Description

Elevator Pitch

SharpSpring (SHSP) is an owner/operator led digital automated marketing SaaS business.   Management is laser-focused on the underserved marketing agency vertical (currently #2 share and growing) providing a low-cost, sticky customer base with expanding capital-free organic revenue growth as the customer base matures.   A recent infusion of capital via convertible note issuance provides a catalyst for accelerated yet rational growth of new customers at high ROIC. The overall digital automated marketing market is growing 30% per annum and the agency vertical is only 20% adopted, providing strong tailwinds for the business to continue growing at strong rates for the foreseeable future.   

SHSP trades at 6.38 per share with 10.95mm fully diluted shares* and $13.4mm net cash after accounting for the convertible note issuance.   ($69.8mm MC; $56.4mm EV).

Given the current price relative to the attractive economics of the business (7.5x LTV to CAC), continued growth at SharpSpring is adding roughly ~$17-40mm of value per annum (25-58% of the current market cap).  Assuming conservative but continued growth through FY2021 at similar economics, an investment in the common stock is likely to compound at a range of 18-36% per annum through 2021. Multiple expansion alone, based on comparable publicly traded and recent M&A comps, implies 35-73% upside today.  

Please note this idea is likely limited to PA and small funds only given ~$200k daily average trading volume.   

*Diluted shares assumes basic shares outstanding (8.4mm shares) + exercise of all stock options (1.1mm) + exercise of outstanding warrants (80k) + full conversion of the $8mm convertible note (1.3mm).
 

Business Overview
SharpSpring provides a digital marketing automation SaaS solution intended for small and medium-sized businesses.    Digital marketing automation software provides businesses with a streamlined and optimized approach to online marketing (attracting visitors, turning visitors into leads, turning leads into customers, monitoring ROI over customer lifecycle, etc) predominantly through inbound personalized and dynamic marketing capabilities.  Inbound digital marketing automation is predicated on the reality that traditional marketing/sales techniques (cold calling, unsolicited emails, generic ads) are less effective in a world where customers are in control of the purchasing lifecycle, actively searching for products using search engines and social media.

SharpSpring was founded in 2012 by current CEO Rick Carlson and current CTO Travis Whitton.  By way of background, SharpSpring was acquired in Q3 2014 by SMTP, Inc. (ticker 'SMTP'), a legacy email-relay business.   Rick was quickly appointed CEO of the consolidated business in August 2015, changed the name of the consolidated business to SharpSpring (along with changing the ticker to 'SHSP'), and sold off the legacy assets of SMTP in June 2016.   

Rick and Travis check all aspects of our qualitative wish list when assessing management-   passionate owner/operators with a wealth of relevant experience, long runways for continued success (ages 45 and 37, respectively), and financially aligned with shareholders as evidenced by modest salaries relative to their equity ownership in the business (further detail in 'Incentives' section further below).  While tenure as a public CEO has been short, capital allocation to date has been patient yet decisive, with an intelligent capital raise executed in March 2018 at effectively 42% above market prices allowing for acceleration of value creation at meaningful ROIC above capital cost (further detail in 'Lifetime Value / Customer Acquisition Costs' section below).

The following video provides further detail on the value proposition of digital marketing automation and gives some insight into Rick’s thought process: https://www.youtube.com/watch?v=idCTALtNQqk

Industry/Competition
The B2B digital marketing automation industry has exploded over the last decade and is continuing to grow at a 30% clip.    Total revenues for the industry were $325mm in 2011, $1.2bn in 2014, and $3.3bn in 2017.

In the B2B SMB space, SharpSpring primarily competes with HubSpot (public standalone), Pardot (owned by SalesForce), Act-On (private).   Other relevant but less direct competition includes Marketo (private, small and enterprise), ExactTarget (owned by SalesForce, enterprise), and Eloqua (owned by Oracle, enterprise).   

Recent M&A comps as well as a direct public comp (HubSpot) imply significant upside to the valuation of SharpSpring (see 'Valuation' section further below).   

With respect to B2B SMB competition, all competitors are comparable in terms of available features (e.g. CRM, social media integration, SEO optimization, lead scoring, ROI analytics, dynamic landing pages, AdWords integration, etc).   SharpSpring differentiates itself in two primary ways: low pricing points and a concentrated focus on a specific vertical (marketing agencies)

Low Pricing
Analyzing pricing in the industry is complicated by a few situational variables (i.e. various pricing tiers and dynamic pricing due to differences in individual customer needs- e.g. traffic/contacts, # of licenses/users, features required, etc).   SharpSpring claims that, on average, SharpSpring products cost on average ~$200-875 per month versus its competitors which charge anywhere from $2k-$5k per month.

