Onvia Inc. (ONVI)

Summary

We focus on smaller companies with Ft. Knox balance sheets and large & sustainable free cash flow yields and we are typically seeking a mid-teens FCF yield or higher on an unleveraged basis.  The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation, through share buybacks, debt reductions, dividends, or accretive acquisitions.  Obviously, it is important we have a management team that cares about shareholder value.  We also focus on small and micro-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered.

This idea is small and not liquid and likely most appropriate for small funds or P.A.’s.

Overview

ONVI was previously written up on VIC by zach721 and we recommend his write-up as an excellent summary of the opportunity.  We will attempt to provide a bit more detail in this write-up as well as provide an update in the company’s performance.  In short, we agree that ONVI is a very valuable business and is executing a sensible strategy to build long-term sustainable value for customers and shareholders.

Onvia (ONVI) is a leading provider of business information and research solutions that help companies plan, market, and sell to government agencies throughout the U.S.  ONVI’s business solutions provide clients online access to proprietary information about government procurement activity across local, state, and federal government agencies.  The business intelligence derived from its solutions allows clients to identify and research new market opportunities, analyze market trends, and obtain valuable insights about their competitors and channel partners.  ONVI believes its business solutions provide clients with a competitive advantage, increased revenue opportunities, and strategic insight into the public sector.

ONVI’s procurement solutions include proprietary content and analytical tools that deliver essential insight and intelligence necessary to win more business with state, local, and federal governments.  ONVI targets companies that have a long-term strategic interest in the public sector and for which the government market is a core part of their business.  All three of ONVI’s sales channels, Small Medium Business (SMB), Enterprise, and Content Licensing, focus on this market.  ONVI’s solutions are organized around its targeted industries, which include: 1) Architecture, Engineering, and Construction; 2) IT Telecom; and 3) Operations and Transportation.  ONVI’s database categorizes 89,000 government agencies, 275,000 company profiles, and 700,000 government personnel.

Software Business Model

We have invested in several software companies over the past few years and had pretty good luck with these investments.  One reason we like software companies is they tend to be highly cash generative and have high gross margins.  Consequently, even small increases in revenue can drive disproportionate improvements in Adjusted EBITDA and FCF.  Furthermore, software companies can drive significant organic revenue growth through investments in sales and marketing and technology and development which are expensed through the income statement but (sometimes) which have a multi-quarter or even multi-year impact on revenue and profitability growth.  Such is the case (we hope) with ONVI.  While ONVI is not currently generating FCF based on our traditional definition of cash from operations less capital expenditures, we do believe management has made and continues to make meaningful investments in the business model through sales and marketing and technology and development expenses, which (we hope) will over time drive meaningful revenue growth.  What we like about ONVI is that the cash generative nature of the business is basically enabling management to internally fund and strengthen the business model over time and management’s strategy is really not very capital intensive.  While we would not bet the ranch on the next quarter or two, we believe that over the next two years, the odds are good that management will get it right, revenues will jump, and so will the stock price. 

Background

Under CEO Hank Riney since 2011, ONVI has been transforming from a low-margin leads generation business into providing business intelligence tools designed to help identify and research new market opportunities, analyze market trends, and better understand competitors and channel partners.  ONVI notes there are 1.9m businesses who are “casual users” of government procurement data but that it intends to shift its focus to what it believes is a more profitable target market of about 30,000 “power users” of government procurement data.  ONVI believes these “power users” will user higher amounts of government procurement data, resulting in higher annual contract value per client or ACVC and higher renewal rates.  In recent years, ONVI’s customer base has declined while its ACVC has been increasing, as ONVI pursues fewer but more profitable clients.  To support this strategy, ONVI has been investing in new products and product upgrades to increase the value provided to these “power users” of government procurement data and investing in its sales and marketing effort, to reach more customers.

ONVI revenues are primarily generated from client subscriptions, content licenses, and management reports.  Almost 90% of total revenues are subscription.  Subscriptions are generally annual contracts, however, the company offers extended multi-year contracts to its subscription clients and content licenses are generally multi-year agreements.  Unearned revenue consists of payments received for prepaid subscriptions.

The table below shows the gradual execution of ONVI’s strategy.  The Company stopped the decline in ACV in Q1 2012 and ACV has been gradually increasing since then.  Growth in ACV indicates that new client acquisitions, contract expansions, and improving client retention rates have more than offset the impact of client attrition.  ACV represents the aggregate value of subscription contracts and is a leading indicator of future revenue growth.  Adjusted EBITDA has been depressed in 2013 by increased investments in sales and marketing and costs of goods sold which are focused on driving revenue increases over the longer term.

