Why I’m long Research Solutions (OTC: RSSS)
Market Cap: $37.5mm
Shares Outstanding (fully diluted): 29.3mm
TTM EPS: -$0.15
TTM EBIT: -$3.0mm
Software is eating the world, and rightfully so. Everything is easier and more convenient when utilizing software as a service, and the growth in value and popularity of some of the largest companies in the world is illustrative of why software and software as a service companies will continue to be at the forefront of capturing consumer/enterprise dollars and economic profits. As an investment category, it’s no secret that software companies can represent ‘best in breed’ businesses given their attractive economics – capital light, marginal cost to add users can be nil, cash flow generation etc. – and if an early stage company that develops an attractive product can execute their business model (acquire customers at a cost below their lifetime value) successfully, they may be able to capture a ton of that value.
So when I saw an opportunity to get behind a passionate, experienced, incentivized CEO who is building a useful software platform that solves the issues of some of the top pharma companies and research organizations, is experiencing rapid growth and customer adoption, and trades at a price that appears to be a discount, I had to jump on board.
Research Solutions represents an interesting opportunity to get in on the ‘ground floor’ of a SaaS subscription platform business that specializes in document distribution and management for the scientific, technical and medical community (STM) as well as academic institutions and corporations. The company operates in two segments: Transactions, which represents the purchase of research documents in ‘single document delivery’ format for a fee, and Platform, which is the company’s fast-growing cloud subscription service currently sporting 79% gross margins, growing >100% per year in terms of revenues and subscription deployments, and providing a unique solution in terms of an efficient research tool to corporations, academic institutions and small businesses.
In the company’s words, Research Solutions’ service offerings are packaged as a single solution that enable life science and other research-intensive organizations to speed up R&D activities with faster, single-source access and management of content and data used throughout the intellectual property development lifecycle.
In other words, the company provides a single-source, ‘one-stop-shop’ for businesses, researchers and academics to access research documents in a fast, secure (copyright compliant) and efficient way. Think of a platform like LexisNexis or Bloomberg (or even iTunes) that provides legal and business information, for a fee or subscription price. We will touch on this more below.
What’s unique about Research Solutions platform is leading status within the industry (the product has won multiple awards from technology marketing firm Outsell), its rapid customer growth and adoption, the recurring revenue like nature of the business model, and management’s focus on becoming the ‘Bloomberg or LexisNexis’ of scientific, technical and medical research.
Although shares have appreciated from my initial purchase, the company trades at a discount to peers from an EV/Revenue standpoint, as well as a discount to what I view as its potential ‘take-private’ valuation. In addition, RSSS is equipped with a clean balance sheet, no debt, a net cash position that makes up 15% of the market cap, and an intelligent, experienced CEO who owns 15% of the company. Management recently sold an underperforming business line consisting of the company’s Reprints and EPrints segment (Reprints Desk), and is now fully focused on building out their lean platform business to become the industry leader in document delivery and distribution.
I feel that if management can execute on the platform business, and accomplish their 2019-2020 breakeven target, operating leverage will start to reveal itself, total company margins will improve, and the company will begin to generate positive free cash flow. In addition, and although my thesis is not dependent on this outcome, I believe the company is an attractive buyout candidate for a larger player looking to enter into the STM research distribution space with an established player.
Given the company’s clean balance sheet, access to a $4 million credit line, and ability to scale with minimum capital investment, it seems as though the business plan will develop nicely and management can continue to grow without diluting shareholders.
The company currently trades OTC, so there is some liquidity risk, given around 29 million fully diluted shares but only 3 million publicly traded float, which puts the company right in my wheelhouse given the lack of coverage (1-2 analysts), minimal IR (one presentation, a few conference calls dating back to 2015), and nano-cap status ($37.5m market cap, $32.5m EV). Although the company posted a net loss of $0.03/share for the most recent quarter and ($2.3m) for the year, I am looking beyond 2019-2020, with the patience to let management execute in order to see the business perform in the way I believe it can. Thus far, management has a history of making sound business decisions, and they are incentivized to grow business value per share alongside shareholders. The potential of the high margin SaaS platform, and discount to peers are the additional reasons why I am long the shares.
Shares currently trade at around $1.20 today, which is less than 1.0x EV/LQA Revenue, providing investors with a decent margin of safety, given my estimates of future growth as well as peer/M&A multiples.