A simple comparison of FY2017 ARPU (GAAP Revenue / Total Platform Users) indicates SharpSpring ARPU of ~$2k versus HubSpot ARPU of $8k.   The gap is likely driven by three factors: 1) SharpSpring offering lower pricing points, 2) HubSpot's significantly higher one-time onboarding fees, and 3) SharpSpring's sole-focus on marketing agency customers.   (It's also worth noting that SharpSpring is one of the only businesses in the space which bills customers monthly- almost all other competitors lock their customers in annually.)

A Differentiated Niche - Marketing Agency Vertical

"By targeting agencies as customers, we've engineered our business model with very large expansion revenue opportunities. The more time an agency spends on the platform, the more clients they end up adding and the more MRR (monthly recurring revenue) we get from that relationship. By building our business around agencies, which is very different than the other players in the marketing automation space, we've created a unique model that shows up in much higher expansion revenue opportunities and much higher lifetime value for these agency customers." - CEO Rick Carlson

This is where things get interesting.  SharpSpring is laser-focused on winning the digital marketing agency vertical.   By becoming partners with its customer (the marketing agency), SharpSpring creates a distribution channel through which the agency maintains complete discretion over pricing of the software to its clients and maintains its role in client relationship management.  This provides SharpSpring with a form of leverage which in many ways mirrors the economics of a franchise business. Three immediate benefits come to mind:

• Provides SharpSpring with capital-free growth as clients mature, effectively reducing average customer acquisition costs
• Outsources the majority of customer service costs to the agency (a win-win as marketing agency is in many ways a client relationship management business), further reducing operating expenses for SharpSpring
• Stickiness - once integrated, the product becomes central to both the marketing agency and the marketing agencies clients business processes.   Marketing agencies will be biased towards offering consistent products across their client base and users of the product will be hesitant to leave a product tied to revenue generation.    This is evident in the LTV figures discussed further below.

SharpSpring charges agencies a fixed fee for each incremental client added by an agency.   As a result of this model, SharpSpring has leveraged its 1,428 marketing agency customers to achieve 6,700+ SharpSpring users.   Management believes that competition is unable to lower prices to SharpSpring's pricing points given the larger install base inherent in selling software directly to end users.   

Management estimates a total addressable market of 50,000 digital marketing agencies in the US alone, of which only 20% utilize digital marketing automation - and they are entirely focused on winning the remaining 80%:

Within 2 years of SharpSpring's official launch (2014) it had become the #2 in the agency vertical.   SharpSpring continues to grow its share of the agency market each year.

Lifetime Value / Customer Acquisition Costs

Although inherently subject to certain forecasting assumptions, the lifetime value (LTV) and customer acquisition costs (CAC) to date are attractive on both an absolute and directional basis.    

Per management as of 17Q4, on a discounted basis after reducing for gross margin costs to support customers on a platform, LTV is ~$50k per new agency ($40k across all customers on a blended basis).   

Of particular interest, management has since increased its mid-2016 estimates of LTV from $20k, which is a function of the stickiness and continued per-user growth experienced as a result of the agency distribution model (and perhaps a rational and conservative management team).   Churn trends downward as customers mature, as switching costs become higher once a marketing platform is integrated into an agencies business model and its clients processes. The below IR slide outlines the economics experienced to date:

Importantly, the average age of the customer base was just over 13 months old as of 17Q2, implying continued organic revenue growth likely to accrete at ~100% margins as existing customers mature.
 

Per management, the company has consistently produced CAC in the range of $6,000 to $7,000 or below as measured on a monthly cohort basis, month-after-month, quarter-after-quarter for more than two years.   CAC for 17Q4 was $6,700.

Taking management's estimates at face, the company is currently operating with a 7.5x LTV to CAC ratio with a payback period of a little over a year.  Even if management was 50% wrong in both directions (e.g., LTV=$20k and CAC=$14k, investment in growth would result in value creation).

Capital Infusion Q1 2018 - $8mm Convertible Note

Management has exercised patience in allowing the LTV/CAC data to mature before meaningfully accelerating an already high rate of growth.  In March 2018, SharpSpring issued an $8mm convertible note to a small fund. SharpSpring spent roughly $6.3mm in sales/marketing expenses between Q4 2016 through Q3 2017 resulting in net growth of ~300 agencies.    Given the continued impressive economics of the business (i.e. 7.5x LTV to CAC), the $8mm will allow for a rational acceleration of marketing spend resulting in meaningful agency growth across FY18 and FY19.

