Cabot Small Cap Confidential 266

The growth stock selloff of February and March knocked good software companies down a peg. But many of these stocks are bouncing back now as investors realize growth isn’t going to evaporate as the pandemic eases.

Today’s addition is a newly public company with a software platform for hosting virtual events. The pandemic supercharged growth and revenue doubled. Deeper evaluation of the trends suggests things will calm down a little, but growth should be sustained well above 20% for years and could even top 30%.

Despite the potential, the stock is dirt-cheap as compared to its peers. We’ll jump in now before investors realize the disconnect.

Enjoy!

Cabot Small Cap Confidential 266

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The Big Idea
It used to be that sales and marketing teams relied on conferences, cold calls, mass mailings and in-person networking events to engage with business clients.

Then the internet arrived, and a lot of this activity moved online. That was great … for a while.

But marketing methods soon gravitated toward automated strategies, such as email and online adds. It didn’t take long for potential customers to associate large-scale online marketing efforts with spam.

This is true in both business-to-consumer (B2C) and business-to-business (B2B) markets. Across the board, people just don’t like a one-size-fits-all (or one-size-fits-nobody) marketing approach that is entirely devoid of a personalized touch.

In the B2C world, social media and other digital engagement tools have since evolved so that companies can better understand their potential consumers. The result has been more personalized marketing messages and higher sales conversions.

But in the B2B world evolution has come more slowly. It needs to get better.

To succeed in today’s world, sales and marketing teams need a variety of digital marketing and engagement tools that can pull in prospective buyers with personalized messages, cultivate relationships, give buyers opportunities to self-educate, gather data (legally), and ultimately drive sales.

When COVID-19 hit, demand for these types of B2B digital marketing solutions exploded. Suddenly what seemed to just make sense before the pandemic became mission critical.

While some of this demand will recede as the pandemic eases, COVID-19 has fundamentally changed the world. In the marketing world, businesses have seen the light. Digital strategies are here to stay.

Digital solutions are both efficient and effective for everybody. Sales teams and engineers don’t always need to deal with cabs, planes and hotels to get in front of potential customers. And customers don’t need to stop everything they’re doing to go to conferences.

Sure, some of this is good to do now and then. But it doesn’t have to be the norm.

Moving forward, businesses will increasingly see digital marketing tools as a “must have” and not a “nice to have.” That’s giving rise to a huge global market worth $40 billion a year.

Today we’re investing in a company that came public after a banner year during which its solutions helped many organizations survive pandemic lockdowns. With increased long-term demand, growth should top 20% for years and could even top 30%.

Despite the potential, this stock faltered soon after its IPO when growth stocks sold off. I believe that, had it come public in a different environment, the stock would be trading at least 50% higher than it is right now.

It looks like a rare opportunity to buy a high-growth software stock at a “value” price.

The Company
On24 (ONTF) is a $1.6 billion market cap company that offers a cloud-based digital experience platform to facilitate business-to-business (B2B) sales. Despite its small size, On24 is the leading provider of purpose-built solutions for this market, which is worth roughly $40 billion.

Organizations use the platform to deliver interactive webinar experiences, virtual event experiences and multimedia content experiences in either live or on-demand formats.

On24’s solutions give businesses the opportunity to lead with a digital marketing strategy and/or to supplement in-person events with digital engagement tools. This flexibility is key. Moreover, On24 offers the key benefit of being able to gather real-time engagement data. This tracking information is not available with in-person events.

Users of the platform often realize higher sales efficiency as compared to other digital and in-person sales and marketing efforts. This is why the company should continue to do well, even in a post COVID-19 world.

The company was founded in 1998 and is still being led by founder and CEO Sharat Saran. In the early years On24 sold solutions for one-off digital conferences. Over the last decade this has changed, and the company now sells to customers using the platform for recurring events. This has led to higher, and more consistent, revenue.

Roughly 80% of revenue currently comes from the U.S. This may begin to change as the company is working to grow overseas. Customers range from rapid-growth small start-ups to large Fortune 100 enterprises.

On24 is well represented in the tech, financial services, healthcare and manufacturing industries. Significant customers include J.P. Morgan (JPM), Morgan Stanley (MS), Microsoft (MSFT), Deloitte, Johnson & Johnson (JNJ), Honeywell (HON), F5 (FFIV), and Wells Fargo (WFC).

Investors may wonder why they should invest in On24 instead of Zoom (ZM). The simple answer is you don’t need to choose one or the other. If you think digital webinars and virtual events is a trend you want to be invested in, you should consider both stocks.

