Investment thesis
In my previous article covering the company, I was bullish on Red Violet’s (NASDAQ:RDVT) growth prospects for its core products IDI and Forewarn. I also anticipated significant margin expansion as the company leveraged its largely fixed cost business model. Shares have risen more than 50% since then and in this article I acknowledge that while the company faces increased risks as it ventures further upmarket, the opportunities could be transformative. Additionally, Red Violet surpassed my revenue and margin estimates for Q2, prompting me to raise my price target to $34 and reaffirm my Buy rating.
Key takeaways from Q2 results
The company posted year over year revenue growth of 30% in the quarter, reaching an adjusted EBITDA margin of 36%. However, investors must note that these results benefitted from a $1 million one-time payment, without which revenue growth would have been 23% with an adjusted EBITDA margin of 32%. This re-acceleration in growth compared to the 20% year-over-year growth seen in Q1 is particularly strong given Q2 is typically seasonally its weakest quarter.
As shown in the image below, the company’s underlying metrics remained very healthy, with a solid addition of new customers and an increase in spend from its existing customers. The number of Forewarn users was lower than my expectations, but I do expect this number to trend higher after the company recently signed contracts with large realtor associations such as Virginia and Minnesota, each having members of 36,000 and 16,000 respectively.
After accounting for the one-time revenue benefit previously discussed, the year-over-year growth in spending from existing customers exceeded 14%. With a gross revenue retention rate of 94% in Q2, I estimate the Dollar-Based Net Retention Rate (DBNRR) to be approximately 108%, indicating particularly strong performance.
Looking ahead: My expectations
Multiple growth drivers for IDI
According to management commentary on the earnings call, the company’s IDI product is seeing double-digit revenue growth in investigative as well as financial and corporate risk verticals. Additionally, its collections vertical has recovered as consumer credit quality continues to deteriorate in this higher for longer interest rate environment. IDI’s real estate vertical has seen a headwind due to lower homes sales, but this could change with lower interest rates anticipated going forward. Based on these factors, I expect the company’s growth to continue at these elevated levels in upcoming quarters. Furthermore, the company’s CEO commentated on the strength of its pipeline, which is a leading indicator for future growth, stating:
We are executing upon that pipeline as we keep mentioning. And, that pipeline is accelerating for us and we believe that we will continue to carry the momentum throughout the year and into 2025…
Moving upmarket and focusing on the public sector
Management is focused on securing larger contracts, particularly with clients generating annual revenues over $100,000. By specifically targeting government agencies at the local, state, and federal levels, these high-value deals are expected to drive significant transformation by providing sticky, highly recurring revenue. The recent appointment of Jonathan McDonald as Executive Vice President for the Public Sector underscores the company’s commitment to these strategic ambitions.
Increased sales and marketing spend
Management has substantially increased the headcount in sales and marketing, which now comprises of 86 employees compared to 63 employees in the prior year period. Thus far, this increased spending has been justified given the acceleration in growth seen in recent quarters. Margins have also increased, and investors should closely track this going forward to ensure that the company is not having to overspend to achieve their revenue growth targets.
Thoughts on valuation
Given that management does not provide any guidance, my valuation model will be based on my estimates and assumptions. In my previous article, I expected full-year revenue to be $71 million, which represented a year-over-year growth of 18%. However, given the company’s impressive growth in the first half of the year, I raise my estimate for full-year revenue to $75 million. This implies a 24% growth in H2 2024 versus the prior year period and is primarily based on the factors which I discussed in the earlier section. I expect adjusted EBITDA to be $24 million, which corresponds to a margin of 32%. FCF is likely to be close to $15 million after adjusting for capex spend of approximately $9 million.
Based on these estimates and accounting for its net cash of $31 million, shares trade at an EV to adjusted EBITDA of 14 at a share price of $27, assuming 13.7 million shares outstanding. Its Price to FCF multiple is just above 24. More mature peers such as RELX Group (RELX), TransUnion (TRU) and Thomson Reuters (TRI) currently trade at forward EV to EBITDA ratios of 19, 15 and 27 respectively, despite growing at 8% on average versus Red Violet which expected to grow faster than 20%. The current valuation therefore is very attractive given the company’s growth outlook and margin upside given its high incremental margins. I would also point out that the company remains an attractive acquisition target, given its strong product offering and management’s history of selling their businesses to larger players in the market. I consider an EV to EBITDA multiple of 18 to be more appropriate, on a risk-adjusted basis. This would imply a share price of $34 which represents an upside of 26% from today’s price.
Risks to consider
One of the most significant risks the company faces is its heavy dependence on data suppliers. According to the Q2 report, its largest data supplier accounts for 46% of total data acquisition costs. Any disruption in securing relevant data at competitive prices could adversely affect the company’s future product offerings and profitability.
As the company moves further upmarket, it faces heightened competition from major players like RELX Group, TransUnion, and Thomson Reuters, who offer similar products. To succeed, the company must demonstrate that its cloud-native platform offers distinct advantages and enhanced capabilities that set it apart from these established competitors.
Conclusion
Red Violet has become a significant player in the Data and Risk Analytics market, and it now aims to target larger customers, particularly in the public sector. However, this does involve risks related to increased competition and higher sales and marketing investment. Nevertheless, the company’s growth outlook remains strong with the potential for higher margins and the current valuation provides an attractive upside for investors.
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