2023-12-05 08:29:32 ET
Summary
- OneSpan Inc. reported strong 3Q23 financial results with double-digit growth in subscription and annual recurring revenue.
- The digital signature market is expected to grow at a CAGR of ~35% for the next 7 years, providing a positive outlook for OneSpan's future growth.
- The company's emphasis on cost savings through workforce reduction has improved its adjusted EBITDA margin and is expected to lead to positive EPS in the future.
In my opinion, OneSpan Inc. ( OSPN ) reported strong 3Q23 financial results. Both its subscription and annual recurring revenue were growing at double-digit rates. These growths were mainly due to more sales generated from current customers, and this is a testament to their product’s usefulness as well as stickiness. In addition to its strong revenue figures, its emphasis on cost savings through workforce reduction has resulted in its adjusted EBITDA margin improving. As a result, its 4Q23 and 1Q24 EPS is expected to turn positive. In my opinion, this might just be the catalyst for positive share price movement.
The digital signature market, which is a key segment for OSPN, is expected to grow at a CAGR of ~35% for the next 7 years. The driver behind this rapid growth in the digital signature market is due to the recent increasing need for safer, contactless document transfer, which has gained traction during the pandemic period. In addition to that, the rising concerns regarding cybercrime are also driving growth in this segment. This is especially prominent in the Asia-Pacific region, where a lot of companies are observing regular cyberattacks. Hence, I expect this to positively bolster OSPN’s future growth outlook.
Hence, I am recommending a buy rating for OSPN.
Background on OSPN
With OSPN’s expertise in anti-fraud and digital identification solutions, organizations can have a safe, compliant, and seamless experience when dealing with customers’ transactions and agreements. OSPN is a digital security solution provider that is trusted by the top 100 global banks and businesses worldwide, such as IBM, MUFG, Deutsche Bank, and Mizuho.
OSPN's major segments are in
- Digital Agreements
- A suite of digital solutions that assist clients in automating and securing business operations through digitalized contract agreements and customer transaction lifecycles that involve legal permission, authentication, and compliance
- The majority of OSPN’s solutions are cloud-based.
- OSPN Sign [e-signature and digital signature]
- OSPN Notary
- Security Solutions
- A wide range of solutions are designed for the protection of digital transactions against attacks.
- includes on-site software products, ID verification, and digital authentication.
Historical Financial Performance Analysis
From the chart below, it is clear that the pandemic and post-pandemic inflationary pressure have a direct impact on OSPN’s sales growth. In 2019, which is before COVID, revenue growth reported was ~20%. 1 year later, in 2020, it fell ~15%. Ever since then, it has been on a slow but steady path to recovery. In 2021 and 2022, revenue growth reported was negative 0.5% and positive 2.11%, respectively, a drastic difference from 2020’s result. For 2023E and 2024E, market revenue estimates are expected to outpace the previous 2 years at ~5% and ~3.4%, respectively. The growth outlook for OSPN is looking positive, and its path to recovery is expected to continue.
Author's Chart
Although revenue growth started to slow down drastically from 2020 onwards, OSPN’s operating expenses did not. Both its SG&A and R&D expenses kept growing until 2022, when they finally tapered down a little. Due to this, its operating income margin was negatively impacted. For 2020 to 2022, it reported negative 2.44%, negative 12.18%, and negative 6.30%, respectively. I believe the combination of a slowdown in revenue growth and a negative operating income margin led to a stock price decline of ~40% over the last 5 years. Later in the post, I will discuss management's response to this trend and their strategy to address it.
Author's Chart
Author's Chart
Due to its negative operating income margin, I have concerns regarding its debt levels and its ability to repay its interest expenses. However, after analyzing its balance sheet, OSPN is healthy on its debt level, and interest expenses pose no liquidity issues for the company. As you can see, its debt/equity ratio has remained fairly consistent and low at ~5.5% for the last 4 years. In fact, if I look at net debt, it has been negative for the past 4 years. This suggests that OSPN has more than enough liquid cash on hand to repay its debt at any moment. Hence, its debt level poses no risk to its overall financial health. Lastly, looking at its net interest expense as a percentage of total revenue, it has been positive for the last 4 years. This suggests that its interest income outpaced its interest expense. Hence, I see interest expenses posing no liquidity risk for OSPN. Overall, its balance sheet looks really healthy.