While the company has faced some difficulties growing incremental gross margins without incremental cost increases, the long thesis is based on the fact that customers like getting more content for the same price, the competition can’t match the depth of RSSS offerings, nor the speed/efficiency, a recurring revenue model is much more valuable than what competitors are offering, and most importantly, RSSS is transitioning from a business that provides single article and reprint transactions to one that is built on subscription based, contractual recurring revenue, which we believe deserves a much higher multiple than legacy Reprints Desk.
Applying a 1.6x EV/Revenue multiple to the shares (50% of average peer multiple) would get us to a share price of around $1.80 – $1.90 today, a nearly 60% premium to today’s prices. I feel I’ve been given a solid margin of safety at current price levels given the company’s growth trajectory, management, addressable market and unique position with their end customers. This ‘back of the napkin’ valuation doesn’t include future growth prospects, expansion overseas, or total company incremental gross margin improvement. I believe there is significant potential for 50%-100% upside over the next 24-36 months, and given my cost basis of less than $1.00, I believe to have been provided a large margin of safety with little chance of permanent capital loss. It wouldn’t surprise me to see shares eventually trading in the $1.60 – $2.50 range short-term, in line with peer multiples and my estimates of future profitability.
It’s early, and this is a small (3-4%) position, but I am excited about the development of this company, as management is off to a good start and has clarified their vision for the future.
The Subscription Platform Segment
The continued growth of the company’s SaaS platform segment is what really interests me when it comes to the success of this investment.
The company’s platform allows customers to initiate orders, manage transactions, automate authentication, obtain reports, and connect seamlessly to corporate intranets. Customers can also enhance the information resources they already own or access via subscriptions or internal libraries, as well as organize workgroups for collaboration around science information.
The platform is cloud-based, and provides customer’s access to the over one million newly published articles each year in addition to the tens of millions previously published. In other words, the company provides ease of use, convenience, cost savings and copyright assistance. End users of the product include more than 70% of the top 25 pharmaceutical companies in the world.
The company currently has 184 platform customers, with new subscription deployments averaging around 21-24 per quarter, and as of 2018, have transacted with over 1,100 customers. This transaction revenue is sticky and recurring in nature with high repeat customer usage. On the platform side, the company now generates over $1.6 million in annual recurring revenue (recurring subscription revenue annualized).
Currently, the company’s Transactions segment makes up 94% of total company revenue, with Platform subscription revenue bringing in the remaining 6%. Average revenue per transaction appears to be around $30 versus average selling price for the platform of $9,834 as of Q2 2018.
Platform subscription revenue sports attractive 80% gross margins, while the Transaction gross margins hover between 21% – 23% due to content costs and discounts.
The company has been able to achieve these results to date despite no buildout in data centers (everything is in the cloud), the absence of large sales offices (small sales force paid via commissions and digital/content marketing) and minimal capex for their core platform product.
While it takes some imagination as well as a long-term vision, I can eventually see the company’s platform segment achieving meaningful scale, and representing a much higher percentage of revenue down the road. From there, one can envision some operating leverage w/ little incremental costs to acquire customers, especially on the Platform side of the business, reduced marketing spend, and recurring revenue positively impacting growth in free cash flow.
In order to move the platform segment forward, RSSS employs a commissioned salesforce, and is engaged in both digital and content marketing in order to drive awareness about the platform and customer adoption. As it stands right now, management is focused on educating their end users about the benefits, and have noted that many large organizations can be slow to change or adopt new technology. Our conversations with management indicate that not many know about the platform product yet, and the company believes scale can be achieved to the tune of somewhere around 4,000 – 5,000 customers (from 1,100 now).
In addition, the platform is sold on a ‘per-seat’ basis, so targeting organizations with multiple research arms would be beneficial, given the possibility for multiple subscription purchases. Subscriptions are deployed for terms of one year, and although the company doesn’t release churn figures, they have stated there is ‘little to no churn’ among their platform customers’ especially as it relates to the top pharma customers.
To achieve this, sales and marketing buildout will continue to be a priority, and the company has recently pushed back on their 2019 breakeven target in order to invest more for growth as opportunities present themselves. These investments are reflected in SG&A costs as well as marketing spend, which has grown (combined) from $5.5mm in 2015 to $8.4mm in 2017, which is 25.7% and 32.7% of revenues.
