Intellicheck (IDN,NDQ) - an unnoticed treasure

Intellicheck (ticker: IDN)

Investment case

IDN is a company that specializes in software to verify identification documents. They use their relationship with regulators to have access to an encrypted code behind identification documents. Through this process the company reaches the highest efficacy rate in the industry. Access to the encrypted code also gives IDN a cost advantage in comparison to competitors. Previously, the company mainly marketed this service to government bodies. However, since a couple of years IDN has begun to provide their services to financial institutions. The excellent efficacy rate of IDN’s identification document verification provides financial institutions with a higher fraud detection rate than other verification services and thereby adds value for these financial institutions through higher loss savings in credit applications. The company is still relatively unknown but has high profit margins and has many opportunities for considerable growth . Due to IDN’s competitive advantages we expect the company to have a long runway of growth. Due to these factors we do think that the company is undervalued and we expect an annual return of around 25% year over year in the coming five years.

Business overview

Intellicheck (IDN) is a United States (US) based software company, founded in 1994 and specializing in identity verification. The company has a market cap of around 165 million USD. Due to IDN’s long term relationship with the AAMVA (American Association of Motor Vehicle Administrators) their main focus was originally the verification of identification documents at governmental bodies in the US. Sincea couple of years, IDN has started marketing its products to service retailers and financial institutions. Their specific area of expertise is preventing identity theft in these industries.

The product

US identification documents/ ID-cards have barcodes that can be scanned to prove the validity and authenticity of the document. IDN uses apps that scan the barcode to verify that the document is valid and authentic. Furthermore, the encoded text behind the barcode is checked next to other security features. These features cannot be faked and are therefore a reliable form of authentication. After scanning the barcode, the person presenting the document is matched to the identification document by making a selfie. The selfie is then cross-referenced in a database to verify the identity of the person presenting the identification document. For this identification process no special or extra hardware is needed. Customers only have to purchase and download the software provided by IDN. Barcodes can be scanned in stores with ordinary scan machines and the Intellicheck-app can be used to do a facial biometric scan.

(Source: website Intellicheck)

Identity theft

Identity theft is a common problem in the US. The identities of 14.4 million US citizens were stolen in 2019 alone. These stolen identity data is sold on the dark web for a surprisingly low price. For instance, social security numbers can be bought for one dollar and a stolen driver’s license only costs 20 dollar.

These stolen identities are used to open bank accounts, use credit card data, apply for loans and to commit other types of fraud. In 2018 stolen bank accounts alone caused a $3.6 billion loss to the financial industry in the US. Victims need on average 300 hours to clear their name and credit report. These types of fraud regularly result in retailers being blamed by victims and therefor cause these retail businesses to lose customers. The costs per fraud case ranges from 2100 to 3500 dollars. Given these numbers it is clear IDN provides a valuable service in preventing identity fraud through identity document verification.

Cost savings

The efficacy rate is the rate with what certainty one can conclude if an ID is valid.In 2020 retailers in the US lost 103 billion USD through fraudulent transactions involving stolen credit card information. In these transactions, identity thieves use a fake ID-card and the last digits of a stolen credit card number to make payments. Taking into account the average costs per identity theft at retailers of 2800 USD, there were around 36.8 million transactions of these ‘’card not present’’ frauds. With a card not present situation, a physical credit card is not present at a transaction. In comparison, IDN charges 0.20 to 0.30 USD per scanned identification document. For this price IDN provides an identification verification system that has been shown in tests to reach an impressive efficacy rate of over 99%. With such an efficacy rate, one can imagine the amount of fraudulent transactions retailers can prevent and the cost savings retailers can achieve with the services of IDN.

Turnaround

Since Bryan Lewis took over the business as CEO in 2018, the company has adjusted their business model from being government focused to being more focused on the private sector. Lewis changed the focus of Intellicheck from governmental bodies to financial institutions as targeted customers. Furthermore, before Lewis took over, IDN charged customers a set monthly fee for the services provided by IDN. Now, customers of IDN pay per scan. IDNs services provide added value to financial institutions because every one of IDN’s scans can the chance of fraud and lowers the risk of the related costs. More scans means more detected frauds and thus more prevented losses. The fees charged by IDN per scan become lower when volumes are higher. So, financial institutions are incentivized to bring on more retailers since more scans means lower incremental costs and saves more costs.

Industry overview

The identification verification industry is very fragmented with multiple players being active in the market. Players with similar services as IDN are Jumio, Mitek, IDmission, Onfido and Trulioo. Since identification verification is needed in multiple industries, the companies are divided over these different industries. Of these different industries IDN is mainly focused on financial institutions Of the aforementioned companies, Mitek is the only public company comparable to IDN, with around 700 mln USD market cap. However, only about a third of Mitek’s revenue is generated with identification verification. Half of its revenue comes from Mobile Deposit, where they deliver technology to scan hardcopy checks to deposit them on bank accounts.

The main difference between IDN and its competitors is the technique IDN uses to verify identifications. Where IDN uses the encrypted code behind the barcode for verification, competitors use artificial intelligence to reverse engineer this encrypted code. Reverse engineering the code costs time and money therefore IDN having direct access to this code provides IDN with a competitive advantage.

