Description

ID Systems is a cash-flow positive company with zero debt which has the potential to more than double its revenue by 2020 following a long and painful history of near-zero growth. While most participants in the stock are aware of the company’s recent connected-cars deal with AVIS and the incremental growth that will come from the integration of Keytroller, their latest acquisition, there is an equally large contributor to revenue growth and free cash flow that is still being missed by sell-side analysts and investors alike, who ask few questions about this segment on the conference calls and whose catalyst they have yet to mention in their reports or include in their models. Even Ladenburg Thalmann, in its 20-page initiation report published on March 2018 did not dedicate a single line to the discussion of the main catalyst in the company’s Logistics Visibility Solutions business, or LVS.  This segment alone, which even the company’s outsourced IR representative flippantly said “should probably be put up for sale”, has the potential to quintuple its revenues over the next 12 months as a result of a one-time catalyst stemming from changes in the cellular communications industry. While investors have been focused on the potential of the company’s AVIS deal and the transformation of their Industrial Truck segment, they have failed to look closely at the company’s comparatively unsexy LVS business, which is being dismissed as simply a zero-growth, low-margin drag on the company’s future prospects. In actual fact, LVS could be the most significant driver of revenue growth over the next two to three years. The company does not provide guidance so let’s look at all three segments of the company’s business in detail and then build a model to illustrate the potential.

AVIS

In 2017, the company signed a contract with AVIS to produce tracking and information systems for AVIS’ rental cars. These on-board systems plug into the cars’ computer and collect information about fuel consumption, mileage, tire pressure, and vehicle location, as well as provide AVIS with the ability to remotely lock and unlock cars doors and cut the ignition. Referring to their deal with IDSY in the company’s latest 10-K, AVIS says:

In 2017, our pace of innovation and advancement accelerated significantly with the announcement of several key initiatives…including our plan to double the number of connected vehicles in our U.S. Avis fleet to more than 100,000 cars by the end of 2018, as the next step toward our goal of having a 100% global connected fleet by the end of 2020.

The current size of AVIS’ rental car fleet worldwide is roughly 600,000 vehicles, so their goal of having a “100% global connected fleet by the end of 2020” implies the possibility of significant revenues for ID Solutions. The current agreement between the two companies, signed in March of 2017, specifies that AVIS will pay approximately $21.3 million to the company for the systems and support services that cover the first 50,000 units. The systems themselves represent approximately $8.5 million of this amount, while 60 months of ongoing service revenue account for the remaining $12.8 million. In Q1, IDSY delivered the first 13,000 of these units while the remainder should be delivered in Q2.  AVIS must continue to make minimum purchases of 50,000 units every six months in order to retain their exclusivity under the agreement, although to meet their goal of having a “100% global connected fleet”, AVIS will eventually need to purchase much larger quantities than the contract minimums. Management at IDSY believes AVIS is likely to be conservative in its purchases given its past history so my model at the bottom of this write-up includes only the contract minimums.

In a conversation with AVIS earlier this month, AVIS explained their rationale behind their deal with IDSY and why they are excited about the prospects for connected cars in general:

There are lots of advantages. First and foremost, we collect more fuel revenue because the connected cars and connected car devices actually measure fuel revenue to the 10th of a gallon as opposed to an 8th of a gallon. We’re also getting overdue cars back faster. Sometimes cars get parked and towed, and there've been times when they'll wind up at an impound lot. The impound lot isn’t required to tell us that they have our vehicle for 28 days, so it often will sit there for an entire month. For a connected car we know immediately when it’s overdue and where it is. We can ping it, and we can have our people go and pick it up immediately. Over time we should also be able to use connected cars to better optimize mileage. Mileage is the holy grail for a car rental company. If you could optimize your mileage that's a big deal. We’re also using these systems to make sure that all our cars’ tires are properly inflated before they are rented. If the system detects a car with inadequate tire pressure in one of our lots it will automatically put that car on hold until the tire has been brought back to normal pressure.

AVIS also discussed their vision for the future of the car rental business in general – that rental companies will eventually move away from brick and mortar facilities such as rental offices and parking structures and will replace them with a hybrid of the Zipcar model, where rental cars will be parked on streets or in small parking lots around the country – unattended – and can be rented one-way, or for as long as needed, simply by using a phone app to unlock the car. A data system, such as IDSY’s, would be used to manage the car rental from start to finish, monitoring car performance, mileage, fuel consumption, tire-pressure and other factors. This will allow them, they say, to expand their car-rental business into any area where rental cars are in demand without having to lease infrastructure such as local offices or parking structures. It also eliminates the vast majority of employee overhead since the entire car-rental process can be handled remotely.

