Mitek Systems, Intro Report


Stock price: $16.69

Enterprise Value: $669.92m

Market Cap: $730.19m

Gross Margins FY20: 86.98%

EV/EBITDA: 17.7x

3YR Revenue CAGR: 30.7%

5YR Revenue CAGR: 31.9%

Unlevered FCF Margin: 23%

Investment Thesis

The benefit to Mitek Systems is the tailwind of digital identity verification. We even see that in the last quarter, the growth in ID revenue was 22% vs deposits revenue of 19%. So, there is this thing called AML requirements and Mitek ID_Cloud meets the requirements, I have to find out who else meets these requirements as direct competitors. It is the Anti-Money Laundering regulations. Switching costs tend to be high here, so I guess my concern of the customer concentration is abated slightly as it would be difficult for them to leave Mitek. Specializing in IDaaS (Identity as a Service), the sector is growing around 16% per year. With a recent convertible debt offering my assumption is they may make another acquisition sometime soon. Valuation seems favorable compared to not only the names I own (ha), but relative to a lot of other tech businesses trading at very high valuations relative to history and could take a while to grow into.

One could call this a GARP play to be quite honest. Cannot wait to continue writing about them and reading.

The Business

Before I spew off what I read in the 10-k, I originally came across the business by depositing my checks into Fidelity. I googled it. It is a public company, yes this is how my brain works, and sometimes how the best ideas can be formed. Investing in products you have used, or do use. I still deposit checks. The company immediately sparked my attention last year, but I never ended up buying it, nor did I spend time digging deeper. Better late than never, right?

The business is operating in the mobile image capture and the digital identity verification solutions market, something that is becoming increasingly sought after by banks (and others, we will get into that further down). Serving over 7,500 financial service organizations, the software and technology is embedded into the mobile apps/browsers to create a better experience for end users. By protecting against fraud, the company has my interest with the increasing CIO focus on security.

The identity verification part is what catches my interest the most, this allows banks and other financial businesses to verify identities. Why is this important?

"According to Javelin's annual identity fraud study, $56 billion was lost in combined identity fraud and identity fraud scams in the United States in 2020, 39 million American consumers were impacted with a loss per fraud incident of $1,350." 2Q 2021 Earnings Call

That is kind of a big deal, and with Mitek, you have thousands of businesses using their solutions to better the security of mobile check deposits and identity fraud. Believe it or not, mobile check deposit is still a thing! Millions of consumers in the US and Canada use Mitek for check deposit (exactly how I found out about them). Being embedded in the financial institutions digital banking apps, you could not have found a stickier product/software to invest in.

Operating Segments

One: Development, Sale, and Service of the proprietary software solutions. Easy enough right? The tech is provided in two separate parts, the software development kit for mobile imagine capture and then the software platform that enables AI and ML to classify/extract data enabling safe and secure mobile deposit and authentication of passports, identity cards, and driver licenses. This is a patent play.

One thing that bothers me, in the latest 10-K they cite that one customer was 16% of their revenue sitting at $15.8m. Customer concentration normally is not my thing, but the moaty licensing business Mitek has may make up for that. Their Fiscal Year ends September 30th. So they are already in Q2 2021. Below is an important screenshot to understand:

We want to understand the risks associated with the business we are investing in, here we can see customer concentration is one risk. Now, we cannot let that be the sole decision maker of adding to a portfolio, but it is certainly something to monitor closely. We also want to understand where revenue is derived from, specifically over time to see if one area is getting larger than the other and vice versa. Deposits make up majority of revenue, identity verification second., but identity is growing at a faster clip.

The company has proprietary patented technology, which their success largely depends on.

What does Mitek think their competitive advantage is? Mobile deposit user experience, patented science, scalability, architectural software design that allows the products to be modified, improved, configured for new products. Easily upgraded software (flexibility as a company).

Fiducia View so far: I like the business, valuation aside (which is not that expensive), the company operates in a highly regulated industry (banking) so the need for their software is lucrative. They have a licensing moat given their CheckRead is deployed within 8 out of top 10 US based banks, 90% of French and Brazilian Banks, and 100% of UK banks. That is incredible. I like the business.

Not only is Mitek used at banks and financial service businesses, but they are seeing accelerated adoption by marketplaces, sharing economy, and hospitality sectors. Optionality in a business is important as we see them expand into new areas. What else can the business be used for? The financial services verticals are banks, credit unions, lenders, payment processors, card issuers, fintech companies, and many more.

In the latest quarter, the results fared well and beat analyst expectations.

In general, Mitek is known to beat. So that is something to look for when forecasting.

Mitek can predict growth based on payment trends, online lending, regulations, usage of sharing apps and online marketplaces coupled with the increasing demand for digital services. These are all tailwinds for the business, and this gives them great insights into the economy and how things are rolling.

Sales of licenses to one or more channel partners are a significant part of the revenue each year, as we have noted earlier in this write up.

