We’ve had some success (and luck) in tech stocks this year – 5GN, WZR and Z1P have all been multi-baggers.
CV Check (ASX:CV1) is another tech stock we’ve been buying recently that I think is a candidate to have a similar type of run.
CV Check is a Human Resources (HR) technology company that provides online, automated checks and verifications to enterprise, business and consumer clients in the hiring process.
The best way to explain what CV1 do is by using Optus, one of their enterprise clients, as an example.
Every time Optus hire a new employee they conduct a range of checks including a criminal history check, a reference check, verifying stated qualifications and for some organisations there might be a financial history check, a working with children check, and so on.
CV1 are the sole supplier to Optus for this purpose. It is provided online over CV1’s platform or increasingly via integrations with large HR platforms like WorkDay, SAP Success Factors, PageUp and SpringBoard.
The spearhead product for CV1 was criminal history checks but having reached the important milestone of cashflow breakeven they’re now aggressively rolling out new products to bundle and become a ‘one stop shop’ for SME and Enterprise hiring needs.
With CV1 trading at a discount to peers, and Annual Recurring Revenue (ARR) now running at $9m-$10m per annum, I think the stock may present an opportunity.
The CV Check Story
CV1 listed in 2015 with a small revenue base and burning cash but with some good technology and a solid idea. The most similar listed competitor, Xref (ASX:XF1) – which provides automated reference checks, listed in the same year.
Xref is a good business that I’ll be comparing to CV1 throughout this wire.
CV1 may have listed earlier than ideal but it allowed them to raise a large amount of cash and gave them a runway to grow.
That growth has been impressive with revenues climbing from $2.6m in 2015 to a current run-rate of $13m-$14m.
ARR, one of the key metrics for a business like CV1, is now running at $9m-$10m and has grown at a 32% CAGR over the last 3 years. Based on the recent business update in May ARR continues to grow at an annualised rate above 30% p.a driven by the signing of a number of new enterprise clients.
The momentum has continued into June with additional enterprise clients continuing to come on board.
This steady growth has allowed them to achieve two consecutive cash flow positive quarters, an important inflection point for the business and the share price.
Their focus is now on investing in sales and marketing to acquire new enterprise clients and roll out new proprietary (i.e higher margin) products to their existing client base.
New Leadership and New Strategy
Along the way there was a change in leadership where the founder stepped back and the CFO (Rod Sherwood) stepped in as CEO.
Importantly, Rod owns 5% of the company acquired through placements and a purchase of shares from the founders, so his own money is on the line. The founders remain the largest shareholder.
Rod’s strategy has been to focus purely on the B2B (business to business) segment.
Last year he cut online advertising spend for the smaller B2C (business to consumer) segment which saw this revenue stream decline, but segment profits increased as the previously acquired pay-per-click revenue wasn’t profitable.
The B2C business involves individuals that go to CV1’s website and purchase these checks themselves. While it contributes meaningful revenue and profit it is much lower quality than the B2B segment. It did not make sense to pay a high acquisition cost for B2C customers when they are typically one-off purchasers with little recurring revenue.
Since then B2C revenue has stabilised at around $4m per annum and will probably grow quite modestly each year. It is not the focus, but it does provide a profitable revenue stream to fund growth of the much larger and more significant B2B segment.
If you look at the chart (below) for group revenue growth since 2015 it is worth noting that while the growth still looks impressive it somewhat masks the underlying strength of the B2B business, as B2C declined from roughly $6m to $4m during the period for the reasons outlined above.
B2B now accounts for >70% of revenues and will continue to increase as a proportion of total revenue.
From here on in, it is all about B2B.
Jewel In The Crown - B2B
The B2B and Enterprise segment is the jewel in the crown.
Businesses like these typically trade on a multiple of ARR with the faster the growth, the higher the multiple.
Alternatively, they’ll trade on an estimate of the lifetime value of their client base (LTV) which is a metric many ASX-listed tech companies now report to the market.
ARPU (Revenue per user, in this case referring to a B2B client or account), margins and retention rates are all key metrics used to assess the quality of a business like CV1. They are the main inputs in an LTV calculation.
You want to see high and rising ARPU, expanding margins and minimal churn (i.e high retention) as that speaks to the quality of the revenue streams being built. You also want to see embedded growth in the client base through an ability to increase uptake of your service and bundle new products for existing clients over time.
The better these metrics the higher the ARR, the higher the LTV and, ultimately, the greater the prospect for share price appreciation.
With that context we can assess CV1’s B2B business.
While the CV1 business model is transactional (pay for what you need when you need it vs XF1’s model of buying credits upfront and using them over time) the B2B/enterprise segment is >90% recurring revenue.
These large enterprises have significant turnover in staff each year, perhaps 5-15%, even if they aren’t expanding the total size of their workforce, meaning they will have to check and verify the new candidates and hires. This provides a source of recurring revenue for CV1.