IDSY sells each of the connected-car systems to AVIS for $170 and receives service revenue per unit of $3.40 per month. Each 50,000 order therefore, brings $8.5 million in revenues to the company and ongoing service revenues of about $2,040,000 per year.  If AVIS’ entire fleet of 600,000 cars are eventually connected with IDSY systems, the company would receive ongoing service revenue of approximately $25 million per year with a gross margin of 70%. One-time product revenue would be $102 million, with a gross margin of 23%. This compares with current company-wide revenue of about $40 million per year. The collaboration with AVIS and the ramp-up in orders has been the primary driver of investor interest in the company to date although it still must be proven whether AVIS will continue to order connected vehicle systems at the rate of 100,000 per year in order to maintain their exclusivity. If AVIS’ exclusivity were to expire, IDSY would be free to sell their connected car systems to other car rental companies with a total addressable market of about 4 million vehicles. At $170 apiece for the system and $3.40 per month in service revenue, this equates to a market potential of $680 million in product revenues and $163 million in annual recurring revenue.

The competition for IDSY in the connected-vehicles space primarily comes from the vehicle manufacturers themselves. For example, GM’s OnStar system will perform many of the functions that IDSY systems can perform although it only works for GM cars, of which AVIS has about 60,000 in their fleet. The same is true for Peugeot and AVIS’ operations in Europe. However, according to AVIS, the vehicle manufacturers are still in the development stage of providing connected capability, and they are not designing their connected capability with the needs of rental car companies in mind.  IDSY, on the other hand, can tailor the on-board system directly to the needs of rental car companies which is why IDSY and AVIS have had a long history of collaboration on connected car solutions, beginning in 2011. Other potential competitors in the future might be Pointer (PNTR) and Calamp (CAMP) but they do not at the moment have competitive offerings.

Industrial Truck

Industrial Truck is the company’s longest operating business, founded in 1993. Through this segment, the company sells systems which monitor the use of fleet vehicles such as forklifts, construction equipment, cranes, and airport support vehicles, and sends real-time information back to the customer for analysis. Using equipment installed on each of the vehicles, an enterprise can monitor how each of its assets is being utilized, whether they are parked or moving, whether they have been involved in a collision, whether they are being driven safely, when it is time to perform maintenance services, who is operating the vehicle, as well as being able to determine the vehicle’s exact location and speed. This information allows an enterprise to optimize the use of its vehicles, enforce safe driving provisions, prevent damage to equipment or products, monitor the productivity of their fleet operators, and assign accountability for accidents and damage.  Revenue from this segment was approximately $23.7 million in 2017, representing 58% of the company’s total revenue. However, it has been relatively flat and lumpy for the last several years as can been seen from the table below:

*For purposes of comparison, the 2017 service revenue figure of $6.2 mil was adjusted downward by $3 mil from $9.2 mil to account for AVIS revenues allocated to this segment

According to the company, growth has been absent in this segment partly because the products sold in previous years were not of the highest quality and partly due to the saturation of the mid-tier and large tier markets, while the lumpiness was due to their exclusive focus on enterprises with assets of 50 to 500 vehicles, making the sales cycles long, implementations difficult, and resulting in large wins in some quarters while having little to show in others. In 2017, under the direction of a new CEO with a proven track record and extensive experience in the industry, the company began implementing a number of initiatives to significantly grow the Industrial Truck business and to reduce the variation in revenues quarter to quarter. They improved product quality, acquired Keytroller, a company with a worldwide dealer distribution network, allowing them to penetrate the small end of the market, and developed a scaled-down version of their fleet management software, branded “106”, which provides a simple solution and easy installation for smaller enterprises. Following these changes, the addressable market for IDSY’s products is now 10 million industrial trucks worldwide, compared to just 700K before the acquisition of Keytroller. Furthermore, this market can now be targeted with multiple products and through multiple distribution channels. Management believes these new initiatives will produce double-digit revenue growth in future years. To be conservative in my model, I have used a growth rate of 10%, which the lowest possible double-digit growth rate.

Logistics Visibility Solutions (LVS)

The company’s Logistics Visibility Solutions segment provides tracking systems, sensors, and software which monitor a customer’s fleet of trailers, chassis, and intermodal containers. Equipment installed on each piece of equipment monitors the location and speed for every asset in the fleet, when the units stop and start, how long they dwell, and whether they are loaded or empty. In different configurations the equipment can also provide sensor data to monitor cargo environment, vehicle tire pressure, and vehicle maintenance needs.

In its March 28th initiation report, Ladenburg Thalmann had the following to say about the company’s Logistics Visibility Solutions segment:

In Logistics, the company is suffering from declining revenue as significant competition and a fully saturated market has caused pricing pressure. We believe a series of new products set to launch later this year can slow, and perhaps even reverse, the declines.

