Good afternoon, Today we have a guest post by SecretCaps member  Philippe Bergeron-Bélanger and Matthew D'addario. SecretCaps has had Ackroo featured in our watchlist for members several weeks ago. 

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Market price: 0.405$

Shares outstanding / fully diluted: 15.3M / 24.3M

Summary

• Clear path to profitability in 2015 and new solid business strategy which new management has already executed on and continues to do so.
• Quality high growth business with favorable economics: 50+% yearly sales growth, 70% gross margins and 50% EBIT margin after breakeven.
• Undervalued and trading at a steep discount to comps based on EV/2015 Sales.
• Positioned in a sweet spot in the market with a focus on SMB, scarce competition and high barrier to entry.
• Potential multi-bagger in the next 2-3 years.

Overview of the company

Ackroo Inc. (“Ackroo”) is a low cost provider of gift card and loyalty solutions for small and medium sized businesses. It benefits from proprietary cloud-based software which integrates directly on the merchant’s PoS system. In contrast, the traditional providers require the use of additional hardware at each of the merchant’s locations to deliver their solutions which results in steep upfront costs for the customer and one-time revenue for the providers.

Business model

The company offers either its gift card solutions alone or a bundle of the gift card and loyalty solutions, and charges the customer on a monthly and per location basis. This first offer ranges from $20 to $50, and the latter from $99 to $250. Additionally, they charge a one-time setup fee just above 1,000$ per location and make money from the periodic reordering of gift cards. The standard contract period is thirty-six months.

Before a change in management in May 2014, the company would solely pursue growth through direct sales which proved to be a flawed strategy. The first 12 months of a direct sale resulted in a loss for the company due to the cost of customer acquisition. However, the company transitioned to pursuing growth through resellers and referral partners, and strategic acquisitions. Under this strategy, sales become profitable from day one as there are no customer acquisition costs. Ackroo gives up 50% of the monthly recurring revenue to resellers, and only 10% of the one-time setup fee with referral partners. Resellers are responsible for providing the sales and training support, leaving Ackroo with responsibility of providing Tier-3 support.

The three current resellers are Everlink Payment Services, Kubera Payments and West Technology Group. As for the referral partners, they are Chase Paymentech and Global Payments. Both are well incentivized to push Ackroo’s services because it helps them retain customers longer and differentiate themselves in an industry suffering from a high customer turnover rate. With acquisitions, Ackroo is looking to either broaden its core product offering or acquire new merchant locations or a mix of both. The acquisitions will mostly be small cash deals. In the case of a larger acquisition, there could be a royalty added to the deal structure. Management absolutely does not want to dilute shareholders.

Economics of the business

The most important metrics to consider are the number of locations and the revenue per location. The locations are the main drivers of revenue, and they also come before revenue does due to lead times for implementing the services. Leads times are around 30 days for small sized merchants (10 or fewer locations) and anywhere from 3-9 months for medium sized merchants (10 to 100 locations). The revenue per location will also come into play as the company looks to broaden its core product offering to extract incremental revenue from its locations. Based on available data, the location growth has been as follows:

• Q2 13 400 locations
• Q4 13 600 locations
• Q1 14 650 locations
• Q3 14 800 locations
• Q4 14 ~900 locations
• Q1 15 ~1600 locations (500 locations from PhotoGIFTCARD acquisition)

According to the last investors deck dated February 2015, the figure for the average monthly recurring revenue (MRR) per location is $71 which reflects the current product mix split of 70% gift card and 30% loyalty. The company plans to get this split to 50-50 which would significantly boost the average MRR per location. Another figure of interest is the average annual OTR revenue per location. That number is $271, and encompasses the regular reordering of gift cards and consulting services.

The company is targeting a 50+% annual sales growth and 75+% annual locations growth, which given their past growth, is easily achievable in my opinion. To realize this growth with their new business model, they will be signing on 1-2 resellers per quarter and further developing their referral partner relationships. The annual revenue growth of 5% in 2014 is misleading because of the change in business strategy. First, the company saw a 37% YoY total transaction growth and 29% location YoY growth in 2014 which shows that the growth is there. Secondly, it’s important to realize that the company only records the net revenue from a sale (revenue net of commissions), thus temporarily skewing the growth rate during the transition period. Thirdly, most of the sales team was laid off in 2014 and the resellers which were signed on later in the year will only start contributing to revenue in Q2 2015. This implies that the revenue growth in 2014 was strictly driven by referral partners and direct sales. It takes about 6 months to fully integrate and train the resellers. Management believes it can reduce the integration time to 3 months as they are becoming more familiar with the process.

Fiscal Year	Revenue	+/- %
2012	$681,142	N/A
2013	$1,284,016	+89%
2014 (unaudited)	$1,353,537	+5%
2015E (conservative)	$2,100,000	+55%
2016E (conservative)	$3,000,000	+43%
2017E (conservative)	$5,000,000	+67%

The projected revenue for 2015 is 2.1M$ to 3.0M$. For 2016 and 2017, the projections are 3-5M$ and 5-10M$ respectively. With a breakeven cost of $2.2-2.3M ($2.1M prior to the acquisition of PhotoGIFTCARD), the company is expected to reach breakeven this year in the most conservative forecast. It’s also very possible they do to $0.01-0.05 in EPS. Under the new business model, the cost structure after reaching breakeven is 70% gross margins and 20% operating costs which equates to a 50% EBIT margin. The company has a 91% customer retention rate which is a testament to the quality of their solutions offering.