There are about 7-8000 regularly active clients in the B2B segment ranging from large government departments down to small business owners. Many of these are blue chip clients.
CV1 continue to add new enterprise clients with G4S Australia, Kennards Hire and a national hotel chain all brought onboard in May. Management have indicated the momentum has continued into June.
The industry split is in line with the ABS stats on employment and management estimate that around 1000 of the 5000 largest businesses in Australia are clients.
The largest client represents <2% of group sales so there is low concentration risk. Retention is north of 90% with enterprise clients particularly sticky.
Growing ARR, Rising ARPU and Expanding Margins
There is a large spread between an enterprise client who might spend >$100k a year with CV1 and a local plumber making one or two hires every so often.
But all the focus is on growing the higher value enterprise and SME client base, so we should see ARPU, retention rates and ARR all continue to climb higher.
For newly acquired enterprise clients their ARPU, or how much they spend with CV1 each year, climbs over time as they increase their usage and uptake of products across their business. This provides naturally embedded growth in the existing B2B client base, which is something XF1 explain really well in their communications to market.
The strategy to acquire these B2B clients was initially through the provision of criminal history checks as the lead product. The bulk (~80%) of the $8m in B2B revenues last year was this product which generates gross margins of about 50%.
The next phase of the growth strategy involves the roll out of new proprietary checks to bundle them to their existing client base. Automated reference checks, financial checks and ID verifications are all at various stages of roll out meaning revenue from other products will accelerate.
Those 7-8000 active B2B clients provide a large opportunity for bundling and up selling of these new products. There is, therefore, significant value in this large and diverse client base.
Importantly, these new checks are >70% margin (up to 80-90% for products like reference checks) which is why gross margin has been trending higher in recent quarters and should continue to do so.
This is the opposite strategy to XF1 which led with their automated reference check, a very high margin product because it involves no external provider, it is just pushed out to the candidate’s references via XF1’s platform. XF1 have proved the utility and client demand for an automated reference check product, and they do it well. They use partners to provide additional checks and verifications.
XF1 margins are currently higher than CV1 because of the above and that is part of the reason why XF1 trades on 9-10x EV/revenue vs CV1 at 3x.
What we will see from here is CV1’s revenue base start to look more like XF1’s as new products comprise a larger portion of total revenue.
CV1’s margins will trend higher, as will the quality of the revenue streams, and I expect multiple expansion and a rising share price to reflect this.
Embedded Growth and Bundling
For some rough numbers on what the impact of the new product roll out strategy might look like we can turn to CV1’s New Zealand business.
The NZ business is almost entirely large enterprise and SME clients and is the market leader in NZ. This means a higher ARPU, higher % of recurring revenue, stickier clients, and so on.
The NZ model has been exported to the Australian business as the group increasingly focuses on B2B.
In Australia the typical client purchases 1.1 products for an average sale price of around $50. In NZ it is 2.3 for around $90. A large enterprise is typically >3. Clients in industries where privacy and security is a greater priority (e.g. financials) might order up to 5.
If they can drive the average order in Australia to 1.5 checks and ~$65 in the medium term we will see the equivalent of 25-30% revenue growth from the existing B2B client base at an incremental gross margin of 70-80%.
In this scenario, all else equal, gross profit would increase faster at c.40% and blended gross margin would move to ~60%.
Those are impressive metrics when you consider that this growth would come solely from existing clients (i.e lower acquisition cost and higher return on capital).
That incremental free cash will likely be reinvested to acquire new B2B customers both in Australia and NZ, but increasingly internationally.
Two Strategies Converging
Take a look at the most recent half year reports for CV1 and XF1.
XF1 is B2B focused so if you take CV1’s B2B segment the two companies had similar annualised revenue figures at 1H19 ($8m-$9m) with XF1 growing faster at 59% vs CV1’s B2B segment growing at 30%.
XF1 has a higher cost base primarily due to higher staffing costs ($9.4m vs $4.8m). This is likely due to a more aggressive sales strategy including a bigger sales team and incentive-based compensation arrangements for the sales staff.
CV1’s strategy has been to prioritise the achievement of cashflow breakeven while still growing the business. The directors made this clear to the market when they tied part of the executive compensation to the achievement of two consecutive cashflow positive quarters (which has now been achieved).
In contrast XF1 have invested heavily to grow faster and in more regions.
Two quite different strategies.
To XF1’s credit they have done an excellent job at not only executing the strategy but also in communicating it to the market. They have been rewarded with a more appropriate valuation.
The market loves growth, large addressable markets, sticky clients, rising ARPU and offshore opportunities. XF1 has all of these characteristics and communicates it appropriately.
Part of the bull thesis for CV1 is that having achieved cashflow break even they will now start to ‘borrow’ some of XF1’s more aggressive sales strategy to acquire new clients.