Other ways in which IDN stands out are pricing and efficacy rates. As mentioned before IDN has shown in tests its identification verification system has an impressive 99% efficacy rate. In short meaning IDN’s system can filter out 99% of fraudulent transactions/ fraudulent or stolen identification documents. Even though competitors claim they have similarly high efficacy rates, IDN is the only player in the industry who can actually check the efficacy of its systems. The reason for this is that due to the relationship with the AAMVA, IDN can check its scans with real identifications issued by the AAMVA. Competitors do not have this privilege. Furthermore, where IDN charges 0.20 to 0.30 USD per scans, competitors like Jumio charge 3 USD per scan and decrease this price with higher volumes. In addition competitors charge their customers a flat rate fee per year. Furthermore, IDmission’s costs are $0.25 for document verification to $1 for liveness + document verification.

Competitive advantages

IDN has a long term relationship with AAMVA for over 21 years. IDN does the ID verification of military bases and secured government facilities. Through this relationship IDN has acquired the exclusive right to test barcodes of new driver’s license formats before release for the DMV (Department of Motor Vehicles). Due to their relationship with the AAMVA, IDN has access to the encyrpted code behind the barcode on IDs. The barcode on IDs cannot be faked because of the several features on the document. The features of IDs and barcodes are updated periodically.

Other companies do not have the encrypted code behind the barcode and therefore need to reverse engineer the code. Competitors use ‘’templating’’ to detect identification fraud. With templating, AI is used to look for specific security features in IDs and thereby scanning for fraud in these documents. These companies need experts and a lot of research to obtain high efficacy rates. IDN does not need to make these investments, creating a cost advantage.

It takes time and money to reverse engineer the code. Also, because IDN has the code, they have a proven efficacy rate of over 99%. IDN has a cost advantage that works in two ways. Having access to the encrypted code makes that IDN does not have to make investments to reverse engineer the encrypted code and causes IDN to be able to set a low price for its customers. At the same time, IDN is the only company on the market that has a high proven efficacy rate that is most likely higher than competitors’ efficacy rates due to multiple previously stated factors such as the periodical updates of IDs. The services provided by IDN therefore help customers to detect more fraud and thus save more costs than the services provided by competitors.

Financials

IDN has raised capital through new issued shares in 2020, causing a cash position two times greater than its total liabilities. The company has raised this capital both as a buffer for COVID-19 related financial headwinds and to invest in the growth, mainly through an increase in the company’s salesforce. Of course the issuing of new shares has diluted the total share capital, and thus decreasing potential earnings per share. However, because IDN has a healthy balance and is expected to turn and stay in profit in the coming years, we do not expect further dilution of the share capital through any further issuing of equity..

The leverage position of IDN is quite small with debt below 20% of its total capital before the share issue. Due to the company’s large cash position, IDN has a negative net debt position. This effectively means that even if the company faces financial headwinds or does not manage to book positive results, that the company has a sizeable financial safety net to absorb even multiple operating losses.

Management and ownership

CEO Bryan Lewis has been active at Intellicheck since 2018. Before IDN, Lewis had a career in sales, private equity and other investment related companies. Under his management the company is expected to generate an operational profit for the first time in over five years . Lewis had the vision to change the focus from predominantly governmental bodies to financial institutions. He saw the potential that financial institutions can make in fraud cost savings with the high efficacy rated identification verification services of IDN. This new strategy has been a turnaround for the company.

Lewis bought shares in the company in 2021 and currently has 0.9% ownership. The shares were given to him via compensation in options. The exercise of this option shows that Lewis has confidence in the company.

Recently, the company has hired a new President, Garrett Gafke. Gafke has held multiple C-level positions in the identification verification industry. In these roles he was mostly focused on business development. Experience we think is very useful in the expansion plans of Intellicheck. Gafke invested private capital in the last couple of months.

Growth potential

Research of Markets and Markets shows that the ID verification market generates a revenue of 7.6Bn USD in 2020 and will expand to 15.8Bn USD in 2025, a CAGR of 15.6%. This shows how big market opportunities are for IDN. As mentioned, IDN has changed its target customers and business model. In recent years, they acquired 4 of the top 10 US banks as customers. However, due to non-disclosure agreements, the names of these banks are not public.

At the moment, 15% of these banks’ customers apply IDNs services. Due to advantages of IDNs services and the easy integration of these services, a rapid growth of this penetration rate is to be expected. IDN could even enter other markets where the application of IDNs services adds value.

(Source: presentation Mitek) 

Valuation

As we have shown earlier, the IDN has a the opportunity for impressive growth. IDN has 4 of the top 10 US banks as customers which have 15% of their clients using IDNs services. The competitive advantages of IDNs services could give way for opportunities in other markets as well.

Revenue has grown with 30% CAGR in the last four years. This growth accelerated the last couple of years due to the strategy change. The company is now increasing its customer base by implementing more retail customers of its financial institution clients, and signing up other financial institutions and other companies. Currently, IDN has the lowest price but highest efficacy rate. Management has already forecasted in its earnings call of the first quarter 2021 that it will increase prices in the coming years because of the pricing power IDN has in the identity verification market. We expect that this will become visible in the company financials in the coming years because IDN will increase its prices at contract renewals and the implementation of new clients.