Products & Upgrades

ONVI launched Onvia-5 in February 2012 which improved the usability and find-ability features of the database.  In July 2012, ONVI launched a new solution, Term Contract Center, to provide clients maximum visibility into over 150,000 recurring contracts.  In December 2012, ONVI launched the first upgrade to Spending Forecast Center with Project Previews, a data mining tool that helps clients focus on future opportunities from budgets and capital improvement plans where they have the greatest probability of winning.  ONVI believes these product investments are changing its value proposition from an aggregator of public procurement documents to a more robust, enhanced database of public procurement intelligence.

In Q1 2013, the Company launched Onvia-6 with a workflow user interface to improve the usability of solutions.  In Q2 2013, the Company improved the content delivery process and clients now receive 90% of their actionable content on the same day the content is captured.  In Q4 2014, the Company launched Vendor Center, an analytical tool designed to help customers evaluate competitors and channel partners in the public sector.

ONVI products include Onvia Database, its flagship product, which provides search functionality on its analytics platform of local, state, and federal government agency purchasing information; Project Center, that offers individual public sector procurement projects at each stage of the purchasing cycle; and Agency Center, which provides users with agencies procurement histories, current projects, and spending forecasts within their target markets.  The company also offers Spending Forecast Center that provides an insight into budgets and capital improvement plans of agencies; Term Contract Center, launched July 2012, which helps clients to make purchases using term or recurring contracts; and the Onvia Guide that offers clients with information relating procurement activity of the agencies, industries, and markets for clients.  Onvia also provides Management Reports, such as contract lists that offer a list of decision makers, agency procurement officers, and zoning officials for customers to develop relationships and identify business partners; and Winning Proposals Library, which compares and contrasts winning proposals. The company serves various businesses through small/medium business (SMB), enterprise, and content licenses.  ONVI tracks, analyzes, and reports historical, real-time and future spending of tens of thousands of state and local government agencies, giving companies a single source for conducting open, intelligent, and efficient business with government.

Competition

ONVI believes the market for comprehensive intelligence on the government procurement market is underserved.  Current and potential competitors include: (1) information companies that target specific industry verticals covered by ONVI’s services, such as McGraw-Hill Dodge, Reed Construction Data (a subsidiary of Reed Elsevier, a $15b market cap global provider of information services), Bid Clerk, Contractors Register, and Deltek (acquired by Thoma Bravo private equity firm for over 3x revenues); and (2) lead generation and bid matching companies such as Fed Market.com, Bid Net (owned by MediaGrif Technologies (MDF.TO), a $350m market cap company which trades at 14x EBITDA and 5x revenues in Canada), Bid Sync, and Government Bids.com.

ONVI is seeking to differentiate itself by expanding its database, enhancing and normalizing its data, developing solutions with high switching costs, and maintaining a loyal base of repeat clients.  To achieve these goals, ONVI is continually investing in content and software applications to provide its clients with intelligence on the government procurement market.  ONVI believes the key competitive factors are breadth, depth, and timeliness of content, content quality, base of existing clients, and client service.

2013 Initiatives

In 2012, ONVI stabilized the declines in Annual Contract Value or ACV and subscription revenue (see chart).  In 2013, the Company focused on leveraging the foundation built over the last two years to grow subscription revenue and Adjusted EBITDA in 2013 versus prior year with a four-pronged approach:

• Expanding the SMB Acquisition sales team by 40% in Q4 2012;
• Maximizing contract value growth within the SMB client base;
• Strengthening the value of its database and adding solutions to help customers win more government business; and
• Developing a strategy for Enterprise sales that is scalable for 2014

The first initiative, to expand SMB Acquisition, has been driven by an increase in the SMB salesforce, which was increased 40% in Q4 of 2012, to 20 sales people.  This initiative is behind plan but results improved in Q3 due to corrective actions.  In early Q3 of 2013, ONVI began to target only regional and national prospects and eliminated the low end product for new clients.  Execution also improved in Q3 with the addition of a new VP of Sales and Marketing.  SMB Acquisition bookings for 9 months have increased 24% over prior year and Q3 SMB Acquisition bookings grew 35% over prior year, as compared to 5% growth in Q2.  Also, new client ACVC increased to $10,405 from $8,862 in Q3 of 2013.

The second initiative, to maximize growth within the existing SMB customer base and ensure clients receive the optimal Onvia solution, will have its success indicated by growth in contract value of existing contracts in 2013 versus 2012.  In Q3 2013, contract value growth rate declined by 10% versus prior year.  Management noted that a large number of subscriptions expire in Q3 and that its account management team was focused on administering contract renewals and focused less on contract upgrades.  In October 2013, the team delivered record monthly contract value growth.

