For long, investors have struggled to understand the long-term argument for investing in Mitek Systems Inc. (NASDAQ:MITK) stock even though the business has continued to perform well, relative to other micro-cap names in the technology sector.
Change can take years – before it happens all at once.
James Clear, Atomic Habits
We believe that has changed now. The mobile check deposit solution has seen a resurgent after the Covid-19-driven growth in contactless services for banks just when digital identity verification products are starting to take flight, with growing customer adoption and commerce shifting to digital at an accelerated pace.
Looking at the valuation, the market continues to value the business based on it mobile check deposit solution with an overhang of growing peer-to-peer financial transactions that may reduce the requirement for such a solution, but rather than waiting for the check deposit solution to eventually decline, the right way to look at the story is to see the check deposit solution as a growing high-margin business with a slow long-term growth profile and identity verification as a fast-growing high-margin business with an exceptional long-term growth profile at the cusp of mass adoption.
Please note that the stock was included in our weekly list for the last two weeks and we are long Mitek Systems in our portfolio as well.
What’s been holding the stock back?
Some may say the stock is up 3x over the last five years, so the stock is not exactly held back. Yes, that’s true but it’s the trading multiple that seems to be capped given the revenues over the last five years have grown at a CAGR of 36% making the stock cheaper on a price to sales multiple.
Historically, investors have two major concerns related to the company:
- The long-term growth or lack thereof of the check deposit business
- Legal risks, especially after USAA’s patent infringement win against Wells Fargo
Both are valid but overblown concerns. Hardly anyone will argue that the check deposit business, which is 67% of the total revenue, can continue to grow at mid double-digit rates over the long term, but all will agree that customer adoption of depositing via an app instead of ATM or branch will only go higher, more so after the pandemic.
USAA won a patent infringement suit related to remote deposit capture technology against Wells Fargo (NYSE:WFC), but to ward off any doubts, Mitek filed a lawsuit in a California federal court seeking a declaratory judgment that Mitek has not infringed on remote deposit capture patents, the outcome of which will be reassuring to both investors as well as customers. Even though Wells’ lawsuits never named Mitek as a defendant, a settled case will remove a major overhang. Expect more on this over the coming months.
Revaluation is warranted and identity verification will make it happen
|Next Yr. PE||P/ Sales||Market Cap (M)||Gross margins Last FY||Sales Growth Next Yr.|
|Palo Alto Networks (NYSE:PANW)||45.7||7.8||$25,230||75%||17%|
|CyberArk Software (NASDAQ:CYBR)||61.7||9.5||$4,290||88%||18%|
As the chart above shows, the stock is trading at a significant discount to its larger peers in the broader security software space whichever way one slices the data, be it the growth rate, margin structure, or sales.
Indeed, the company is trading at 10-11x cash flow, last quarter’s numbers annualized, and the expected revenue growth rate for the next year might move higher after an impressive earnings report two weeks ago.
What will force the market to take notice? Numbers, especially identity verification
Identity verification is starting to rev up
The company has been delivering consistently over the last many years and last quarter was no different, with revenue up 16%, software, and hardware revenue up 11%, services and other revenue up 22%, and transactional SaaS revenue up 42%, among the best in the industry.
Adoption of identity verification as a service is going mainstream, with customers experiencing an elevated level of transaction volumes. Last quarter, the business saw 25 additional mobile ID implementations, a record, and a good leading indicator for volume growth over the next few quarters.
Digital identity verification is changing from convenience to a must-have feature, with gig companies using it for onboarding new applicants and governments using Mobile Verify for distributing government benefits.
And the future is much more exciting.
Channel partnerships are starting to help Mitek enter into new verticals, e.g. Venetian, Las Vegas, is using Mitek’s Mobile Verify for checking hotel guests remotely, bypassing the front desk, and traditional check-in procedures. Even the staunchest bears will not doubt the quantum of opportunity as more hotels and resorts adopt such solutions for contactless check-ins.
Many states have allowed notaries to perform remote online notarization and Congress is pushing to pass the New Standardizations and Secure Notarization Act, authorizing every notary in the U.S. to perform remote online notarization. This can be another big opportunity for Mitek’s Mobile Verify, which can allow e-notary users to determine the identity of the user with a picture of their driver’s license or other government-issued ID documents, along with answering a few questions while ensuring that documents are notarized with verified parties.
Down the road, Mitek’s Face Compare with Liveness Detection technology, launched in February, has the potential to strike it big given the market will eventually want to move a step higher than just e-signatures and this high assurance biometric signal can help fill that void.
Don’t count digital check deposit out yet
Yes, the check deposit business may not be able to carry high growth rates over the long term, but the business is growing at a decent double-digit clip, profitable, and carries a dominant market share. Attributes of a good ‘cash-cow’. With more than 7,000 financial companies as users and billions of electronic deposits made so far, relationships and data are probably worth more than the market’s assessed value of the business.
Okay revaluation, but how much?
We tried to look at this relative under-appreciation of the business from multiple angles.
- As evident from the chart earlier in the note, the stock is trading at a 50-70% discount to peers in the security space.
- Transactional SaaS business, which increased by 42% during the last quarter is at an annualized revenue run-rate of 30-35 million, which makes the business worth $250-300 million even if one assigns a conservative 7-10x sales multiple, similar to what some of the similar growth profile peers are valued.
- The street is estimating that the company can grow earnings at 15-20%, making the PEG ratio of the stock at 1.25-1.5, significantly lower than peers or the broader technology space.
Disclosure: We are long the shares of Mitek Systems Inc. Before writing a note, we usually ask (via Twitter and Stocktwits) for things readers would like us to cover in the note, please do share your views for our next note. This is purely an academic exercise for our internal use and we are NOT recommending buying or selling based on these projections.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.