Description

We believe Shotspotter is an attractive investment opportunity today with a 16% IRR over the next 4 years. In addition, as SSTI is a “story” stock with a subscription/recurring revenue angle, we believe that valuation multiples can sustain a strong rerating as momentum returns to the name (like the wild run Cardlytics has had over the past year!)

Shotspotter is an acoustics technology company. The company’s primary product is Shotpotter Flex, a product that uses acoustic sensors to triangulate gunshots within urban environments. There are generally 15-25 sensors deployed per square mile. When a gunshot is detected, the acoustic “fingerprint” is picked up by the closest sensors and pinpointed to within 5-10 meters of the actual gunfire. These sounds are analyzed by software (machine learning that classifies the sounds - i.e. whipping of a branch in the wind vs pistol shot), and then verified by an acoustic expert that sits at a centralized Incident Review Center. Once the gunshot is classified this way (multiple shooters, high capacity weapon, etc.), an alert is sent through the SSTI app to law enforcement around that area. This process typically takes 30-45 seconds.

80% of gunshots in the U.S. are unreported. Shotspotter automates gunshot detection and allows law enforcement to respond to crime scenes rapidly. Furthermore, it allows officers to police proactively and generate community goodwill (civilians like having PD show up after a gunshot in a few minutes - in some neighborhoods police never show up as civilians have given up on reporting incidents):

We believe SSTI is an attractive investment due to:

• After a phenomenal performance off the back of some large expansions (i.e. Chicago), SSTI struggled in 2019 as expectations were high and the company experienced multiple delays in deployment. With the stock down ~50% from highs, we think rebased expectations should allow the story to run in 2020

• We think barriers to entry are high, as SSTI benefits from a completely dominant position with over 100 successful deployments (~5-10x competitors), and benefits from “police chief capture.” Police chiefs often share success stories with one another, making them strong promoters and champions for SSTI. Furthermore, SSTI often hires former chiefs to strengthen their relationships with local departments and increase go to market sales success. NPS score of 53, with new customers having higher scores

• The company has a strong recurring revenue base with predictable economics. Shotspotter charges roughly $70,000 per square mile on an annual basis, with contracts ranging from 1-5 years (generally with a 3 mile coverage minimum). Churn is relatively low (roughly 3%, which includes a large 8.5% year due to Hurricane Maria that wiped out Puerto Rico. SSTI has since re-won the contract and will be redeploying in 2020).

• The company has incredibly high contribution margins. Gross margins have improved from ~30% in 2015 to ~60% in 2019, while EBITDA margins have gone from -27% to 22% in 2019. We believe incremental operating margins will approach ~65% in 2019. The company is profitable today and we believe the company can scale margins to 30%+ without any “SaaS hand wavy exit margin assumptions”

The Market:

In the US, there are ~40,000 gun related incidents a year, of which ~37% are homicides (CDC). This comes out to roughly 12.2 gun deaths per 100,000 a year, or ~4.5 homicides per 100,000. While the U.S. has undoubtedly seen a decline in gun violence per capita over the long run, the directionality has reversed recently. “Since 1999, the number of gun deaths held steady year after year — at 10.4 firearm fatalities per 100,000 people” This started ticking up in 2015 (11.8), and is now most recently at 12.2. According to Giffords, gun homicides have increased 30% from 2014 to 2017. The prevalence of gun safety as a policy debate, coupled with the recent reversal in violent gun crimes positions SSTI favorably for continued city penetration.

A big point of debate around SSTI is the company’s addressable market. In its most recent investor day, SSTI estimates that the domestic market is $550m+ (1,400 cities at roughly ~6 square miles of coverage each), the international market is $200 million (200 cities at 6-7 miles), and there’s another $325 million in campus security and other products. 

We think these numbers are likely overstated, but we believe SSTI is a viable investment even if the addressable market is a fraction of the company’s stated TAM. As SSTI captures an overwhelming majority of the market, a smaller TAM (say $275 million instead of $1.1 billion) implies a significantly more “niche-y” market that is more likely to deter potential competitors who would have to spend significant amounts on product development, field tests, and go-to-market (and hence solidify SSTI as the only viable solution). 

Using census tract data, if we define a deployable miles as 1) tracts where homicide rates are 10% above national average - >5/100,000, and 2) population density of >250 (slightly below the average density of MSAs in the US, and vs. US average of 87), we come up with roughly ~2,100 miles addressable for SSTI (much less than 8,000, but also 3x higher than SSTI’s current 720 miles). If we flex the homicide rate down to average and bring the population density down to 200, our addressable miles exceed 3,000.

We don’t have a strong view internationally, but gun violence rates in many latin american countries are 3-4x higher than the US. SSTI is targeting $15 million in international revenues in the medium term (15 cities). Even if the addressable market isn’t $200 million, we think targeting 15 cities is not an unreasonable goal. There are 14 cities with much higher homicide rates globally before we hit the first US city (St Louis at 61/100,000). LATAM is 9% of the world's population but represent 40% of all murders

In aggregate, we think we can model out an attractive IRR under the assumption of a much smaller TAM than $1.1 billion. Assuming 15 international cities at $15 million, $5-10 million of Missions/safari/campus, we only need $75 million of domestic miles to hit $100 million of revenue in 5 years. This nets out to 1,070 miles (vs. 720 miles today).