Author's Chart
Author's Chart
Author's Chart
Strong Revenue Growth & Emphasis on Cost Savings Might Turn the Tide
In my opinion, OSPN reported strong 3Q23 financial results. Its revenue grew 3% year-over-year; subscription revenue, on the other hand, grew even more at 18% year-over-year. Its annual recurring revenue [ARR] also grew in a double-digit range, as it reported 10% year-over-year. In terms of net retention rate [ARR], it stands at 108%.
These growths were mainly due to more sales generated from current customers, and this is a testament to their product’s usefulness as well as stickiness. I expect its current product strength to bolster its future growth outlook. This view of mine also ties with management’s view, as they guided full-year 2023’s revenue to be between $228 and $232 million, up from previous guidance of $226 and $232 million. By increasing its revenue guidance, management is exuding confidence, and this confidence further bolsters my outlook on OSPN.
In my opinion, adjusted EBITDA improvement is one of the noteworthy accomplishments of OSPN for this quarter. For 3Q23, the adjusted EBITDA margin reported was 11%, up from 3Q22’s ~8%, and this represents an improvement of ~3%. The adjusted EBITDA margin expansion was driven by its focus on cost reduction, as it is striving towards the “ rule of 40 ” at the end of 2024.
It did so by cutting down the number of employees by ~15% in 3Q23. In the previous quarter, it reduced its workforce by ~5%. In totality, I expect this 20% cut to have a significant impact on its future margins, and I expect its future margins to improve. The reasoning behind this stems from the fact that based on 2022’s total revenue of ~$228 million and combined with management stating that the workforce downsizing resulted in cost savings of ~$20 million, this saving represents about ~8.7% of its revenue, which is quite significant.
In addition, cost-saving on wages brings long-term benefits and is not a one-off event. My outlook on OSPN’s margin expansion also aligns with management’s expectations, where they expect the adjusted EBITDA margin to expand. For the full year 2023, adjusted EBITDA is expected to be between $2 to $4 million, up from the previous guidance of $0 to $3 million.
Imminent Growth of Digital Signature Market
I will be discussing the potential market for digital agreements and security solutions and how they can bolster the outlook for OSPN. The worldwide industry was valued at an estimated 3.9 billion USD in 2022 and is estimated to arrive at $43 billion by 2030. From 2022 to 2030, its compound annual growth rate is estimated at around ~35.0%.
During the pandemic , there was an increasing need for contact-free transmission of documents without compromising safety and security. Ever since, the practice of e-signature has accelerated significantly as businesses look for a more efficient and effective channel for distributing documents. The SEC , IRS have provided guidance on the acceptance of the use of electronic signatures to allow flexibility in documents' filing and distribution during the pandemic, supporting an effective and secure mode of communication.
Due to the accelerating expansion of connectivity and technological transformation, there are increasing concerns and risks of cybercrime in the APAC. Cyberattacks are one of the top few risks to business operations in the APAC region. In 2022 , ~60% of businesses in APAC had been targets of cyberattacks, and an estimated 32% had been hit more than once. There are plenty of incidents, such as the A cyberattack in December 2022, that compromised access to the data and structures of a New Zealand-based IT managed service business that provides services to a range of clients, including government agencies. Another would be Toyota’s data leak, where a source code was leaked, allowing access to a restricted server with five years’ worth of customers’ data.
In summary, there is a rapidly growing market for e-signatures as they promote efficient and secure communication. With OSPN’s expertise in secure, high-grade digital agreement solutions and their wide variety of security solutions, its outlook would be robust in this digitalized age.
Recognized as a Leader by IDC MarketScape Worldwide eSignature Software 2023
eSignature software is a key sub-market in document applications. Aside from its basic features to draft, revise, and issue a variety of documents, its key importance in this age of technology, where security risks are imminent, lies in the effectiveness of a strong, encrypted communication distribution. Therefore, the quality of eSignature software varies widely among different companies, and it is important for organizations to recognize and consider them.
IDC, 2023
In September 2023 , based on the International Data Corporation’s [IDC] evaluation of over 20 e-signature vendors such as DocuSign, Adobe, and PandaDoc, OSPN earned the title of leader by IDC MarketScape. IDC’s stringent scoring methodology considers standards, both qualitative and quantitative, for each company. Each company’s near-term product, business execution, and how well their strategies can meet customer needs are part of IDC’s evaluation. IDC’s report has noted that its strong audit trail is a key product differentiator; therefore, it specializes in highly regulated businesses as it offers top-notch services when it comes to authentication, compliance, and a full audit trail.
