Description

Long ONTF

ON24 (NYSE: ONTF) is a cloud-based, SaaS platform for digital engagement via interactive webinar and virtual event experiences. It trades at 0.8X NTM Sales, has ~65% of its market cap in net cash, and is finally reaching an inflection point in its turnaround efforts. At first glance it is easy to dismiss this as a melting ice cube but examining Core ARR across verticals tells a very different story. I believe ONTF’s “hidden” asset is worth more than the entire EV today. ONTF is down ~88% since its IPO, management has bought back >$100mm of its share count in the LTM, and ADV is ~$2.5mm: when the story finally works, ONTF’s price action could be dramatic. This is my highest conviction long for the year.  

Business Overview:

ONTF was founded as NewsDirect in 1998 -> launched a webinar platform in 2003 -> built out its lead generating data layer and transitioned to a SaaS model in 2013. Enabling B2B digital engagement is still the core use case today and it did ~$171mm in topline over the LTM. For reference, ONTF’s FY ends on December 31.

ON24 Elite is the flagship offering which combines a video or audio-based presentation with features such as supporting slide materials, video-clips, screen-sharing, live question messaging, and real-time surveys. This customizable layout is compactly displayed on the end user’s screen, is accessible in a live or on-demand format and can be repurposed/syndicated across different regions. Clients can then monitor how an end user interacts with their digital material via ON24 Intelligence (their analytics offering). The result is very impressive: the average user interacts with the webinar for ~50 minutes and ~20 unique data points are generated per user. The buying signals generated are highly accurate in identifying whether a customer is serious about a purchase. Compare this to two common engagement channels: physical events and digital ads. In-person events are engaging but are expensive to host and provide almost no data on prospects besides an attendee’s email. Digital ads/email marketing provide scalability, but this channel has low engagement rates and frequently has the opposite effect of disengaging/churning users who mark these notifications as spam.

ONTF then integrates with various CRMs (i.e. Salesforce, Adobe, Oracle) so that these leads directly translate to top of funnel inputs. Customers sourced via ONTF come in at a notably lower CAC (webinars are highly scalable) and provide better unit economics since the onboarded customers have been thoroughly vetted for strong product market fit. Enterprise clients comprise ~80% of ONTF’s client base, while ~45% of ARR comes from multi-year agreements. ONTF’s top 25 customers have expanded their aggregate spend with ONTF 5X over the past 5 years. It is the number one pipeline driving channel for ServiceNow, with other marquee clients across verticals that you can easily look up. All this is to say ONTF’s value proposition is absolutely real.

A common argument against ONTF is that Collaboration providers like Zoom could come in and steal ONTF’s lunch. This has proven to be the opposite of what actually happens. Zoom offers only a fraction of the data and insights ONTF’s platform does. Management has stated Zoom provides good leads to ONTF because customers get their first taste of digital engagement from Zoom and then turn to ONTF once they decide they want deeper functionality. Management also mentioned that certain point solutions that sprung up during COVID folded recently as marketing budgets shrank. I believe ONTF is better positioned vs. competitors than before COVID. ONTF has won various accolades within the event management space, ranking as the #1 webinar software according to G2.

ONTF was growing ARR at a high-teens clip through 2019 but hit the jackpot with the onset of COVID. ARR growth accelerated to ~100% in Q3FY20, NRR reached 140%+ and FCF margins hit close to 20%. ONTF proceeded to peak-time its IPO in February 2021, raising $348mm in net proceeds at a ~15X Sales valuation.

As interest rates rose, marketing budgets (particularly pertaining to demand generation tools) got taken to the woodshed and of course COVID meant ONTF had pulled forward sales. Growth went negative, management missed guidance and legacy VCs dumped their shares in 2021/22 – all of which sent the share price into free fall.

Several things excite me about ONTF going forward. Following this bloodbath, management decided to double down on its Enterprise focus, simplifying their pricing structure to better align with customer needs. Management has noted it is significantly easier to expand its wallet share within an existing Enterprise customer than it is to land an incremental SMB (which also churns at a much higher rate). Second, management deliberately sunset its Virtual Conference segment (once ~10% of Sales) in Q4FY22 and de-emphasized its services revenue. This is so that personnel and resources are better allocated towards the core segments. Obviously, this has made the topline look atrocious (both segments have shrunk >50% since then) but that is partially why this opportunity exists. Third, management has done two significant waves of layoffs, cutting ~30% of headcount since Q1FY23 and reducing their cost structure by $50mm heading into FY24. This has already shown signs of fruition as they hit breakeven EBITDA two quarters ahead of schedule (Q4FY23 -> Q2FY23). Finally, management issued a special dividend in Q4FY22 and has since bought back >$100mm in shares. This is not core to the turnaround, but it is reassuring to me that management is buying back shares instead of pursuing a stupid acquisition with the excess cash on the B/S.