Competition

There are a couple competitors, though most police chiefs weren’t familiar with an alternative to SSTI. Safety Dynamics offers an audio/video sensor called SENTRI systems. It is deployed in fewer than 10 cities (despite being around for 20 years) and has a history of losing customers to Shotspotter. Wi-fiber is a smart city solution which recently displaced SSTI in Canton Ohio (August 2019), but otherwise has <20 cities, none of which are tier 1 or tier 2 (hence, no evidence of scalability). It appears a large reason for the Canton displacement was due to price ($60,000/year vs $150,000) and mobility. However, the city plans to hire a civilian crime analyst to help monitor the system - given that, the apples to apples cost savings is probably lower than reported. Most of SSTI’s competitors use proximity sensors, which are low cost, but have limited coverage with high false positive rates. In addition, while SSTI is gun-focused, Wi-fiber is predominantly a wireless smart lighting system, which tacked on acoustics secondarily (https://www.youtube.com/watch?v=eJoUz4zWrWs). 

Overall we think Shotspotter’s technology is much better than competitors with significantly more efficacy literature, proven deployments, and local champions. We think it’s important to note that a competitive barrier exists in relationship formation. Many officers/chiefs from ATF (Alcohol Tobacco Firearms) rotate through the doors into SSTI, creating stronger relationships to win department contracts (SSTI hires former chiefs of police that are well regarded as forward thinkers, a practice highlighted by multiple experts). 44 agencies agreed to serve as references.

While not super kosher, if we use Google trends analysis, we see that Shotspotter has gained roughly +125% interest from 2015/16 to today. Meanwhile, there aren't enough search results for “Safety Dynamics SENTRI”. “Safety Dynamics” itself shows up as optional health service location based in NYC, and “SENTRI” takes you to the department of homeland security. “Wi fiber” results also come up only in Utah (it’s a cable provider down there). 

Effectiveness

In the beginning SSTI was really ineffective/inaccurate as the model wasn’t a subscription model. SSTI sold the equipment and software, but customers set them up themselves, which often times was haphazard and not well maintained. Since the transition to a lease/subscription model where SSTI is responsible for deployment, it seems accuracy and satisfaction have improved substantially (based on expert commentary). In addition, as the company generates more and more noise data, it is utilizing machine learning to improve sensitivity of the sensors and reduce false positives (per investor day: ShotSpotter asset 20+ years of gunfire and non-gunfire acoustic events used as training data set)

Shotspotter has a plethora of customer results in its investor day (pages 20+) including stats such as:

• 26% decrease in violent crimes in Las Vegas
• 66% decrease in gunfire incidents in Oakland
• 40% reduction in Englewood shootings in Chicago
• 48% reduction in shooting victims in Cincinnati
• 81% agree/strongly agree that SSTI improves police-community relations
• 69% agree/strongly agree that SSTI acts as a gun violence deterren
• 95%+ agree/strongly agree that SSTI accurately detects and identifies gunshot locations
• etc etc

In addition, we believe experts/police chiefs typically have a positive view of the system:Initially, Shotspotter wasn’t super accurate but over time, data cleaning has improved and accuracy rates are 80-85%, which is “excellent”

• It is very precise, but the big question is how much area do we want covered. Do we want coverage or more officers?
• Secondarily, can help police officers find shell casings that are “fingerprints” for guns so they can trace incidents with the same weapon over time
• Ties into police camera systems so cameras / CCTVs can pivot to the shot location / integration causes more stickiness
• we increased coverage of SSTI over 3x
• Helps improve community sentiment as police officers can respond to the 80% of shots that are fired and not reported, and check up on civilians in the community proactively
• Police chiefs typically call each other to ask about the system, in a very much referral type culture
• Most have heard of a competitor but very few can identify the name
• Market is locked down tight; took 20 years to get here; only takes one bad experience with high false positives for skepticism to spread (for newcomers)
• Believe can be a standard in American cities
• Customer churn generally happens when grants were one off/experimental and there wasn’t real buy in into the solution
• They are moving into public safety in general 

Valuation

• Starting with 720 miles in 2019, we assume SSTI adds roughly 100-110 miles a year on average to ~1,250 miles in 2024
• We assume prices increase to $76k/mile as contracts roll over to the new rate (70k). We think there’s room for another price hike in the next 5 years, but assume that this is a mix of 90% domestic and 10% international (which has 2x the rate)
• ~$10 million of Missions, Safari, Campus, + other potential revenues
• We have gross margins improving from 59% to 69% with 75% incremental gross (vs. 78%, 68%, and 70% last 3 years)
• We model incremental operating margins of ~55%; with sales as 13.4% of revenues, R&D at 9.3%, and G&A at 10.5% of revenues at maturity (Falls in line with company’s long term guidance)
• Exiting at a 16x EBIT (or 20x non-cash P/E)
• 15-16% IRR over 4 years
• We think this is a reasonable case, and if SSTI figures out a way to make coverage more affordable to open up the TAM to the actual ~8,000 miles it states, there can be substantial upside to our modelling

Catalyst

new city wins, particularly internationally. Bookings growth!