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Date : 13/04/2021

Nuix Limited

ASX :

NXL

Market Cap : $1.68 Billion

Buy

52 Week Range : $4.63 - $11.86

Share Price : $5.08

Nuix has had a massive correction. The stock comes with growth potential and the low price results in a rating upgrade to a "Buy" from us.

Company Analysis

Nuix Limited (ASX: NXL) is a Sydney based technology company that listed on the ASX in December 2020. Coming in at a market cap of $1.7 billion back then, it became the most valuable tech stock IPO of the year. The stock soared 50% on the day of the float and shares closed over $8 a share.

Back in January when we covered Nuix at a period when there was a lot of hype, we recommended members to Watch given that the stock price had overshot our estimates and it more often results in a correction or is met with high degrees of volatility.

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Source: Tradingview.com

So why did the share price half? Well, we can see in the above chart that the volatility began to set in once the stock reached its peak price of over $11 a share in late January. Nuix was trading at very high multiples back then and even the slightest of misses in earnings can result in a sell-off. This is exactly what transpired. The first earnings call after a highly anticipated and popular IPO is extremely important for the firm and the market. To give you a perspective of high Nuix was flying relative to its technology peers, Nuix was trading at an EV/EBITDA multiple of 56.4x – which was higher than Appen, Altium, Technology One, and NextDC. A miss in earnings will thus result in sell-offs galore.

Nuix was dragged down to levels below its IPO price of $5.31 a share. Another contributing factor has been the rise in bond yields that happened during the same time. Tech stocks globally were sold-off along with bonds. Since then, the stock looks to have come back in the favour of investors, and it currently trades at $5.08 a share – still lower than its IPO price. The shares now are trading below the intrinsic value and have also resulted in their Director – Rodney Graeme Vawdrey increasing his holding by 100,000 shares via an on-market trade. This reinforces that Nuix’s full year guidance is intact and there is room for growth in the share price as well.

So, what does Nuix do? Nuix provides intelligence software and investigative analytics by analysing large volumes of data in the back end. They have very wide use case scenarios such as: criminal investigations, financial crimes, litigation, data protection/governance/compliance, employee & insider investigations, etc. To sum it up, they are becoming a need to have software to manage risks in corporations, governments, law enforcement, law firms, etc. They already have over a thousand customers coming in from 79 countries. Few notable clients include – Amazon, Barclays, Samsung, CommBank, etc. They have played a significant role in the investigation of the Panama Papers and also the Royal Banking Commission debacle of 2018, among other criminal investigations. It is also believed that Nuix works with some of the largest intelligence agencies in the world and they have participated in investigations surrounding terrorist activities, corporate scandals, and organised crime.

Half Year Earnings – FY2021

  • Revenue (statutory and pro forma) at $85.3m, down 4% year-on-year and 44% of FY21 forecast
  • ACV (12 months ended 31 December 2020) at $162m, up 3% year-on-year
  • Pro forma EBITDA at $31.6m, up 3% due to strong profit margins
  • EBITDA margin up at 37%
  • Pro forma NPAT at $9.5m and 48% of FY21 forecast1
  • Statutory net loss after tax of$16.6m, or $0.06 on an EPS basis

1H FY21 revenue was buoyed by high recurring revenue and strong new business sales of $13.1 million offset by a weaker US dollar ($2.4 million impact), disruption in US Government procurement processes and deal slippage of $2.4m (which were subsequently closed in January 2021). Profit margins increased in the period because software licenses generated 98% of 1H FY21 revenue and costs were kept under control.

  • Momentum building with new business up over 17% compared to 1H FY20, 49 new customers, and the number and dollar value of SaaS deals growing.
  • Continued investment in R&D–26% of 1H FY21 revenues, delivering product enhancements and progressing Cloud use cases for the Nuix Engine.
  • Attracting key new hires with a focus on sales personnel and engineers.

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Source: Nuix

Q1 was a fairly soft period for Nuix, the December quarter was encouraging with a strong performance in all sales regions despite the US government being impacted by delayed access to decision makers because of COVID and the US election. The stronger weighting towards the second half is in line with expectations given COVID and seasonality. With the Biden administration’s transition now complete and the recovery form the pandemic underway, the headwinds will reduce going forward.

Over the past six months, Nuix added 49 customers including industry leading brands in the US, UK, and Europe. Strong customer engagement, a maturing and growing pipeline, and low customer churn (4.2%) are expected to boost ACV for the second half of FY21 with a return to more certain operating conditions is anticipated in Q4 FY21.

The Nuix IPO raised $953million to provide existing securityholders with an opportunity to realise a portion of their investment in Nuix, to enable new shareholders to invest in Nuix, to fund the cancellation of options exercisable before completion of the offer, and to pay down debt. As of 31 December 2020, Nuix’s balance sheet had net assets of $263 million including net cash of $103million – a healthy financial position for the firm.

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The above table shows how quickly revenues were growing across all regions for Nuix. The reduction in revenue by 4% is what caused the share price to come crashing down in February. Nuix generates most of its revenues in the USA as it is The Market to be in if you are a technology company. The Biden administration taking over from Trump at a time when the pandemic was wreaking havoc and the USA was also dealing with a lot of social unrest meant that US government agencies and policy makers – who are Nuix’s main customers were not really able to commit to policies surrounding criminal investigations, financial crimes, litigation, data protection/governance/compliance, employee & insider investigations, etc. As the situation improves, however, a rebound is forecasted – quicker than ever.