In our current digitalized environment where high security is mandatory for day-to-day operations, OSPN’s recognition as a leader by IDC MarketScape places them in a strong standing. There will be continued growth in this segment, where organizations seek secure, high-grade digital agreement solutions.
Comparative Valuation
Based on the system software industry in which OSPN operates, I have compiled a list of competitors in the table below. I believe this group accurately represents this industry. Competitors’ median market cap is ~$9 billion, while OSPN is ~$408 million. Thus, in terms of company size, OSPN is only ~4.5% of its competitors.
Due to its significantly smaller size, it underperforms its competitors in all areas, but this is reasonable for a smaller company due to its lack of economies of scale as well as the need to drive growth at the expense of margin in order to capture more market share. Let me break down the metrics as follows to give you a more holistic picture:
- In terms of forward revenue growth, it is expected to grow at 3.49%, while competitors’ median is ~11.43%.
- In terms of TTM net income margin, it is -14.57%, while competitors’ medians are 5.27%, but I do note that some of its competitors also reported negative net income margins.
- In terms of TTM gross profit margins, it is 66.52%, while competitors’ median is 87.39%.
Due to OSPN's negative net income margin, using forward EV/Sales is a more reliable and accurate metric to determine my future target price. In addition, some of its competitors also have negative net margins, making forward P/E not feasible.
While it underperforms its competitors, I argue that a 53% discount to their median forward EV/Sales might be a bit too steep. In addition, when I look at its 5-year average EV/Sales, it is ~2.6x. At this multiple, it represents a more reasonable discount of ~19%. Given the strength and growth catalysts I have discussed above, I believe OSPN deserves a higher multiple. In order to stay conservative, I will assign 1.8x forward EV/Sales. At this multiple, my target price is slightly below the consensus average target price of $13.67, further bolstering my belief that my approach is conservative.
The market revenue estimate for OSPN is expected to reach $237.73 million in 2024, and I believe this estimate to be reliable, as it is in line with management’s guidance where they guided low to mid-single digit for full year 2024. By applying the 1.8x forward EV/Sales to its 2024 revenue estimates, my 2024 price target is $12.31, and this represents an upside potential of ~20%.
Risk Involved
Cost Reduction Initiatives
OSPN is scrutinizing and prioritizing their cost reduction initiatives, reducing headcount quarter after quarter. This may help improve profit margins, but it also poses certain risks, especially when the market is extremely competitive with other bigger competitors such as DocuSign and Adobe. OSPN does not hold the highest market share, and intensifying competition, especially from larger players with more resources for innovation and customer acquisition, poses a concern. OSPN’s operation efficiency may be negatively impacted at the expense of short-term financial health. It is seen There is also a declining trend in R&D [as % of revenue], which may compromise long-term sustainability while their bigger competitors [DocuSign and Adobe] have a steady incline in R&D expenses. This is critical for OSPN as a key differentiator for its expertise in providing solutions for highly regulated businesses, and it may lose its competitive advantage to its rivals. Therefore, heavy reliance on minimizing costs may be unsustainable in the long term and risk OSPN's ability to innovate and operate efficiently.
Conclusion
In conclusion, OSPN’s 3Q23 result shows strength, as both ARR and subscription revenue grew at double-digit rates, driven by its products’ strong demand and stickiness. On top of revenue growth, its cost-cutting measures are also effective, and it results in adjusted EBITDA margin expansion. I expect this cost savings through headcount reduction to provide long-term benefits because it is not a one-off event.
Apart from these, the digital signature market is also poised to grow strongly for the next 7 years. It is expected to grow at a double-digit CAGR, and I believe this provides OSPN with a fantastic opportunity for growth expansion. In addition, OSPN being recognized as a leader in the e-signature segment also positions them well to capture the rapid growth that is anticipated. Overall, I believe the rapid market growth combined with its strong branding will bolster their future growth outlook.
Although OSPN underperformed its competitors, I believe this is reasonable due to its smaller size compared to them. I believe the market has oversold the stock, which has resulted in its forward EV/Sales being at a significant discount to competitors’ median. In my model, I anticipate an upside potential of ~20%. Together with the strengths I have discussed, I am recommending a buy rating for OSPN.
For further details see:
OneSpan: Digital Signature Market Poised For Rapid Growth