While there is nothing incorrect about this viewpoint, which is factually correct and is shared by the vast majority of investors and analysts, it does not address the enormous opportunity that will arise in 2019 and 2020 when Verizon, T-Mobile and ATT will shut down their 3G cellular networks around the country, forcing nearly every customer in the space, both large and small, to discard their old equipment and replace it with equipment capable of utilizing 4G LTE.

https://www.link-labs.com/blog/cdma

https://www.androidheadlines.com/2017/02/t-mobile-cto-wants-sunset-2g-3g-2019.html

https://www.linkedin.com/pulse/verizon-shutting-down-3g-2019-what-means-you-how-we-can-john-hickey

At the high-end of the market, there is an installed base of approximately 1 million 3G units belonging to large enterprises, each with 50,000 units or more, that use the 3G network to provide monitoring of freight in the US. All these assets will need to be replaced between 2019 and 2020 as the modem embedded in each of these units can only communicate using 3G. This is an enormous opportunity for the company that is currently being overlooked. At the moment, IDSY has an installed base of approximately 120,000 units in this segment. Of these, 60,000 belong to small enterprises, each with a small number of units, while 60,000 belong to Walmart and are utilizing satellite communication, which is not 3G dependent. This means the company has ZERO penetration into the high-end of the market and will have a opportunity, in 2019 and 2020, to make inroads among large enterprise customers, each requiring units of around 50,000 each, as a result of the transition from 3G to 4G. The company also believes they will retain the vast majority of their 60,000 smaller customers, replacing each of these units with 4G-capable equipment, particularly given a series of new product offerings.

The new products, which will be launched later this year and showcased at a tradeshow in October, are the key to winning these new accounts. Unlike their competitors, they will allow companies not only to collect information about the location of their trailers, containers and other shipping vessels, but to visually see the freight inside them. Even more interesting, the company will soon be able to tag individual pallets with sensors and monitor the pallets independently for vibration, humidity, location and temperature. These new capabilities will give IDSY a tremendous advantage when competing against other companies for the 1 million new units that must be replaced as a result of the sunsetting of 3G networks.

What is most interesting about this development is that it doesn’t require a huge leap of faith to believe that the company can win one or two large accounts in a market in which they currently have zero penetration, and into which they are about to launch a series of innovative new products not currently available through their competitors. In addition, in 2019 and 2020, every one of their potential customers, representing one million installed units, will be forced to replace their equipment.

Each unit is sold for $300, with the entire cash payment received up front and revenues booked over a 4-year period. Service revenue of $5 per unit is recorded monthly. Should the company close two large deals of 50,000 units in each of 2019 and 2020, they would receive $30 million in cash in each of the two years, book $15 million in revenues for each of the next 4 years, and receive $12 million in recurring annual revenue on the addition to their installed base of 200,000 units. This compares to 2017 revenues for the company across all segments of only $40 million. In my model at bottom, I have assumed one large contract win of 50,000 units, one contract win of 30,000 units, and 20,000 units resulting from the rollover of existing accounts and the acquisition of new smaller customers, in each of the years 2019 and 2020. The company historically sells approximately 20,000 units per year.

Putting it all Together

Below is a model for IDSY’s product and service revenues for 2018, 2019 and 2020 in each of the three business segments using the assumptions outlined in the sections above. Historical numbers in each segment back to 2011 are also included for comparison. Under these assumptions, the company would generate after tax free cash flow of $8.6 million in 2019 and $16.3 million in 2020, thereby increasing their cash balance from $16.9 million in Q1 2018 to roughly $25.5 million at the end of 2019 and to $41.8 million at the end of 2020. EBITDA in 2019 would be about $7.9 million and $19.3 million in 2020.

Notes:

Service revenue gross margins for all segments are 70%

Product gross margins for Industrial Truck:

                 2018 – 48%

                 2019 – 45%

                 2020 – 43%

Product gross margins for LVS:  20% for all years

Product gross margins for Connected Vehicles:  23% for all years

Adjusted Op-Ex ignores D&A and stock-based compensation

Orbcomm (ORBC) and CalAmp (CAMP) are the closest publicly-traded comps for IDSY. Orbcomm trades at an EV to Sales multiple of 3.9 and an EV to Ebitda multiple of 37, while CalAmp trades at an EV to Sales multiple of 2.25 and an EV to Ebitda multiple of 28. I am not suggesting that IDSY will trade at these levels or that it should trade at these levels, I am merely pointing out that the comps are trading at relatively high multiples. These companies are much larger in terms of sales than IDSY, which even if successful at achieving $100 million in revenues in 2020 will still have only one third the revenues of Orbcomm and less than one third the revenues of CalAmp.

In order to provide a sense for what the stock could be worth if the company is successful in achieving $106 million in revenues and $19.3 million in Ebitda in 2020 as suggested by the model, I have created a table below which shows the stock price of IDSY at various multiples ranging from an excessively low 1x sales and 5x Ebitda to the current multiples of CAMP and ORBC at 3x sales and 30x Ebitda . IDSY stock will most likely trade somewhere between these two extremes.

Catalyst

Catalysts

AVIS continues to place orders at the rate of 50,000 to 100,000 units per year

The company wins one or more large contracts in the LVS segment

Industrial Truck continues to grow organically in the double digits