It is worth noting that this fund purchased 519k shares (~6%) of the common stock prior to the convertible note deal.   As a result of both the large common position and the additional $8mm convertible note funding, the CEO of the fund (Daniel Allen) was appointed to SHSP's board, further aligning minority shareholders with management.

The $8mm note accrues interest at a 5% PIK and allows conversion into common equity at $7.50 per share.   For conservatism and simplicity, I am assuming full conversion and resulting dilution of 1.3mm shares.

This deal is a very positive catalyst for SharpSpring, and it highlights the CEO's capital allocation prowess in effectively issuing shares at 42% above market (at the time).    
 

Valuation

Rather than providing false precision, I have considered a few different perspectives in thinking about the current price of the business:

Enterprise Value Growth (ROIC)
The company has disclosed the economics of agency customers for the first 36 months of becoming a client of SHSP.   We have extrapolated these figures out using assumptions which are in all likelihood worse than reality, discounted back to present at a 12% rate.   At SHSP's current growth of 1k customers per annum (gross), the company is adding ~$17mm in enterprise value annually. See below:

Under more reasonable assumptions (in the extrapolated section), incremental value add may be substantial:

True growth in value in 2018 & 2019 is likely even higher given the 2018Q1 $8mm convertible financing which should allow SHSP to accelerate growth and add ~1,000 additional clients.   

Please note that the figures above are general ranges and not intended as exact predictive targets. The takeaway is that the business is priced meaningfully below intrinsic value given current levels of ROIC.

Revenue Multiple Expansion

SHSP currently trades at 4.2x FY17 EV/sales and is growing at a ~25%+ clip.  

Direct SMB B2B comps:

• HubSpot is the primary public SMB B2B digital automated marketing company for which we can comp.   HubSpot trades at 10.4x FY17 sales and 8x FY18 Sales. Sell side has HUBS growing 29% per year. S&M & R&D as a % of revenues are comparable to SHSP.  
• October 2012-  ExactTarget acquired Pardot at 12.9x FY2011 Sales and 8.7x FY2012 Sales for a valuation of $96mm.   

Indirectly, there have been a few M&A deals pertaining to enterprise digital automated marketing platforms (note- Marketo is in both the medium and enterprise markets):

• May 2016-  Marketo (MKTO) was purchased at 7.2x run-rate sales (Q1 2016 annualized) for a $1.8bn valuation.  Marketo was growing sales ~39% per year when acquired.
• June 2013- ExactTarget acquired by Salesforce for 8.6x Sales ($2.5bn valuation) - ExactTarget was growing ~40% at the time.   
• December 2012- Oracle acquired Eloqua at 9.7x TTM revenue - Eloqua was growing ~31% at the time.

These comps give some general perspective of upside via multiple expansion.  The ranges used below are conservative relative to the M&A activity listed above.

Note 1 - assumes acquirer receives cash on balance sheet today including post-convertible note issuance; shares outstanding assumes full conversion of 1.3mm shares from the convertible note

Note 2 - assumes no remaining cash after growth;  shares outstanding assumes full conversion of 1.3mm shares from the convertible note

Longer Term Perspective

Using the disclosed LTV Metrics in the IR Deck excerpted above (Age of customer, Remaining Customers-net of churn, Average Revenue Per remaining customer), I have outlined the assumed revenue profile for FY2021 (see 3rd table below).   This can be read as follows:

• For the 943 agencies added in FY2017, only 39% remain and each contributes ~$15.6k to revenue.
• For the 1400 agencies added in FY2020, only 60% remain and each contributes ~6k to revenue.

Additionally it projects out increases in CAC and resulting increases in total advertising spending for reasonableness.   Revenues in FY2018 will be ~$17mm at a minimum. At ~70% current gross profit margin, $3.3mm of R&D (versus $2.9mm in FY2017) and $5.9 G&A (versus $5.3mm in FY2017), the company should net $9mm to contribute to sales/marketing spend.   With $13mm of cash on hand, the business has more than enough to fund the growth projected in this scenario.

These assumptions are conservative for two reasons:

• Assumes churn at a substantially higher pace than disclosed by management
• Assumes no increases in pricing
• Assumes no revenue from agencies added prior to 2016

For the reasons listed above, $30mm is likely a bare minimum base case.  Aligning $30mm of revenue against comparable revenue multiples per the 'multiple expansion' section above, the FY2021 forecast looks very attractive even at current multiples:

Runoff

Should LTV and CAC drastically shift in a negative direction over the course of the next year, the business is priced at a sufficient margin of safety if managed correctly (some comfort is warranted given managements ownership).

