Description

Please note: Kneat Solutions (KSI CN) is a microcap stock with limited daily trading volume.   

Investment Summary

Kneat Solutions is a founder-led vertical SaaS solutions company with a long-term vision to be the number one data-centric system for management of regulated processes across multiple industries worldwide.  

Today, the company is a SaaS provider of digital validation and testing software to the life sciences industries (i.e. pharmaceutical, medical devices, chemical, health, personal care and diagnostics.)   

The company’s platform (Kneat Gx) provides complete comprehensive document validation of processes, products, equipment and software.  The life sciences industry is heavily regulated by the FDA and every manufacturing process, piece of equipment, and computer system involved in the manufacturing of pharmaceutical products and medical devices must be tested and validated in accordance with the Good Manufacturing Practice regulations.  Validation has historically been a manual, paper-intensive process leading to extensive delays in production and high costs associated with data and document retrieval and management.

For much of the company’s history, Kneat has been focused on the pharmaceutical sector.  The company currently services 8 of the 10 largest pharmaceutical companies in the world, and the majority of the top 20.  More recently, the company has had success expanding to the broader life sciences industry.  To that end, Kneat’s last four announced strategic wins include: a US-based CDMO; a US-based manufacturer and distributor of medical supplies; a US-based manufacturer of health and wellness products; and a European-based global consumer products company.    

Despite being a very small company, Kneat enjoys a strong competitive position in its market, and, in our view, the company is well positioned for durable growth over the next 3 to 5 years.  According to management, the company has had zero customer churn (a couple of customers that left have come back) and near best-in-class metrics for net revenue retention.  We estimate ARR/SaaS revenue can compound annually at 35%-45% over the next four years, suggesting that SaaS revenue can grow 4x by 2027.  We believe the shares can compound at 20%-25% over the next three to four years.  We estimate the company can largely reach these goals by simply expanding its footprint with existing customers.  We estimate operating losses peaked in 2024 and expect the company to be FCF positive in 2026.  

Recent management commentary 

From today’s MD&A:

CEO Eddie Ryan – “In my letter to you at the same time last year, I shared Kneat’s plan for 2023: add new customers, expand within existing customers, leverage our partner community, further develop the Kneat platform, and get Kneat’s own systems and processes ready for several years of rapid top-line growth. I am pleased to report that our team at Kneat delivered on all fronts….

This past year stood out as a record year for strategic wins, as we announced eight large, multi-national enterprises as new customers. While we welcomed numerous smaller and mid-sized companies to the platform as well, it was expansions within large enterprises, which run multiple validation processes and operate sites around the globe, that drove most of our revenue growth in 2023. This is in part because it can take a customer between three and six years to fully scale Kneat across its sites and processes as they look to digitize and harmonize validation enterprise-wide. We estimate that our existing customer base has the potential to contribute more than $65 million in Annual Recurring Revenue when fully scaled to all validation processes across all their sites. This is nearly double our Annual Recurring Revenue at the end of 2023, without adding a single new customer. But of course we are adding new customers, all the time."

From today’s press release:

CFO Huge Kavanagh - “2023 was a pivotal year for Kneat. After significantly increasing the size of our team in 2022, we grew into these investments over the course of this past year, and it’s paying off: in the fourth quarter of 2023, gross profit increased at nearly twice the rate of operating expenses. As we continue to grow our SaaS revenue, invest at a more measured pace, and develop efficiencies as we scale, we expect 2024 to be a year of material progress toward profitability.”

Operating Momentum

The company has announced 10 large strategic customer wins in the past 12 months (8 in calendar 2023, 2 more to begin 2024).  Management defines strategic wins as typically offering the potential to evolve into multi-million customers.  As such, these most recent wins could add $20 million to Kneat SaaS revenue base over time.  We believe Kneat’s largest customer Merck generates over $3 million in annual revenue and could grow its business with the company to over $5 million a year.    

Large untapped opportunity in and outside of digital validation

The company conservatively estimates that its current customer base can organically expand from its current size, ARR of $US28 million (C$37 million) to more than $65 million – just from digital validation.  We believe this estimate is conservative.  Kneat can be successful by simply expanding its business with the largest companies in pharma and related sectors.      

According to the company’s annual State of Validation survey, only 37% of respondents have adopted digital validation.  This suggests that digital validation in life sciences has a long way to go.  Management believes digital validation of life sciences is a $2 billion global opportunity in and of itself.

Kneat Gx is a highly flexible, configurable product.   Management has noted that customers are applying Kneat’s software solutions to other workflows and asking Kneat to broaden its focus beyond digital validation.  Management believes Kneat Gx can be used to configure and manage regulated data and documents across many adjacencies.    

The company believes switching costs are quite high for entrenched customers.  Years worth of data must be maintained, and validation systems must be integrated with a customer’s IT systems, including resource planning, manufacturing, quality, engineering and maintenance.  Kneat has been focused on building APIs to more tightly integrate its software across its customers’ IT solutions.

Management

Kneat’s origins trace back to 2007.  Two of the company’s three co-founders had backgrounds in pharmaceuticals industry building, commissioning, validating and providing ongoing maintenance services for manufacturing facilities.  In doing so, they recognized the incredible inefficiency that existed in validation which, at the time, was done on paper with forms and with Microsoft Word.  

The company is led by CEO Eddie Ryan and CFO Hugh Kavanagh.   In recent years, the company has significantly grown its bench of talent.  The shares trade in Canada and the company is headquartered in Limerick, Ireland.

Growing ecosystem of partners

Kneat has managed deployments for its customers, and, in recent years, Kneat has been deemphasizing professional services and increasingly relying on a network of professional service providers, consultants and technology firms to deploy Kneat Gx.  This growing ecosystem will be critical if Kneat is to grow and significantly expand its presence among smaller and mid-size life science companies that could help dramatically increase the size of the company’s revenue base.  Kneat currently has 77 partners and service providers.

Competition

Kneat’s principal competitor is ValGenesis.  ValGenesis is private company that competes directly against Kneat in the life sciences industry.  The company raised $24 million from Morgan Stanley in a private placement in 2021.  ValGenesis has some notable customers in biotech and medtech.  Kneat management has indicated that they consistently win head-to-head RFP’s against ValGensis with the largest pharma companies.  

In our opinion, the market is large enough for both companies to do well.  

Valuation

Kneat shares are not cheap on an absolute basis or on traditional valuation metrics.  On an enterprise value to SaaS revenue basis (adjusting for option proceeds and estimated cash burn of C$20 million over the next two years), the shares trade at 7.2x our 2024 SaaS revenue estimate and 4.8x our 2025 estimates  If the company grows ARR/SaaS revenue in line with our expectations, the shares should do quite well over time, even allowing for some multiple compression.  We believe operating losses peaked in 2023, and we expect Kneat to begin generating free cash flow by 2026.

The company recently raised C$20 million in a bought deal financing and the company currently carries a cash balance of around C$33 million and C$22 million of debt. 

Investor Deck: https://investors.kneat.com/static-files/356def88-839a-4ba7-b002-9bbfb6fc38a6

Risks 

Competition

Cash burn

Higher interest rates

Catalyst

Catalysts

Continued expansion with existing customers

New strategic logo wins 

Reduced cash flow burn

Market cap liquidity