In terms of differentiation, the major ways in which On24 stands out from Zoom is that Zoom is often suitable for small meetings, but not larger ones. On24 offers businesses the ability to totally customize the look and feel of the user experience (custom branding, etc.), use a wide range of interaction tools (more than video, chat, polls), capture a ton of user data, and seamlessly share that data with other marketing applications, including those from Salesforce.com (CRM), Veeva (VEEV), HubSpot (HUBS), Marketo (MKTO), Oracle (ORCL) and more.

Platform & Products
On24’s platform gives businesses digital engagement tools that can help them generate revenue through (1) interactive experiences, (2) data-driven analytics, and (3) integration solutions that tie into other marketing automation, CRM and Business Intelligence (BI) platforms.

The platform is built on two main parts; a web application stack that processes requests from web browsers and APIs, and a streaming infrastructure stack that processes live signals from customers, encodes it, and delivers it to designated audience members.

Let’s talk about the three main solution categories.

ON24 Experience Products
Experience products make it easy for customers to build, design, manage and scale live interactive webinar experiences, large-scale virtual event experiences, multimedia hub experiences and other personalized content experiences.

It’s just as easy for an On24 customer to use the platform (no code required) as it is for their end-consumers, who can guide their own self-education process, don’t need any downloads or plugins, and can access events from any web browser and on any device.

ON24 Elite: Live or pre-recorded interactive webinar experience that can engage hundreds or thousands of prospective customers in real-time and/or on-demand formats. Highly customizable with video or audio presentation with supporting slides, video clips, screen-sharing, live Q&A, surveys and more. Elite is the flagship solution and is typically the first product new customers purchase.

ON24 Virtual Environment: Similar to Elite but designed for larger-scale online events such as a conference, tradeshow or training centers. Virtual Environment houses multiple tracks of interactive webinar-based keynotes and breakout sessions powered by the Elite solution. Interactions are captured in order to provide customers with event analytics.

ON24 Engagement Hub: An always-on, online resource portal solution that customers use to provide rich multimedia content experiences (videos, whitepapers, etc.) that prospective customers can find and engage with whenever and from wherever. It includes off-the-shelf features so customers can quickly publish, curate and promote interactive webinar experiences alongside other marketing content.

ON24 Target: For when customers want to build, curate and share personalized rich multimedia content experiences that are designed to engage specific segments of prospective customers and present them with relevant calls to action.

ON24 Intelligence
This is the analytics backbone that powers the On24 platform and gives customers first-person data, analytics, benchmarking data and reporting. Data is presented at the account level for each platform experience, for each piece of hosted content and for each prospective customer that engages with an experience on the platform. Dashboard views make it easy to digest the data and make comparisons with industry benchmarks.

ON24 Connect
This is On24’s ecosystem of third-party application integrations and APIs. Integrations permit insights provided by ON24 Intelligence to be accessed and leveraged across customers’ other business applications (mainly marketing automation, CRM and BI platforms) or accessed through custom-built APIs.

Growth Initiatives
International Expansion: On24 is trying to grow its sales force overseas, specifically in Europe and Japan. Success here is a key part of maintaining double digit growth.

New Product Introductions: Software companies need to keep adding solutions that customers are willing to pay for. ON24 is no different. The newest solution is ON24 Breakouts, as well as engagement functionality that allows customers to connect with audiences through 1-on-1 discussions, group meetings and peer-to-peer networks. Expect more in the future.

Grow Integrations: Potential customers want digital marketing solutions that work with what they already have. To a reasonable extent, the more the merrier when it comes to integrations. On24 recently added an integration for ON24 Elite to work with Veeva (VEEV) CRM. This should help fuel growth in the pharma, biotech and medical device arenas where Veeva specializes.

Ramp Sales Teams: On24 is using some cash flow to double the sales force to around 120 by the middle of 2021. These reps will take six to nine months to get up to speed, meaning we should see some beneficial impact by the end of Q2 2021, with more progress in Q3.

The Business Model
On24 generates revenue under a cloud-based subscription model (for software), for services (for directors and producers to help with premium webinar support and live event monitoring) and for one-off events (called legacy revenue). The legacy revenue stream ended in 2020.

The company sells through a direct sales force, within which team members tend to focus either on Enterprise or Commercial customers. Not surprisingly, the On24 platform serves as the foundation of the company’s marketing strategy. One ON24 Elite subscription gives a company one workspace (one content area) and two log-ins. Additional workspaces and log-ins cost extra.

The Bottom Line
The company grew total revenue by 8% to $89.1 million in 2019 and by 76% to $156.9 million in 2020. Stripping out legacy revenue, the growth rate was 17% in 2019 and 91% in 2020. The pandemic was a clear growth catalyst, and it also helped earnings. The company’s 2019 adjusted EPS loss of -$0.38 turned into a profit of $0.46 in 2020.