Results of Operations

Quite impressive, specifically on the services and other on a YoY basis. Sales and Marketing is a pretty large percentage of revenue, fine with me. Net income up 12% YoY. (This is from their recent 10-Q by the way).

Revenue is primarily growing due to the Mobile Deposit, ID_CLOUD, and CheckReader software products, coupled with the identity verification hardware products.

Sifting the Q2 Investor Presentation & Earnings Call

For me personally, I learn a lot quickly from investor presentations. I think they are a good part of a process after understanding how the business operates. Last Q, their ID revenue growth was 22% and deposits revenue was 19%. FY12-FY20 they have had a CAGR of 31%. There is emphasis on trust issues in the presentation, with a screenshot of identity verification taking center stage. Mitek runs off a continuous learning engine with massive amounts of data flowing through their system, they have the ability to train and test algorithms with real world examples. This reminds me of Cloudflare, and how products are built from the data they receive and understand as a continuous rate. Mitek has proprietary and patented technology that is built by a team of PhD's and MS scientists, that is pretty incredible.

List of some customers below:

This is an impressive customer base, some I expected, but DocuSign and PayPal and Fiserv took me by surprise!

Now we can look at a few eggs from the earnings call, for some reason I love reading earnings calls. I think you can gain a lot of insight from them and recognize patterns over the quarters to years as you analyze a business.

Here are some notes from Q2 call in 2021:

  1. Rising momentum in the identity verification market, keys to building trust and doing business online.

  2. Existing customers are expanding more use cases of verification

  3. Adding customers outside financial services

  4. Mitek is the only enterprise class provider in the identity category, standards of service remain unchallenged

  5. Mobile banking usage continues to increase every Q

  6. Q3 will be the first comp quarter on a oY basis since the pandemic begun

  7. Saw increased transactional volume related to the pandemic, impact growth rates

  8. "Last quarter we saw strength in just about every geography. It was a banger of a quarter. I know Jeff touched on some of these one-time things, but when you take the really good year we had in FY20. The strong quarter we had in Q1 and now an even stronger quarter in Q2. We can feel it. It's there and we're seeing it across geography, across industry. This is a problem that just about every organization needs to figure out how to take care of."

Also, when studying a new company I prefer to read at least 2 full years of earnings calls to start. In here, I will go over some highlights from their Q1 earnings call in their 2021FY

  1. Momentum in identity verification market --> common theme already

  2. Expanding customers with gig economy, marketplaces, financial services

  3. Emphasis on "continuous authentication" within organizations, not just point of on-boarding anymore

  4. "Well executed identity verification is primed to be the bridge between these two urgent requirements. Identity verification has moved beyond just being an enabler, it now serves as an integral element of most organizations, technology stack, and we believe the next decade of fraud prevention will be defined by an organization's approach to the lifecycle of continuous identity and access management capabilities." - Max Carnecchia, CEO

  5. Transaction volumes up, customers like Airbnb expanded use of Mitek into new geographies and greater usage of their digital services

  6. North America and Europe are driving new identity customers, fighting fraud in global markets and geographies are their target market.

  7. Mitek is the only enterprise class provider in the identity category

  8. Check depositing is far from dead, "Among consumers who use their bank's mobile deposit capabilities this year 42% did so for the first time in 2020, 85% intend to continue depositing checks using their mobile devices in 2021. To this point, 70% of respondents claim that depositing a check was one of the most important mobile banking features in 2020."

Financial Glance

2018-2019 was M&A heavy, so there were M&A costs and it suppressed net income. We are now coming out of that, and Mitek should post very solid bottom line growth over the net three and five year periods. This is also the reason their share count has almost doubled since 2011, M&A.

Below is a beautiful homemade chart, Mitek Revenue and Gross Profit over the last 7 years:

Margin Profile:

As of FY20:

Revenue growth drastically slowed from 2018 to 2020, 2018 showed growth of 40% top line and 2020 was only 19.8%. Fully expect revenue to start to tick back up next three and five year periods. There were M&A costs that suppressed net income, hence the large net income growth. Share growth due to M&A as well.

For the next quarter, you can see where they said comps would be the first COVID quarter:

(Source: Koyfin)

Normally a well run business will beat estimates, we could estimate $30m in revenue for the next quarter, also in the screenshot a few paragraphs above you could take the average beat and tack it onto here in % terms. To be frank, the longer I do this, the less I care about quarter to quarter (unless it is a situation like Anaplan where they are not profitable and widening losses while revenue slowed, whereas Cloudflare has revenue accelerating and losses are closing).

Relative to every other name I own in my LT port, this is cheap. I like the business, I like the FCF margins, I like the potential in Identity verification, and I like the small cap allocation. My portfolio is increasing becoming small cap tilt, I love it.

Trading at 12.88x 2023E EV/EBITDA estimates about 29.71% EBITDA margins I think it is a pretty nice investment from here on out. I would say this is likely conservative. I will be adding shares to my long-term portfolio on Tuesday. Thank you for reading and I will continue my research and due diligence.

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