The third initiative, to strengthen the value of the database and continue to add solutions, was driven in Q4 by ONVI’s launch of Vendor Center, which provides strategic intelligence on companies that do business with state and local governments.  Clients will be able to identify, track, and benchmark competitors and potential partners.  Management believes that Vendor Center represents an important step in its strategy to move from lead distribution into public sector market intelligence and analysis.

Q3 2013 Results

Total revenue was flat at $5.4m in Q3 2013 versus prior year as a result of lower report revenue.  Report revenue is not expected to increase in the future because content previously delivered as one-time report is now included in the subscription solutions launched in H2 of 2013,

ACV increased by 3% to $19.1m from $18.6m in prior year.  Growth in ACV indicates that new client acquisitions, contract expansions, and improving client retention rates have more than offset the impact of client attrition.  ACV represents the aggregate annual value of subscription contracts and is a leading indicator of future revenue growth.

ACVC increased 12% to $5,156 per client vs. $4,610 in prior year.  Growth in ACVC demonstrates that an increasing number of clients have a strategic interest in the public sector.

The company expenses 100% of variable sales costs upon sales but recognizes revenue on no more than 8% of a new annual subscription each month.  The impact of variable sales costs may be more noticeable in short term Adjusted EBITDA and net income until the company’s revenue base increases.

Q3 Adjusted EBITDA was $722,000 versus $843,000 in prior year due to increased investments in sales and marketing and costs of goods sold.

Investment Thesis

ONVI has a Ft. Knox balance sheet with $8m in cash and no debt at 9/30/13 for net cash of $8m (20% of market capitalization).  ONVI has 7.3m shares outstanding at about $5 per share for a market cap of about $36m less $8m of net cash or an enterprise value (EV) of about $28m.  Based on LTM revenues of $22m, ONVI is trading at 1.2x revenues, which is attractive for a software company with gross margins of 80%+ and 90% recurring revenues.  LTM EBITDA is $2.7m and LTM cash from operations is about $2.3m, so ONVI is trading at 10x EBITDA.  However, as discussed, 90% of ONVI’s revenue base is recurring subscription revenues.  The Company is also investing in: 1) product development; 2) sales and marketing, and 3) its technology platform, all of which are being internally funded by cash-generative business model.  We believe these investments have strong potential to drive improved ACV and subscription revenues in 2014 and 2015.

ONVI’s investments in product development and sales and marketing appear to be gradually taking hold and should eventually be reflected in meaningful increases in Annual Contract Value (ACV) and revenues.  ACV represents the aggregate annual value of ONVI’s subscription contracts and is a leading indicator of future revenue growth. In Q3 2013, Annual Contract Value per Client (ACVC) increased 12% to $5,156 per Client compared to $4,610 in prior year.  Management believes growth in ACVC indicates that an increasing number of clients have a strategic interest in the public sector and companies within this target market typically have higher ACVC and renew at higher rates, which are key attributes of a profitable long-term client.

We think ONVI’s high gross margins, cash generative business model, and Ft. Knox balance sheet will allow management to drive shareholder value over the next few years with multiple levers, including: 1) organic investment in product development and marketing to strengthen its existing operations; 2) niche acquisitions to add and strengthen new verticals and geographies; and 3) capital allocation optimization strategies, including share buybacks.  We believe these three levers can be used over the next three years to maximize shareholder value.

Cash Generative Business Model with High Gross Margins

ONVI has a cash generative business model which is asset-light with limited capital expenditures and working capital needs and a high ROIC.  We note that ONVI has generated positive cash from operations in six of the last seven years, despite the difficult economic environment.  Since 2009, the Company has generated $14m in cumulative cash from operations or about 40% of the current market cap.  Further, ONVI currently trades at an attractive 1.2x LTM revenues, of which about 90% are subscription based, recurring revenues.  With even modest revenue growth in 2014 and 2015, ONVI can generate significant FCF.  We note that ONVI has a large NOL which should result in minimal cash taxes over the next several years.

Subscription Revenue Base and Diversified Client Base

The Company has a subscription revenue base which is very stable.  The contracts which it enters are generally one-year contracts which provide ONVI with a strong base of subscription revenues.  The Company also has a diverse base of clients: its total client base was 3,950 clients at year-end 2012 and decreased to 3,700 clients at end of Q3 2013.  This is consistent with its strategy to improve profitability by acquiring and managing fewer strategic clients at a higher Annual Contract Value per Client (ACVC).  Management believes Annual Contract Value (ACV) is a better measure of quarterly sales activity than the number of clients.

