Valuations in our sector are rocking — with no signs of slowing down.

Best-in-class, scalable technology solutions that exceed customer expectations are in high demand.

2020 saw a rush of adoption and evolution in eCommerce and online presence, not created by but fuelled in pace by the advent of the COVID-19 pandemic.

By sector we are referring to technology, and fast-growing subsectors digital identity and verification needs and facilitations, the financial technology space, and all eCommerce interactions in this next internet era. Fintechs are consistently part of challenger banking now, or neobanking, upending the oligopolistic traditional financial services practice. This sector is bringing along fast-moving partners and symbiotic cutting-edge solutions that meet and drive customer expectations and behaviour. For clear reasons, the need for safe and trusted digital tools is quickly spreading to all arenas, including verified identity.

Tom Kennedy has been remunerated by KABN Systems NA in the past twenty-four months. He holds a long position in KABN (CSE:KABN) at the time of publication.

His research is intended for the sophisticated investor to assess market developments and company performance and make insights. His comments are in no way intended as a solicitation to trade in any securities. All comments are subject to Risks and Uncertainties outside of the control of the author.

Please see the Disclosure Statements at the end of document.

In Canada and the US, and in fact across the globe, technology is a sector in significant favour and flux, and is attracting a lot of interest right now.

Dozens of new companies over the past few months have found private investor groups in multiple seed rounds, and many are hitting the public markets via IPOs and RTOs for more exposure and access to capital. The M&A cycle is seeing a lot of activity too. Incumbent players are moving fast on new developments to bolster their product offerings and keep up with the customer and market demands. Financial investors are searching for the next unicorn, or more likely a puzzle piece positioned to be gobbled up at handsome valuations by leveraging vertical integrations or amalgamating user bases into their own.

Internet deals in the US led the way in Q4/20, with almost double the dealflow Healthcare saw in second place. While we do not expect this pace to continue its linear growth, we do expect that 1) Canada typically lags the US markets, and 2) the horse has already left the barn. While KABN’s timing appears to have been excellent, execution demand will only increase as these players are expected to demonstrate they are worth premium valuations.

Figure 1: Q4/20 was all about internet deals

Source: PwC/CB Insights MoneyTree™ Report Q4 2020.

The stock market is very useful for valuation as buyers and sellers commit to pricing every day trading is open. Over the past two years, we have seen a cyclical shift away from certain sectors like commodities, consumer goods, and traditional financial services towards technology.

There are many ways to illustrate this point. We compare the Dow Jones industrial Average, a metric of the broad US markets, against the Technology subsector, over the past two years, in Figure 2:

Figure 2: Tech Stocks are just beginning to outperform

Source: Investing.com; Tom Kennedy.

While the COVID-19 pandemic has undoubtedly had huge exogenous impacts on markets and consumer habits, we contend it did not create this evolution. That said, it has clearly sped things up.

One anecdotal way to explain adoption is that inevitably the customer is likely to embrace a more convenient, safer, cheaper, or better alternative brought on by technology eventually. The exact timing however is often difficult to pinpoint. During the pandemic, many people chose to or were strongly encouraged to purchase food online. This may be an activity they had never engaged in before and might not even have the technology. So they end up buying groceries that arrive at their door in good time and good order, or a prepared meal, and they enjoy it, and are now committed online shoppers. According to 451 Research, a boutique eCommerce research firm in the US, eCommerce spending rose by 23% year over year in 2020 over 2019. These kinds of numbers represent rapid adoption that will not reverse to pre-COVID levels.

We would note the broader market has also done very well during the pandemic, which is helpful to enhancing access to capital for any subsector.

A different way to look at the relative performance of tech versus the broader market is seen comparing the value of $1 invested (all figures USD for this point) on 23 March, 2020 to 22 January, 2021. That dollar would be worth $1.95 now, relative to $1.67 for a buck in the broader Dow Jones Industrial Average.