FY2018 Revenues: ~17mm

GM%: ~70%

GM: ~12mm

G&A: ~5mm

S&M and R&D curtailed

Pretax Income: ~7mm

Pretax yield: ~10%

Runoff profitability will only increase as the client base matures and growth continues at profitable rates over the short term.  

Management Incentives

• CEO is an owner/operator who takes a modest salary relative to his equity position-   FY2017 salary of $240k versus $5mm equity ownership (791k shares). I'm hesitant to list out videos as part of the pitch, but here is another interview with the CEO if interested: https://www.youtube.com/watch?v=19EI7IHqYvk
• CFO and CTO (co-founder) similarly have attractive salary:equity ratios.  CFO- FY2017 salary of $185k versus $582k equity ownership (91k shares); CTO-   FY2017 salary of $160k versus $1.6mm equity ownership (251k shares).
• When SharpSpring was acquired in 2014 the consideration was for $5mm with an additional $10mm earnout.   The $10mm earnout (split evenly between the current CEO and current CTO) was structured $6mm cash / $4mm stock across the current CEO and current CTO.   $3mm of the $6mm cash was converted to stock subsequently by both parties, further signaling confidence
• As a result of both the large common position and the additional $8mm convertible note funding, the CEO of the fund providing the capital (Daniel Allen) was appointed to SHSP's board, further aligning minority shareholders with management.   His fund also purchased 519k shares in common equity prior to the convertible deal.

Why does this opportunity exist?

• Illiquid - averages $200k daily average trading volume
• Small - <$100mm market cap.  Not investable for most funds.    
• Off the beaten path-  
• Searching "SHSP" on the SEC edgar filings doesn't work-  likely due to the transition in name/ticker from SMTP to SHSP.   
• Few paying attention - seekingalpha shows only 779 followers.  
• Little analyst coverage (but growing).   17Q2 conference call had 1 analyst on the line.  17Q3 = 2 analysts. 17Q4 = 3 analysts.
• VC Chairman resignation and forced selling-  Previous Chairman Semyon Dukach (venture capitalist) owned 27% of the business.  He resigned on 7/31/2017 and sold basically all of his shares in one day on 11/21/2017.  Semyon is a VC and isn't interested in running a public company- and the timing of his resignation coincided with the announcement that he is creating a new fund: (http://www.wbur.org/bostonomix/2017/07/24/techstars-director-new-vc-fund).  His resignation and subsequent sale of 27% of the company seem removed from anything fundamental to SHSP's business.   

Risks

• Regulatory Risk: Regulators both in the US and EU have expressed concerns w/ respect to tracking of user activity (cookies/web beacons).   "Do Not Track" regulation could reduce the efficacy of SharpSpring's products. This is likely not a concern for a while given the speed at which governments move and legislators actual ability to implement anything tech-related. Regardless, SharpSpring has implemented a "visitor ID" construct for anonymous visits which allows for enhanced tracking (assigns unique identifiers to anonymous visitor IP addresses) which slightly mitigates this risk.
  
  
• Increased competition, particularly in the agency vertical: I'll let the CEO answer this one with his response regarding his views on whether competition has been increasing:   "Not only don't I see it changing in any way to the negative, I see us become stronger and stronger in that space. The last thing I'll point out as kind of a third part to this answer is that we just -- at this point it's hard to conceptualize new entrants coming into our market. We have not seen that happen really at all since the company has been in the market in the last 3.5 years. We still consider HubSpot and Pardot and Act-On and those competitors, the ones that had been here doing this for a decade as our major competitors. But we just don't compete with anybody else really on a daily basis. And the reason for that is the barriers to entry to this market are so incredibly high.    At this point, marketing automation solution includes a pretty complex rules engine that is really, really difficult to build, that has to process billions of discrete transactions in a day across thousands and thousands of companies as you track each page impression from every visitor on these companies -- from these companies websites. You've got to be able to deliver e-mail, you've got to run -- got to be able to track all the stuff and do analytics. You have to have hundreds and hundreds of integrations as we talked about today. So today SharpSpring integrates with literally hundreds of applications. And I could go on and on and on, but it really -- this is not the kind of software platform that you get 20 or 50 developers together and build in a year. It's not that kind of thing. So I know I'm giving a long-winded answer here, but, hopefully, my excitement comes true about where we're positioned in the market and the overall market itself"
  
  
• Drastic shifts in LTV and CAC as growth accelerates-   Of course, this is the primary risk and these metrics should be watched closely as the company matures.   

Catalyst

-Accelerated growth of new customers achieved through the recent convertible note capital infusion

-Maturation of the existing customer base leading to incremental organic revenue at ~100% margins