Fiscal Year	Losses	+/- %
2012	$5,424,872	N/A
2013	$3,882,411	-28%
2014 (projected)	$2,300,000	-41%
2015 (projected)	$0	-100%

PhotoGIFTCARD acquisition

This most recent acquisition demonstrates management’s capability to make worthwhile deals. PhotoGIFTCARD’s business was personalized gift cards and it serviced 500 locations. For an undisclosed small cash sum, Ackroo gained 500 locations that it will upsell its services to and added a complimentary service to its pipeline. The upselling of Ackroo’s services to these acquired locations will mostly happen in 2016 because of leads times and the necessary 3 month period to assimilate the acquisition in the company’s platform. If all these locations are upsold, it can generate over 500k in recurring revenue per year.

Market potential and competitive landscape

By primarily targeting small and medium sized businesses, the company has positioned itself in a sweet spot in the market. There is scarce competition to begin with and the market is just simply enormous. Every retailer with 100 locations or less is a potential customer and Ackroo is happy to take on the larger retailers as well. Current referral partners represent over 200,000 locations and Global Payments alone has 100,000 of them in Canada, which is indicative of the huge market potential. More importantly, Ackroo is only one of three companies that Chase lets integrate into their PoS system. That is a significant barrier to entry for competitors. Furthermore, the company plans to enter the US market towards the end of the year by bringing on a US based reseller.

Their biggest competitor is Givex, a company that does $100M in annual sales. Both have comparable pricing; however Givex has a higher minimum commitment because it’s looking to attract larger businesses. It has but no choice to leave the smaller retailers to Ackroo or the scarce competitors in the space. Additionally, Givex has already opened the market for small mom and pop shops, making customer education easier. Nevertheless, “paper” (paper certificate for gift cards or loyalty punch cards) still remains a sizeable competitor as many smaller businesses still use them. Ackroo converts a lot of clients from paper to plastic and will continue needing to do so. Their largest opportunity to capitalize on “paper” to plastic conversion is in the Caribbean with their reseller West Technology Group. With a population of 40 million people that is way behind in the technology adoption curve, they will get the first-mover advantage by selling their solutions as retailers are making the switch to PoS systems.

As previously mentioned, another way the company will grow its merchant base and services offering is through acquisitions. The landscape is filled with small companies that have key merchant locations or complimentary product offering, but are generating little revenue like PhotoGIFTCARD. Ackroo should be acquiring a few of these in the future.

Management

The CEO, Steve Levely, has done a terrific job of conceiving and executing the new business plan in the short amount of time since he’s been leading the company. Since May 2014, he’s fixed the cost structure, signed on three resellers, signed one partnership agreement, updated the product offering, and completed a strategic acquisition. Fixing the cost structure was no easy feat considering the prior bloated structure. Based on his performance to date, I feel confident in his ability to bring the company to profitability and take advantage of the huge growth opportunity in front of Ackroo.

Despite insiders only owning 10% of the shares outstanding, their interests remain well aligned with those of shareholders. The CEO is relatively young so he’s not in the same financial situation as his older counterparts. Furthermore, he’s had to buy out the old management’s and directors’ shares and options at higher prices, demonstrating his conviction in the business. Most of shares were acquired at a price of $0.50-1.00. More importantly, the CEO is extremely sensitive to diluting shareholders and has no intentions of doing so.

Valuation

Using an adjusted 24.298M shares fully diluted (excludes the 0.50$ options plus the warrants at 1$ and 7$ that will expire later in the year), we see the stock is trading at 4x EV/2015 sales. The valuation gap is huge when looking at comps. The nearest comp alone trades at a multiple of 13x or three times Ackroo’s current multiple. As management continues executing, not only will the intrinsic value rise, but I also believe the gap will close, resulting in a multi-bagger from the current stock price.

Comparables (as of Feb 4, 2015)	Est Rev	Current Mkt Cap	EV/Rev
Ackroo (AKR)	$2.1M	$8M	4x
3 Tier Logic Technologies (TTM)	$2M	$26M	13x
Spindle Payments (SPDL)	$1M	$24M	24x
Slyce (SLC)	$3M	$77M	25x
Snipp Interactive (SNP)	$1.5M	$54M	36x

Risks

• Competitors become more aggressive in the SMB marketplace and steal market shares or opportunities from Ackroo.
• Resellers own the relationship with the merchants. Poor service could lead to a decrease in the customer retention rate.
• Conversion of acquired clients and integration time of new clients/referral partners/resellers take longer than expected, which would slow growth and impact the valuation multiple of Ackroo.
• Company doesn’t achieve the growth they modeled out for resellers and referral partners.

Conclusion

Despite having a quality product offering, wonderful business economics, a sweet spot in the market, and more, the company’s previous go-to-market plan was not the right one which emphasizes the importance of having a quality management team. With the right management in place now, I’m confident the company will become a big success. In my opinion, the stock is still inexpensive based on relative value to comps and intrinsic value, and could become a 10-bagger in the next 2-3 years.

Disclosure: Matthew and Philippe have taken part in the last private placement and have bought additional shares on the public market. Aaron also own a position.

SecretCaps does not currently have a position in Ackroo. By reading this post you agree to SecretCaps full disclosure. This post is not investment advice and is strictly informational. Do not trade based upon the content in this post and always contact a financial professional before executing any trades.

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