Stabilization and Gradual Growth of ACV and Subscription Revenues

Since implementing their strategic plan in 2011, management has stabilized the decline in subscription revenues and has seen small but steady growth in subscription revenues during 2013 to date.  While growth in SMB Acquisition revenues has been less than expected for 2013 thus far, management has continued to respond throughout the year with incremental strategies designed to drive improvements in SMB Acquisition.  There are some signs of possible success, as SMB Acquisition bookings were up 35% in Q3 2013 as compared to 5% in Q2 2013 in response to management’s focus on only national and super-regional potential new customers.  Management has continued to increase the focus on “power users” of government procurement information and we think this is a good strategy that will eventually find meaningful traction.  Subscription revenues have grown three quarters in a row, since stabilizing starting in Q1 2013.

Well Established in Attractive Markets with Sensible Strategy

Under CEO Hank Riney, the company has established a high value-added proprietary database with a niche position in providing information about government procurement opportunities.  ONVI has focused on content expansion, taxonomy or intelligent searching, data normalization, proprietary data, and decision analytics to try to drive pricing power, customer stickiness, and differentiation.  We believe ONVI is well-positioned to benefit from possible rebound in government spending, as state and local governments are in a better position to pursue projects which have been delayed since the recession.  We think the company has established long-term relationships with clients focused on government procurement opportunities and is building a stronger value proposition with product enhancements and upgrades.  We believe the Company can continue to drive increases in Annual Contract Value per Customer (ACVC) by continued improvements in its value proposition which, ultimately, should drive higher subscription revenues and Adjusted EBITDA. 

We like ONVI’s strategy to focus on higher-value customers in its marketing activities and to enhance the software products and services as a more strategic partner for customers.  We believe this will likely increase the renewal rate of current customers and give ONVI increased pricing power with customers.

Multiple Acquisition Bids for ONVI And Industry Acquisition Multiples Indicate Underlying Value

Symphony Acquisition, a private equity firm focused on investments in software companies, made multiple bids to acquire ONVI over a two-year period.  We think this reflects the underlying value inherent in ONVI’s business model and customer base.  Further, acquisition transactions in ONVI’s industry and of related firms have been completed at 2.5x to 3x revenues, such as Deltek’s acquisition of Input Inc., a market research firm competitor of ONVI, for $60m or 2.5x revenues in September 2010 and Thoma Bravo’s subsequent  acquisition of Deltek in August 2012 for $1.1b or 3x revenues.

Potential for Share Repurchase or Dividends

ONVI has not paid dividends in recent years as management has focused on stabilizing the business model and strengthening the balance sheet.  ONVI repurchased 1.3m shares from Symphony Acquisition or about 20% of total shares outstanding in April 2013 at $3.50 per share. 

Solid Balance Sheet and Expected Build-up in Net Cash Position.

ONVI has a Ft. Knox balance sheet with a net cash position of $8m at 9/30/13 or about 20% of the current market capitalization.  We believe ONVI can generate FCF in 2014 and 2015 as investments to drive higher revenues mature combined with 80%+ gross margins which could drive meaningful incremental Adjusted EBITDA and FCF.  We think ONVI could end 2015 with a net cash position of $13m+ or about 40% of the current market capitalization.  Alternatively, management may use the strong cash position to repurchase shares, pay dividends, or complete accretive niche acquisitions.  We think the potential build up in net cash over 2014 and 2015 will highlight the strong cash generating capabilities of the business model and could attract investor attention

Attractive Upside Potential

OMVI has generated about $3m of LTM cash from operations.  We believe ONVI can grow ACV, revenues, Adjusted EBITDA and FCF in 2014 and 2015.  With gross margins of 80%+, even modest growth in revenues can add meaningfully to Adjusted EBITDA and FCF.  We believe ONVI is making strategic investments in sales and marketing, COGS, and capital expenditures, which have the potential to drive incremental revenues, gross profits, adjusted EBITDA, and FCF.  One key will be the success of the SMB Acquisition program. ONVI has limited capital expenditures and working capital requirements.

We believe ONVI could generate revenues of $26m+ by 2015 and trade for at least 2x revenues plus $12m of net cash by year end 2015 or a market value of $65m or close to $9 per share (+80% from $5 per share today).  This is consistent with where other small software companies have traded or been acquired, especially those with high proportions of recurring subscription revenues like ONVI.

Conclusion and Target Price

Based on 2x revenues estimated for 2015 of $26m+ plus a net cash position of $13m, we believe ONVI could have a market value of about $65m in 2015 or $9 per share (+80% from $5 per share today).  Further, ONVI’s attractive and diversified customer base could prove attractive to a strategic or private equity acquirer (as already evidenced by Symphony Acquisition’s multiple attempts to acquire the Company).