On a quarterly basis revenue growth accelerated throughout 2020, starting at 14% in Q1, building to 82% in both Q2 and Q3, then spiking to 123% in Q4 (ended in December). In Q4 2020 annualized recurring revenue (ARR) grew by 100% as existing customers added more products and signed multi-year agreements. Free cash flow was positive for the first time ever, coming in at $36.5 million. In the Q4 earnings announcement management guided for 2021 revenue of $205.5 - $208.5 million (up 32% at the midpoint) roughly $5 million ahead of consensus estimates.

Growth remained strong in Q1 2021 (reported in May) as On24 beat on both the top and bottom lines. Revenue was up 102% to $50.1 million and adjusted EPS was $0.05 (versus -$0.04 in Q1 2020). Total customer count grew to 2,062 and customer count spending over $100,000 in ARR more than doubled to 325. Customer lands in life sciences, financial services, and retail (including a large home improvement retailer) showed terrific breadth across industries. ARR per customer rose 36% to $80,305, an all-time high.

Looking forward, Q2 2021 (the current quarter) will see the largest ever cohort of new customers renewing as businesses flocked to the platform when the pandemic struck. It’s hard to know how many of these customers will renew and how many will bounce. Management appears to be thinking conservatively and assuming higher-than-normal levels of customer churn.

Analysts are currently modeling Q2 growth of 29% to $51 million and bottom-line breakeven. For Q3 2021 analysts see 30% growth, to $51.2 million. Adding it up we get to 2021 revenue growth of 34% ($210 million), just a hair above management’s guidance. R&D and sales and marketing investments will curb profitability. Adjusted EPS is seen around -$0.03 in 2021, then turning positive in 2022.

Stepping back, On24 should be able to grow revenue in the 20% to 30% range for several years. While there are sure to be customers that choose not to renew as the pandemic fades, I suspect those will be the ones that never really got up to speed on the platform in the first place. The reality is flu (and COVID-19) season isn’t that far away and businesses now know that digital strategies, including marketing and sales, are a must-have.

Risk
Competitors Add Similar Features: If Zoom and/or other competitors add similar functionality in terms of user experience customization, data analytics and integrations there would be less incentive for customers to use On24. That said, competitors would likely increase pricing for these features.

Lower Use of Digital Tools After COVID-19: The pandemic forced everyone online in a wide variety of ways. It’s possible some businesses turn away from online tools in a post-COVID world and go back to the way they did things before (in-person conferences, etc.) I think this is very unlikely to happen in the extreme sense, but it’s something we’ll want to watch in the coming quarters.

International Expansion Execution: On24 is trying to grow its sales force overseas, specifically in Europe and Japan. If this effort falters the stock price could suffer.

New IPO: ONTF just came public in February and investors are not yet familiar with the story. Additionally, lockup expiration is in one month, on August 2.

Competition
On24 competes with a large number of companies offering various engagement tools that include webinar, virtual event, video portal and content management software, online meeting tools, digital marketing tools and even physical events and related software. Well-known competitors with competing solutions include Zoom (ZM), LogMeIn (Francisco Partners and Evergreen), Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOG), Cisco (CSCO), Intrado (Apollo Global), Webex (CSCO) and Cvent (Vista Equity).

The Stock
Trading Volume: ONTF trades an average of 255,000 shares daily. Heavy days are 500,000 shares or more and there have been five of those over the last three months.

Historical Price: ONTF went public at 50 on February 3, 2021 and jumped 42% the first day. It immediately got caught up in the growth stock selloff and shares trended down, ultimately finding a low of 31 in late May. After a few weeks consolidating in the low 30s ONTF jumped 9% on June 3 and has been slowly gaining altitude since. The stock has been trading in a relatively tight range lately, with the exception of yesterday, when shares were uncharacteristically volatile and traded on larger-than-normal volume.

Valuation & Projected Price Target: ONTF trades at a dirt-cheap EV/2022 revenue multiple of 5.3 based on estimated 2022 revenue of $250 million. Keeping all other factors the same, if we doubled that multiple to 10.6 the stock would still be cheap as compared to other software companies consistently growing above 20%. Therefore, my starting price target is 80, slightly more than double the stock’s current price and in line with ONTFs all-time high price (from February).

Buy Range: I expect to keep ONTF at buy for some time as I foresee a long and gradual rise in the share price. Expect some resistance around 40 and again at 48. I don’t expect to revisit our Buy rating until the stock gets closer to 50.

The Next Event: Management is expected to present Q2 2021 results around July 28.

Updates on Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for August 5, 2021.

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