Their recent business update noted a doubling of the sales team. They will establish a Melbourne based sales operation and compensate new hires based on performance. They’ll also push a bit harder on online marketing for the B2B segment.
Allowing some time for the new sales personnel to be on boarded, we should sales growth accelerate over FY20. If this strategy is successful, the market will increasingly look to XF1 as a way to guide CV1’s valuation.
With CV1 capped at $44m and XF1 at $95m you could argue there is room for a re-rate.
The other attractive element that XF1 possesses over CV1 is international growth. Larger addressable markets, more blue sky, geographic diversification - it all gives the market more to get excited about.
The difference in size of the respective addressable markets, with XF1 going global and CV1 focused on Australia & New Zealand, is a valid argument to explain XF1’s higher valuation.
What is interesting is that CV1 have suggested on investor conference calls and presentations that they will now seek to grow internationally. This could be an important catalyst for the stock.
If you look at CV1’s current product range they already offer thousands of different international checks. A client like Optus isn’t just hiring Australian nationals, so CV1 needs to be able to verify a new hire in essentially any country that their existing client base might be hiring in.
It is not a huge step to start growing internationally. Most of the tech and product offering is already there.
Where I think the XF1 vs CV1 offshore strategy might differ is that XF1 have gone in all guns blazing with a direct sales strategy to grow overseas revenue. That may well prove very effective, but it is expensive.
CV1 have received excellent feedback on their technology from large offshore players. They have mentioned a number of times their intention to leverage their technology through white labelling or partnerships.
If and when they expand offshore I expect it to be via partnerships or licensing arrangements.
The other possible strategy is to acquire a small business in the US or Europe with a good client base, running at or near breakeven and then leverage their Australian technology overseas. Similar to what they did in NZ.
Regardless, the news of offshore expansion - if and when it comes - is likely to be positive for the stock.
In summary the strategy is all about growing B2B revenues via:
· Roll out of new and higher margin products and bundling these to existing SME and Enterprise clients;
· Acquiring new B2B customers via an increasing focus and investment into the sales team;
· International expansion.
How Do We Value CV1?
The company is targeting to remain cash flow neutral, with free cash flow reinvested to grow faster.
All else equal the faster they grow revenue, particularly ARR, the higher the share price.
Achieving cash flow breakeven is important because it removes the concern that they will need to raise. At some point they may indeed come back to the market for an acquisition or simply for funds to accelerate growth, but I would think it unlikely to be at current prices given there is no immediate need and the board view the stock as undervalued.
These sorts of businesses that are pushing hard for growth and employing a ‘land and expand’ customer acquisition strategy will typically trade on either a revenue multiple or on the lifetime value of their existing B2B client base. These will be the key metrics to watch.
Given the quality of the B2B segment - >90% recurring, high retention, growing ARPU, expanding margins, etc - any LTV calculation comes out substantially higher than the current share price.
ARR is running at between $9m-$10m p.a. Total revenue is run rating at $13-$14m.
As ARR grows, and the market better understands the CV1 story, my expectation is that it will trade CV1 on an increasingly higher revenue multiple.
The current EV/Revenue multiple is just under 3x. We’ve touched on XF1 trading on 9-10x. There are many HR tech stocks trading much higher than this but XF1 is the closest comparison.
For what CV1 has achieved, the quality of its revenue streams and client base and the trajectory for sales and margins I view a 5x revenue multiple as within reason.
That would support a share price of 25-30c.
If CV1 wants to trade at closer to 10x it will need to keep growing ARR, acquire new enterprise clients, grow the proportion of revenue from higher margin products and continue to communicate its growth opportunity to the market.
The recent May update showed the business added $350k of ARR in one month, which annualises to >30% ARR growth. This came in what was a seasonally slow month given the timing of Easter and the Federal Election. Hiring was (unsurprisingly) put on hold by many businesses, so to grow ARR at this rate in such an environment is impressive.
The outcome of the election is likely favourable for CV1 given it is ‘business as usual’ for business and enterprise clients. Anecdotally, hiring has picked up once again and CV1 management have noted that they have seen a pick up post election and into June.
As they move into FY20 with this momentum and as the new sales hires start to ramp up it leaves the business well positioned for accelerated growth in the B2B segment.
Beyond that, and looking further ahead, if you assume that CV1 can continue its current 30% ARR growth over the next 3 years then ARR will approach c.$20m. Assign a 5-10x multiple to that figure and you can see how the thesis for CV1 to be a multi-bagger starts to come together. But that will of course take time.
This is now a growth story. The main risks relate to execution of the above strategy. Keep an eye on the rate of ARR growth and new enterprise/large SME signings. Management need to keep executing here.
Potential kickers for the stock include new client wins, accelerating growth over coming quarters, acquisitions, partnerships and possible international expansion.
All of the above is why the Fund took a position in CV1 and remains optimistic on its prospects.
The Capital H Inception Fund owns shares in CV1.