Now we get to the juiciest part of this idea: outside of the Tech vertical, ONTF’s software is being used for digital transformation within mission-critical workflows. In Life Sciences and Financial Services, ONTF helps clients enroll new members and train agents/brokers virtually. For Professional Services (i.e. accounting, legal) and Manufacturing, ONTF allows organizations to digitize and automate professional certification and credentialing programs. These clients also use ONTF’s software to train their partner network and to develop a centralized content resource center. Before using ONTF, these clients had a go-to-market motion that predominantly happened offline. That is obviously far more costly and time-intensive to do at scale, which explains the adoption ONTF is seeing here. Additionally, these verticals (i.e. Healthcare, Financials) are highly regulated and thus require Enterprise-grade security from their platform of choice. A key reason ONTF wins these deals is because they streamline compliance approvals and meet stringent security standards. I view this as a real moat vs. ONTF’s competitors.

Here's how I think about it: 1) this new use case is mission-critical to clients and is based off a secular tailwind (i.e. digital transformation), 2) ONTF’s platform is best-in-class in terms of security and functionality and 3) this segment is actually growing HSD YoY! My conclusion then is that this is an entirely different business from the “Demand Generation/Tech segment” and should be valued separately.

Valuation:

There are two angles to this: “Tech ARR” and “Digital Transformation ARR” (my own labels). Subscription Revenue as disclosed by management is useless here because it includes Virtual Conference revenue, which I write off as a 0. Professional Services revenue is actually GM% positive, but I will be conservative and call that a 0 as well.

Management discloses Core Platform ARR by Vertical. “Digital Transformation ARR” is comprised of Financial Services (17%), Professional Services (13%), Life Sciences (11%) and Manufacturing (12%) – all of which were confirmed publicly by management to be growing ~HSD% YoY in 2023. I’m not sure what Other (13%) is, so I will group it in with Tech (34%).

The Tech vertical is the demand generation tool ONTF was originally known for. This is software with an enduring value proposition: it is a reliable marketing channel for Enterprise clients, hence their “who’s who” list of clients. In the Q1FY23 earnings call, management disclosed that NRR for Enterprise clients was ~94%. The decline in NRR was driven primarily by contract sizes shrinking, instead of actual Enterprise churn. The churn they did see post-COVID was predominantly from SMBs. Management stated that gross retention and churn across each renewal cohort improved QoQ for the first time in Q3FY23; I believe the metrics are finally starting to inflect. I think management has a handle on the situation, considering they met the high end of guidance in the past three quarters and beat/raised most recently in Q3. Budgets for demand generation marketing will inevitably come back as the macro improves. I think growth for this segment will turn positive in H2FY24, but it is really a matter of time rather than a question of whether terminal value exists.

I think Tech ARR can return to a HSD growth clip from 2025 onwards as growth gradually re-accelerates. I will emphasize that this revenue stream was growing at a high-teens clip even before COVID. I think Digital Transformation ARR can accelerate to a low DD clip from FY25 onwards. I value the Tech ARR segment at 2.5X Sales. I value the Digital Transformation ARR at 4X Sales. That gets us to >140% in upside through FY25 on very reasonable assumptions. Growth should flow in at a higher incremental margin than before given the sizable OpEx that was stripped out -> the market should rerate as ONTF proves out its EBITDA profitability.

The upside is clearly there, but what makes this idea especially compelling to me is the risk/reward skew. Let’s say Tech ARR only grows at a GDP-type clip, in which case I value it at 1X Sales. Let’s say Digital Transformation ARR decelerates to a MSD clip (even as the macro improves), in which case I’d value it at 2X Sales. Again, this is mission critical + is levered to a secular tailwind. That gets us 46% in upside for our downside case!

I’ll go a step even further and lay out an “apocalyptic” scenario. Let’s say Tech ARR (+ Other) is a melting ice cube and is thus worth 0. If Digital Transformation ARR normalizes at a LSD clip and we value that at 1X Sales, that gets us 2% in downside (yes, you read that right). As long as management does not do a stupid acquisition (unlikely considering the buyback in place + Indaba being a willing activist), it is hard for me to imagine a scenario where we see meaningful capital impairment.

A very plausible scenario is that this gets taken private by a strategic player looking to scoop up a best-in-class software platform + some very valuable Enterprise clients. Most of the G&A and S&M can be stripped out within a year; after accounting for cost synergies, a strategic acquirer would be getting a recurring revenue stream with 25%+ EBITDA margins at ~0.7X Sales. I would think this is a no-brainer for a strategic acquirer at today’s valuation. There is a clear floor on downside here. ONTF also has ~$37mm in NOLs; if I apply a 33% discount to this balance, we get an extra 7% in “cash” relative to today’s market cap.

Catalyst

Earnings