Industry Analysis

The market for investigative analytics and intelligence software includes the markets for eDiscovery software, digital forensics software, GRC software and endpoint security software:

The eDiscovery software market generated approximately US$3.0 billion of revenue in 2019 and is expected to grow at a CAGR between 2019 and 2024 of approximately 3.6% to reach approximately US$3.6 billion by 2024.

The digital forensics software market generated approximately US$1.0 billion of revenue in 2019 and is expected to grow at a CAGR between 2019 and 2025 of approximately 11.5% to reach approximately US$1.9 billion by 2025.

The GRC software market generated approximately US$10.5 billion of revenue in 2019 and is expected to grow at a CAGR between 2019 and 2024 of approximately 4.2% to reach approximately US$12.8 billion by 2024.

The endpoint security software market was estimated to generate approximately US$12.8 billion of revenue in 2019 and to grow at a CAGR between 2019 and 2024 of approximately 4.9% to reach approximately US$16.2 billion by 2024.

Data suggests that over 90% of legal cases now require a digital footprint. With the shift towards a digital economy, the use of eDiscovery software will only increase. Organisations are looking for ways to mitigate the risks they are facing when it comes to data, and with data being the gold mine of the future, Nuix and other such players have developed products that are a necessity rather than a want.

  • Managing data
  • Complying with legal and regulatory obligations
  • Risk mitigation from data breaches
  • Exploitation of data

These are all areas that Nuix’s products help their customers. Thus, the total addressable market in terms of number of potential customers is very large. Any business that is digital will ultimately have a need to protect and safeguard themselves from exploitation.

Graphical user interface, application

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Source: Nuix

Investment Thesis

Most of Nuix’s revenues are generated in the Americas. Followed by EMEA and then the APAC. Just 20% of its overall revenues are generated in Australia. In FY2020, Nuix generated $98 million from the USA, $50 million from EMEA, and $29 million from APAC – this translates to 55%, 28%, and 16% of the total revenues. We have also already mentioned how high the growth rates were during this time across all the regions. Nuix’s business is becoming a mainstream requirement for corporations and governments around the world, and this has translated to high growth rates in the past and also high growth forecasts in the future. Their gross margins are a steady 88% – indicating incredible efficiency for an enterprise software business. EBITDA margins have a rising trend over the past few years, and this is expected to also increase due to Nuix’s operational metrics continuing to improve. The two metrics to keep a very close eye on are – Churn and ACV.

Chart, bar chart

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Source: Nuix

Nuix has a demonstrated track record to attract new customers, retain existing customers and grow the contract value generated by its customer base over time, highlighted by low churn and Net dollar retention values in excess of 100%. A net dollar retention of over 100% for the past 3 years shows that Nuix is generating more money from its existing customers than they did in the previous year. A healthy metric and a cornerstone when it comes to measuring SaaS businesses. These two metrics will therefore result in increasing the annualised contract value (ACV) of the company. This will result in expanding EBITDA margins in the long-run and thus the narrative behind the high EV/EBITDA multiples that Nuix trades at.

R&D investments have continuously increased – suggesting that the firm continues to improve its products. Software Development costs also have a similar trend – with the firm spending $42 million in FY2020 – a growth of 12%. Nuix’s growth opportunities are fuelled by the exponential growth in data and regulatory compliance. The Company will continue to build on its core technology based around the powerful Nuix Engine which processes unstructured data at speed and scale. Nuix has a strong foothold in the US$4 billion eDiscovery and Digital forensics software markets and will continue to build strategic initiatives, particularly in the US$23 billion government, risk and compliance (GRC) market. Together these markets make up the investigative analytics and intelligence software market.

Therefore, based on our forecasts, the below chart shows how Nuix’s performances will look for the next 3 years. EBITDA for full year FY2021 is expected to slide marginally as Nuix is expected to hire staff for sales and engineering. This will increase the S&G costs of the firm – weighing in on the margins.

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With the listing and Nuix raising capital, their balance sheet has been fortified further. They ended the half-year period with $102.6 million in cash and $24 million in additional debt facilities available to them. The cash generation has been strong, and their low capex shows that their operations are highly efficient. The similar trend in their current ratio and quick ratio shows us that most of the short-term assets are tangible and liquid – mitigating any risks in the short-term. Long-term, Nuix’s assets outweigh their liabilities by 2.76x. The firm has just $38 million in total debt and given their high cash position, the risks are mitigated. This takes the capital structure to 87% equity capitalisation and only 13% debt capitalisation as of December 2020.

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Coming down from the high-flying multiples Nuix was trading at earlier, shares are now trading at 24.96x forward EV/EBITDA. This is down from 56.4x EV/EBITDA when we last covered the stock. The multiples in the chart below are based on the current market capitalisation, an enterprise value of $1.5 billion, and our forecasts for revenues and EBITDA that we mentioned earlier in the report.

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Recommendation

Nuix’s business operations are highly efficient. They are in a high-growth stage and their revenues and margins will continue to expand. Their director has also bought shares after the sell-off to reinforce that the company is being led in the right direction. We upgrade our rating on Nuix and recommend long-term investors to “Buy”.

 

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