Description

We first wrote about OneSpan nearly four years ago in November 2018 and recommend you refer to that writeup for basic overview of the company and industry.  In addition, the company held an Investor Day in May 2022 which is also worth reviewing.  As we forecasted in our original writeup, the stock had roughly 100% upside potential over the next two years, which it achieved over the summer of 2020 hitting roughly $33/share.  Since then, the stock has crashed to levels below what we witnessed in 2018 despite a complete transformation of the Company that we believe has set up the company for long-term success.  Street estimates do not reflect any of these major changes, though that is partially due to management maintaining conservative full year 2022 guidance despite outperforming in Q1, Q2 and Q3.  Longer term, given notable correction in the stock, we see ~100-200% upside from here.

OneSpan is a mobile & identity cybersecurity software company with an impressive eSignature business.  The Company caters towards financial institutions and counts 60 of the top 100 global banks as customers despite its small size.  We believe there is significant cross-selling potential within the existing customer base for the eSignature solution, as well as prospects for new business wins.  To truly pursue this opportunity, new leadership was required, which served as the basis of a major public proxy contest last year as the Board was a significant impediment to unlocking (and maintaining) substantial shareholder value.  

Here is a brief list of the major changes since last year:

• Since our last writeup and following an activist’s successful proxy fight last year, the entire Board has been replaced with tech industry professionals and shareholder-friendly advocates

• New CEO quickly hired and has led entire C-suite sweep

  • New CEO Matt Moynahan hired in November 2021 – former CEO of Forcepoint (a Vista Equity cybersecurity software company that was sold to Francisco Partners)

  • CEO has replaced nearly entire executive team

• Entire sales force rebuilt – overseen directly by CEO

• $30-37mm of cost optimization identified (~15% of revenue) – roughly half executed to date though none of this benefit appears to be factored into street estimates

• Investor Day in NYC in May – commitment to achieving 30 on a Rule of 40 basis by 2025

• New segment reporting

  • Security Solutions (low growth / high margin): identity & mobile security solutions spanning software term licensing, maintenance, and legacy hardware tokens

  • Digital Agreements (high growth / low margin): #3 eSignature player behind DocuSign and Adobe

• New $50mm share repurchase program underway

• Launch of new Virtual Room solution (a secure video meeting solution that incorporates identity authentication)

• Strong Q1, Q2 and Q3 2022 performance – beat street figures but only modestly raised full year guidance following the Q3 print, leaving an attractive set up for 2023 as street estimates do not reflect any of these major operational improvements

Despite the massive transformation that has taken place, including a new strategic vision with long-term targets laid out at an Investor Day, the stock price has nearly cut in half since mid-2021.  Part of this is undoubtedly due to multiple compression in the software space, the market’s distaste for small caps, and the illiquid nature of the stock.  However, we believe the business, financials and OSPN shares are set to inflect meaningfully as all this heavy lifting will finally get reflected in street estimates and investor sentiment.

In addition, we believe OneSpan has substantial strategic value that should be attractive to a host of potential acquirers, such as:

• Technology: Zoom, DocuSign, nCino, Fidelity National, Fiserv

• Security: Palo Alto Networks, Fortinet, Gemalto (Thales), RSA (Clearlake Capital / STG), CA Technologies (Broadcom), IBM, Ping/SailPoint/ForgeRock (all owned by Thoma Bravo)

• Private Equity (many suitors for a deal this size)

Sum of the parts stories can sometimes fail to reach their full potential in the public markets – as such, we believe the Board should consider strategic alternatives sometime in 2023 if the stock price does not reflect OneSpan’s intrinsic value, especially after issuing 2023 guidance.  This could include a sale of the entire Company or selling off each segment to separate buyers.

Financials / Valuation

There are now two segments:

• Security Solutions

  • Legacy hardware token business which is in managed decline yet highly profitable

  • Mobile Security Suite – software-based mobile & identity security solutions now sold primarily as term licenses (subscription revenue))

  • Maintenance – tied to legacy hardware and perpetual/term licensing contracts

  • Overall segment should grow LSD as software growth offsets hardware decline

  • Mid-60s gross margin expected to expand to ~70% area given software mix shift

• Digital Agreements

  • eSignature cloud SaaS solutions – differentiated given focus on financial institutions with identity security features in foundation

  • Expected to grow 30%+ annually with mid-70s gross margins; operating margins will scale over time

• Corporate Expenses

  • Entire G&A plus some shared R&D and S&M

The Company issued long-term guidance at its Investor Day (below) which we believe is highly conservative.  While management openly committed to hitting 30 on a Rule of 40 basis by 2025, their targets imply only reaching ~20 (10-12% consolidated revenue growth + 8-10% EBITDA margin).  Clearly, they will either grow much faster, be much more profitable, or both.  And while the Street has yet to issue 2025 estimates, consensus estimates call for ~5% growth and ~1% EBITDA margins in 2024 – significantly below management’s conservative targets.

Our forecast below assumes the cost optimization efforts flow through against solid growth execution.  The Company has ~$100mm of cash on its balance sheet today (no debt), and we model continued share repurchases.  Revenue, Adj. EBITDA and FCF are all set to inflect meaningfully in 2023 and beyond towards hitting the Rule of 40 in 2026, making now the best time to buy OSPN stock.  Street estimates are at the very bottom and as you can see, those figures are well below ours.

The Company also reports segment level profitability, though important to note there is a separate “Corporate Expenses” line that they do not allocate to either segment.  We have attempted to break down our expectations of R&D and S&M per segment relative to the respective segment’s growth profile.  This exercise has given us increased confidence in the trajectory ahead, which includes an inflection in revenue, Adj. EBITDA and FCF in 2023.

In terms of valuation, we look at this three ways:

• 2023E SOTP: 10x Digital Agreements Revenue (in line with other 30-40%+ SaaS growers), 14x EBITDA for Security Solutions and Corporate Expenses = yields 3.4x Total Revenue

• 2024E SOTP: Same multiples above, though dramatically improved profitability provides major uplift to value

• DCF: this gives full credit for the long-term operating plan (including completed execution of the cost cutting plan), which carries execution risk

In our view, a near-term sale around the 2023E SOTP valuation estimate would be a huge win for shareholders.  If the Company is not sold, we are hopeful the new management team will continue to execute well and drive a multi-bagger for shareholders over a few years.

Catalyst

• Sell-side begins to properly model OSPN - there are no credible estimates today - street EBITDA is at 2022 $1.6mm, 2023 $1.3mm, 2024 $1.7mm - Meanwhile we are modeling 2022 $2mm, 2023 $16mm, 2024 $32mm, and 2025 $53mm.  
• Buyback of shares using the net cash of $94mm on the balance sheet
• OSPN gets acquired