The company has made operational losses in the last few years. However, even though operating expenses were stable, revenue is increasing and the gross margin is expected to be stable near 85%. The incremental profits are high due to the ease of adding customers. Clearly, astheir revenues grow IDN will enjoy operational leverage and see a significant increase in its operational profits.

The expected growth of revenue is dependent on how fast the company will sign up new customers and implement retailers. The company’s operating expenses (Opex) hinge predominantly on the personnel costs, stock compensation, other incentive plans and R&D. One can expect that the incentive plans are based on targets that will add value to the company’s operating profits. The plans are set up to acquire and implement more customers. Therefore, we forecast operating expenses to grow slower than revenue. We expect that the first couple of years Opex will grow relatively fast because IDN is adding to its sales team. However, since the financial institutions are incentivized to onboard more retailers, we expect that the product will eventually sell itself.

(Source: own estimates)

IDNs SAAS revenue grew 24% in the first quarter of 2021. This seems low in comparison to revenue growth in the last couple of years. However, the revenue has grown limited due to the COVID-19 measures in the United States. Due to the measures, a lot of physical stores are still not open or fully operational yet.

However, despite the lockdowns IDN is acquiring more customers. IDN signed 25 NDAs with prospective clients in Q1 2021 who have a serious interest in IDNs services. Therefore, revenue growth is expected to take up when measures will be lifted later this year. The penetration rate of IDNs customers is still relatively low at 10-15%. Showing that IDN is only at the beginning of a long growth path. The company is getting more and more exposure and this will result in more customers. Therefore, it is expected that high growth in revenue of recent years will continue in the coming years. We expect a CAGR of 38% for revenue to 2026. Implementing these forecasts in a Discounted Cash Flow model (DCF) with a discount rate of 10%, and terminal growth rate of 2% gives a valuation of 16.50 USD. Using an Exit Multiple Valuation with a Free Cash Flow multiple of 27, based on comparables such as Mitek and other Security and SaaS companies, gives a Market Cap of 497 mln USD or a stock price of 24.2 USD in 2026. This suggests an annual rate of return of 24.8% in the coming five years, far outperforming our target return of 12%. We do think that this estimation is still conservative considering that revenue would be 75 mln USD in 2026. This is still small in comparison to the expected total addressable market of over 16 bln USD that same year.

Bear case

To bring our valuation in more perspective we have also looked at a worse and a better scenario. It is possible that COVID-19 restrictions will be active longer than expected, customer retailers will not be fully operational and thereby growth will be limited in the coming years.

The growth of IDN is also achieved by hiring sales people who acquire more customers. IDN is very selective in hiring sales people. In this scenario we take into account that IDN cannot hire enough sales people and thereby limiting revenue growth. IDN would still grow due to the implementation of more retailers through current customers. Also, a lower hiring rate and lower customer acquisition rate would result in lower operating expenses. In this scenario we have a CAGR of 30% in revenue to 2026. Via DCF we estimate a stock price of 6.05 USD and 8.50 USD via the Exit Multiple. The Exit Multiple valuation would imply an annual rate of return of 0.6% in the coming five years.

Bull case

In our bull case we take into account a faster opening of retailers. In addition to this, based on the statement by IDN’s management regarding the comapnies pricing power, efficacy rate and low price in comparison to rivals, we can argue that gross profits will grow from 87% to 90%. Next to these estimations, we also imply the adoption of IDNs services in industries other than the financial industry. Due to these estimations we think that growth rates will stay around 30-50% range longer than in the base and bull case. In this scenario we have a CAGR of 48% in revenue to 2026. In contrast to the bear case, operating expenses will also accelerate due to more hiring of sales people and increase of incentive plans due to more signings of customers. With a DCF estimation we come up with a stock price of 40.22 USD and 49.80 USD in 2026 with the Exit Multiple. The Exit Multiple valuation would imply an annual rate of return of 43.4% in the coming five years.

Risks

- The top 10 customers generated 66% of revenue in 2019. Losing one customer would seem like a big threat. However, this statistics gives a distorted view. The top 10 customers mainly consist of banks who in turn have a wide range of customers such as retailers using IDNs services. If a bank goes bankrupt or discontinues its relationship with IDN, retailers can still use the services of IDN. This is definitely the case when, taking into account the competitive advantages and the easy integration of IDNs services.

- Losing access to encrypted code of the AAMVA. IDN does the ID verification of military bases and secured government facilities. DMV does not want to partner up with anybody since the information they have is very sensitive. This provides them with an incentive to keep doing business with IDN. Also, IDN has been through several security checks throughout the years and the company has not had any security breach at all. Even if the AAMVA would engage with some other players as well, we argue that the addressable market is still large enough for IDN to have the opportunity for high growth.

Disclaimer: Always do your own research. This is not investment advice and for informational purposes only. Partnership Investing is not a registered investment adviser and may or may not hold securities discussed on this blog.