Intersections: A cheap $LOCK

Intersections ($INTX) is an $80M microcap with a strange combination of a dying legacy identity theft protection business, Identity Guard, a bail bond industry software business, and wearable computing – for dogs.

I came across the company as a comp in a short presentation of one of their competitors (LifeLock, $LOCK). At that time the stock had a 8.5% yield and was trading at less than 4x EV/EBITDA. It obviously intrigued me and entered my watch list.

The main reason why the stock was trading so cheaply was that most (almost 70%) of their primary business’ revenues derived from large US financial institutions. Bank of America itself accounted for ~45%.

For years $INTX relied on these financial institutions (Bank of America, Chase, Capital One et al) to help advertise / cross-sell their identity theft protection business. After the Consumer Financial Protection Bureau (CFPB) fined some of these companies for deceptive marketing, one by one they terminated their agreements with $INTX, leaving that legacy business in a major decline. In most cases the company just saw new subscribers come to a halt, in others, they even lost all their existing customers.

The company committed to service the remaining subs and is trying to maximize the cash flows from the business. But even with low churn, there is little doubt that this business is in a perpetual decline.

(Their Canadian business is also mostly via these type of agreements, so although revenues from that business have been stable at $32-33M/year, there are lots of risk to that business as well.)

Identity Guard is the company’s direct to customer offering (think $LOCK) that has had decent growth over the last few years. ~41% of the company’s 2013 new subscribers were related to IG (or other consumer-direct brands). The company grew IG revenues by a compound rate of 21.5% over the past four years with very little marketing spend.  The company projects that IG will exceed $100M in revenues (from 2013′s $42M) by 2017.

The companies pet health monitoring platform – called Voyce - is a zero now, but provides large upside optionality. Voyce won “Best of CES 2014″ awards and has attracted lots of media attention. The company plans on selling their dog collar device for $299 with a $15 monthly fee for ongoing monitoring and platform access. It’s obviously impossible to value a business like this at this stage, but with 83M dogs in the US, even a tiny piece of the market would be huge. (1% of market = revs of ~$250M + $12.5M/month.)

When investing in companies with optionality for the upside return, it is crucial to have a margin of safety. $INTX has $21.5M in working capital, $18.65M ($1 per share) of cash, $8.4M in a private investment (White Sky), and only $5M in long term liabilities. Importantly, even with the decline in their existing business, they still generated $5-$6M in operating cash flow in each of the last three quarters.

Their Identity Guard business is where I think any valuation conversation has to begin. IG is about a tenth the size of $LOCK. $LOCK has 3.2M subscribers vs. 324k for IG. With $LOCK’s market cap at a little over $1B, just $INTX’s IG business could be worth $100M. (Note that this is more than their entire current market cap.)

I think you have to value their legacy identity theft protection business (including the Canadian business) as a runoff.  There is little reason to assume this business will be around in the long run, the key question is how long will it be around. I estimate that this business generated $54M of revenues and $7M in operating income this past quarter. Even if you assume an accelerated deceleration, I think it is not far-fetched to say it is worth $50M (especially since the Canadian business has – for the time being – remained stable).

If you back out numbers from management’s guidance, I think they are convinced their pet project (pun intended) will be a $100M business within two years. I’m going to take a more conservative approach and value Voyce at zero. I think it should be thought of as pure optionality.

On a consolidated basis, management guided revenues to trough in 2014 at $260-$275M and return to growth in 2015, 2016. (2015 @ >$300M and 2016 approaching $400M.) Most of that growth is expected to come from IG and Voyce. In the 3 years between 2010-2012 when the company generated $347M-$370M in revenues, they did $48M-$58M in adj EBITDA and the stock traded as high as $23. Again, the company’s EV today is around $70M.

There are some risks here as well. While the company has no current borrowings, they just amended their credit agreement because of non compliance with coverage ratios. Their new Bank of America credit line: $1 (one dollar).

Insider ownership exceeds 51% of the shares outstanding. Thomas Kempner (board member) owns (most via Loeb Holding Corp) 38%, Michael Stanfield (CEO) owns 6.5%, & other directors and executives own a combined ~6.6%. While this might be a positive in a sense of aligned interest, it does enable the management team to run the company as a quasi-private (self dealing) corporation. For example, in this year’s proxy, they only received 47-50% of the votes for their compensation and stock incentive plans. ($8M compensation to the top four execs is pretty excessive for an $80M co’ imo.) They also have had many – non-related - pet projects and investments over the years (most of which end up being transferred to discontinued operations).

Since November of last year short interest has over doubled from less than 1.3M shares to a current 2.6M. While that might not be so much on an absolute basis, it does equate to 20x the stock’s average volume, 14% of shares outstanding, and 35% of the float (when you exclude management’s & Osmium’s shares).

The current dividend costs the company $3.7M each quarter. It is very likely in my opinion that it will be cut or entirely suspended. It is hard to envision the company earning enough FCF as they shift to more of a “direct” model (IG) and ramp spending to roll out Voyce. If the stock does fall on an elimination or cut to their dividend, it might actually provide a good entry point into the equity.

Conclusion: Purchasing $INTX at these levels might be a decent investment even if it was just for IG, the fact that investors also get a still profitable runoff business as well as the Voyce optionality, makes this a real interesting opportunity.

- Aron

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4 Responses to Intersections: A cheap $LOCK

  1. Tyler says:

    Admittedly, I’ve done very light research on these guys. That being said, what’s your thoughts on the risk of losing BofA customers? If I understand the contracts with the big banks correctly (good chance I don’t, skimmed through the K risk factors), can’t those guys stop INTX from servicing their customers with some limited heads up period? The reason I ask is the CEO fielded a question in one of the recent calls regarding INTX’s back up plans for this situation. I think he said something that included “catastrophe” and “painful.”

    That’s my big fear that has kept me out of this name. If BofA leaves, it’s tough to imagine much value in the runoff business. At the same time, FCF turns into cash burn.

  2. MicroFundy says:

    Yes, it is a possibility. Capital One recently took all their customers with them. Since customer service/processing/data + billing costs = ~33% revs, have to assume they restructure cost side of things faster than anticipated. IG growth offsetting some of losses but BofA still has almost 900k customers.

  3. Bruce says:

    Hi Microfundy,
    You wrote that insider ownership exceeds 51% of outstanding shares, yet insiders who work there can’t seem to sell shares or vested options fast enough, even at these lows.
    That isn’t very confidence-inspiring. What can you say about this, please? Also, you didn’t cover the shorts thesis; I assume they most certainly have one considering 25%+ of outstanding shares are sold short.

    Thanks

    • MicroFundy says:

      Bruce,

      I have not seen much insider selling on the name. Other than a recent 6k shares, most “sales” were in combination with option grants/exercises, which are typical – to cover taxes.

      Also, in general I am more willing to give insider selling a free pass in most cases. I advise clients to diversify and expect execs that have most of their net worth – financial capital and human capital tied into one – the same – company… to do the same.

      I thought i did cover the short thesis.
      *Most of their current revenues come from a business that I believe will not be around in a few years.
      *Insider ownership allowing excessive comp / pet projects.
      *Voyce at current expected price point has lots of risks to management expectations.
      *Dividend cut.
      *Credit line cut

      Hope this helps.

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