Risks
Firstly, the check market's volume could decrease at a faster rate than the share gains of mobile check deposits. Secondly, growth in mobile banking could stall, which likely has an impact on MITK's growth rates. Lastly, there is the risk of technological disruption which could make checks obsolete or increase competition for ID verification.
Conclusion
MITK is a buy at $12.0 and 12x forward P/E. MITK has a monopoly on the mobile capture market and uses this advantage to finance and cross-sell its ID verification solutions. The opportunity exists due to a potential delisting, the resolution of which could catalyze a re-rating.
Assuming MITK grows its EPS at a rate of 10% p.a. (lower than 2022 at 14%) for the next three years and a forward P/E multiple of 20x (lower than peer group), I calculate a price target of ca. $25.5 representing an upside of 107%. I conservatively estimate the downside of a potential delisting to be 50%.
Please let me know in the comments what you think about my "Best AI" idea. I'll be happy to answer any questions below.
For further details see:
Mitek Systems: Underappreciated AI Winner With Near-Term Catalyst