To state the obvious, for the business model to work, the company has to acquire customers at a price below their lifetime value. All kinds of assumptions have to be made to separate out the platform business CAC and marketing spend (the company doesn’t break it down), and I’ll admit trying to model CAC or come up with a reasonable sanity test for whether the business model will work was very difficult. One thing we can be sure of is, our model will be wrong.
I can begin to see some sort of avenue for lowered CAC over the next few years, assuming platform deployments continue to grow, marketing spend declines, and the company settles into an average platform price of around $10,000/user.Assumptions2015201620172018E2019E2020EAverage Platform Price$11,949$9,846$9,834$9,500$10,000$10,000Total Deployments2159140240390775Deployment Growth Rate61.5%181%137%71%63%99%Estimated Churn10%10%10%10%10%10%COGS20.7%18.4%20.9%21.0%21.0%21.0%Marketing Spend (% of platform revenue)916%507%345%241%105%26%CAC (marketing spend/new deployments)$135,105$53,725$41,830$47,000$27,200$5,220.78
For the above model, CAC is very difficult to measure since we are attributing TOTAL company marketing spend to platform deployment growth and platform revenue only. This is most likely wrong, but I wanted to outline what it might look like if all new marketing dollars were being spent on platform customer acquisition and growth.
In order to paint a clearer picture of what a fair multiple of revenues would look like, we can separate revenues into two categories, recurring and one-time, and assign two separate multiples. Transaction (although there is a steady, recurring element, will be labeled as one-time) revenue will be given a multiple of 1.2x, while Platform (recurring) will be given a conservative multiple of 3.5x. These multiples are discounted somewhat from peers due to RSSS size and unprofitability (no balance sheet issues).RSSS ValuationCurrent Valuation (2018E)RevenueMultipleValueValue per Share (fully diluted)Transactions$26,688,6961.2x$32,026,435Platform$1,950,0003.2x$6,240,000Upside Total Value$38,266,435$1.310.40%Blended Multiple 2.2x$63,005,131$2.1570.6%Forward Valuation (2019E)RevenueMultipleValueValue per Share (fully diluted)Transactions$29,090,6791.2x$34,908,814Platform$3,900,0003.5x$13,650,000Upside Total Value$48,558,814$1.6623.8%Blended Multiple 2.3x$75,878,562$2.59105.6%Forward Valuation (2020E)RevenueMultipleValueValue per Share (fully diluted)Transactions$31,708,8401.2x$38,050,608Platform$7,750,0003.5x$27,125,000Upside Total Value$65,175,608$2.2377.0%Blended Multiple 2.3x$90,755,332$3.10146.0%
Note: the company actually considers Transactions revenue as recurring as well, given customer retention rate and repeat orders. Yet given slower growth and margin profile, we want to be conservative and label it as one-time.
If RSSS is able to achieve continued high revenue growth, as well as grow platform customers and deployments, recurring revenue multiple may even improve, and shares could trade in the $2.4 to $3.5 range within a few years.
While one could argue that RSSS deserves a size or liquidity discount, one could also make the case that it should trade at a bit of a premium reflective of it’s enhanced growth potential. I expect to see this happen as platform revenue begins to become a meaningful part of the business over the next few years.
Management has guided for break-even by 2019, however, as mentioned above, profitability may take a backseat to customer and platform subscription growth. When the company gets their metrics right (CAC lower than LTV w/ a decent payback period), it will be more valuable for RSSS to keep spending to grow as opposed to worrying about GAAP profitability.
A not-so-clear path to profitability would typically be enough to eliminate a potential investment for me. There are certainly unknowns here. However, I feel comfortable holding for the long term, given the company’s clean balance sheet, my strong belief in management’s ability to execute, the company’s unique position in the document distribution space (solving a real problem) and the growth runway that lies ahead. To date, management has been completely rational, and seems to understand where to allocate dollars in order to drive the company forward.
I feel like there are multiple ways to win, and am happy being aligned with an incentivized CEO who owns a large chunk of the company. It’s important to have the patience and willingness to let management execute in order to see the thesis play out, and envision this category-leading company to go after a huge market with their ability to demonstrably scale.
The catalysts include growing platform sales leading to a better margin and profitability profile, new customer acquisition, further penetration of the 700,000 small business market worldwide, expansion overseas, subscription price increases, and an EV/Revenue multiple lower than peers.