Small Cap Value Report (Tue 21 Mar 2023) - ABDP, REAT, WYN, STEM, TRST, QXT

Good morning from Paul amp; Graham.

Banking problems are rumbling on, with the latest contagion risk apparently over who owns the bank bonds that are seemingly being potentially wiped out in refinancings/takeovers. That topic is beyond my pay grade, so if any of our banking experts have a view on it, do post a reader comment below. I might reach out to my network of experts and see what they say, so if I pick up anything useful, I’ll pass it on.

Rail strikes – it seems that a settlement has been reached. So I’m wondering if any of the companies (especially in hospitality) which blamed the strikes for poor trading, will now start issuing ahead of expectations updates instead?! To be fair though, it should help the sector at least somewhat, for companies which operate in city centres anyway.  (EDIT: readers are saying in the comments below that the rail strikes are not yet fully resolved, so looks like I jumped the gun here, apologies!)

Explanatory notes -

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Masses of results are out this morning, so we’ll work through as many as we can – we’ll be doing mainly shorter sections today, to cope with the volume -

It’s getting too big, so I’ve had to split this into two. Here’s my remaining to do list, not sure how many of these I’ll manage to cover today -

Share price: 88p (-5%)

Market cap: £370m (=$454m)

I will again refer readers back to our September 2022 SCVR where I laid out an investment thesis for this stock.

Time for an update this morning as the company has issued full-year results for 2022. This statement does include a revenue warning for the current year.

Financial highlights for 2022:

• Revenue +23% at constant currency to $149m (very important to note that Trustpilot reports in US dollars, although 40% of revenues are from the UK)

• Annual recurring revenue +20% at constant currency to $162m

• Loss for the year $15m (2021: loss of $26m)

• Year-end net cash $73.5m (2021: $93.2m)

I was curious to see the H1/H2 split of losses and cash burn, so I’ve had a quick look back at the most recent interim results.

In H1 of this year, the company suffered a loss of $9m. This implies that the loss in H2 was only $6m.

Additionally, the net cash position had already fallen to $73m by the end of H1. So there was no further deterioration in cash in H2.

Therefore, H2 looks like a significant improvement over H1.

For what it’s worth, Trustpilot’s founder-CEO confirms that the company achieved positive adjusted EBITDA in H2 (versus a loss of $5m in H1).

Let’s move on to the strategic highlights:

• 46 million new reviews added, bringing the total to 213 million

• Active domains rose from 84k to 100k

• 11% increase in annual views of the “Trustbox” (the Trustpilot logo showing a company’s Trustpilot score) to over 100 billion.

• Fewer fake reviews needed to be removed due to additional measures implemented in 2022.

All of this sounds good to me.

Current trading and outlook

As our business expands, we are expecting to move to adjusted EBITDA profitability and positive adjusted free cash flow in FY23. Our focus on sustainable growth, plus the impact of the investments we have made, give the Board the confidence that the business will deliver margin expansion in FY23, and it remains confident of the significant and growing long-term market opportunity.

As with one or two other companies I’ve covered recently, bottom-line profitability is still some distance away here. Positive adjusted EBITDA and “adjusted free cash flow” are not the same thing as profitability, although they may sometimes be treated as substitutes for the real thing.

In my previous coverage of this stock, I’ve acknowledged the ongoing losses here. But my suggestion has been that the enormous cash pile provides a long runway for profitability to be achieved.

Unfortunately, we also get a revenue warning in today’s outlook statement:

In the current year, we have felt the effects of the uncertain macro environment on new business and retention bookings in Q1, which will result in lower revenues from in-period bookings in FY23, and consequently we are more cautious in our outlook and expect a mid-teens percentage constant currency revenue growth rate in the current year, albeit with greater operating leverage and higher adjusted EBITDA than previously expected.

This sounds strikingly similar to what happened with the expectations for 2022. Trustpilot’s revenues didn’t quite hit expectations, but they “actively managed our business” to control costs and boost their profitability. So 2023 is shaping up to be similar.

International performance

In the UK, Trustpilot enjoys “highly attractive unit economics”, because it is here that (in Trustpilot’s words) “the viral network effort has taken hold”.

The question is whether Trustpilot can turn this into long-term international success.

Revenue growth in North America was only 10% for 2022, but it was a much more interesting 28% in the “Europe and Rest of World” segment. I thought this piece of commentary was worth mentioning here:

Whilst we do not need to invest in marketing in order to enter and grow within markets, during the year we chose the Italian market to test the potential for marketing as a means of accelerating our growth and have seen promising early results.

The campaign significantly increased Italian consumer’s awareness of Trustpilot, rising from 18 per cent to 25 per cent at the end of November – and 28 per cent amongst the business audience. We look forward to tracking the longer-term benefits to our brand in Italy.

Management plan – in a separate RNS, we learn that the founder-CEO “wishes to transition into the role of founder and non-executive director where he will be an evangelist and brand ambassador”. The Board will look for a new CEO and an “orderly handover” will be arranged.

My view

Overall, there is slightly more bad than good in today’s update. The revenue warning perhaps shouldn’t come as a huge surprise, and the news on profitability offers some consolation. But it would be more satisfying to see the company’s profits improving through revenue growth rather than through cost management.

The news regarding the founder-CEO also requires some pause for thought. Is he looking to gradually move on from the business so that he can spend more time doing other things? Or is he simply looking for someone else to do the dirty work of day-to-day management, while he continues to work hard for the company’s big-picture success? I hope it is more of the latter than the former.

Valuation is also clearly still in the speculative end of the spectrum. But if I check the price/sales metric (using ARR for sales), I get a Price/Sales ratio of 2.8x. This is not expensive relative to what high-flying tech companies with quality earnings streams can achieve.

If I deduct the cash balance from the market cap to get Enterprise Value/sales, using the same method, I get a ratio of 2.3x. Again, this is not expensive for high-quality recurring subscription revenues.

Therefore, I’m going to continue to give the share the thumbs up. It’s much riskier than the companies I usually like, but I think it’s a genuinely unique business.

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