This represents an alpha, or relative outperformance, of the tech subsector, at 16.8% over that timeframe which is approximately 10 months of data. A couple of caveats are that we have chosen the US market for more robust data but further believe the US market is an excellent proxy for Canada. That said we have not normalized for the exchange rate, but there are so many things from elections to interest rate movements and virtually infinite economic minutiae that affect all durations of currency fluctuation. In addition, Canada typically lags the US, particularly in market developments. This element enhances our point if true and furthermore contributes to the benefits of obtaining a wider US investment audience both from a valuation and adoption perspective.

Figure 3: Value of $1 invested at pandemic market bottom

Source: Investing.com; Tom Kennedy.

Global professional services firm Accenture surveyed 47,000 customers on their digital banking practices in their Accenture 2020 Global Banking Consumer Study. Our interpretation is that the customers can be segmented logically by range of adoption, from Traditionalists to Pioneers, and they are rapidly adopting digital interactions with a focus on humanized elements (“Congratulations, your loan is approved!”) with security and online threats being a major theme. Note that ‘humanized’ and ‘personalized’ are two different important factors. Humanized means counteracting the user feeling their requests are being served by a computer program, while personalized refers to a customized experience with their online interactions that feels tailored to their needs, attitudes, and utility rather than fees seemingly for a beige product suite with few alternatives. Well, guess what incumbents: there are fast-moving disruptors with better and better mousetraps.

Trust in interactions has also fallen precipitously as seen in by the survey’s results, led by bank institutions and insurance, but broadly across all major categories. Trust in banking fell to 37% in 2020 (from 51% of customers trusting their bank in 2018), Insurers fell to 32% (40% — 2018) and Online Payments to 21% (from 30% Trust in 2018).

KABN is uniquely placed to play a role in all these personalized, customer-centric interactions. The customer stands to gain online safety and confidence, the customer owns and can transparently monetize their own identity, and Liquid Avatar stands to be a customized key, wallet, and armour to open empowered and expanded online presence and functionality.

Two relevant transactions were announced thus far in 2021. The first was Kount, which announced an acquisition for US$640 MM in cash by Equifax (EFX:NYSE). The second was the acquisition of fintech startup SoFi for US$8.65 BB by one of Social Capital’s special purpose acquisition corporations.

So to valuation: in each of these cases, the takeout premiums were impressive, and de-emphasize revenues in favour of what SoFi refers to as “WINNER TAKES MOST.” We know what this means. My thesis is that the firms with best-in-class products that are in a position to respond to the massive growth in online eCommerce are going to share a huge pie, not take the whole thing. And the value they are in a position to create is driving buyers to pay up for years of as-yet unrealized performance.

Take Kount, a leading provider of anti-fraud solutions to thousands of North American brands.

They have two significant assets, one being a robust proprietary data library and the other being a “secret shopper” type process whereby they test your company’s system for fraud protection. Kount then operates as a high end security consulting firm with bespoke solutions for clients’ eCommerce suites.

This drove a valuation we estimate at >13x trailing twelve months’ (TTM) revenue, a number that obviously demonstrates the value of their non-revenue performance. They appear cash flow breakeven for at least another full year, as Equifax speaks to the value they will add in over two years of future performance as part of the basis of their purchase price. Equifax constantly runs the risk of becoming a dinosaur every passing day and needs the shot in the arm that is found in new and promising technology. That said, they have the liquidity to acquire new products and teams rather than build them in-house so they can quickly leverage for their existing customers and cross-sell for internal use and customer acquisition alike. Equifax is no stranger to security challenges across their own customers, being dealt a blow in 2017 over a security breach that exposed over 150 million customers’ private data.

Social Capital’s offer to acquire SoFi represents a significant going-public premium. SoFi is widely recognized as a central market disruptor in financial services right now. This transaction represents an acquisition by a Special Purpose Acquisition Company, not dissimilar to an RTO (reverse takeover) method of going public. This is effectively a financial transaction with a lofty premium in spite of the lack of any synergies or strategic development other than going public.

SoFi is a fintech pioneer that is disrupting the banks, being vastly more customer friendly and customer focused, and offering a far lower cost model given the internet infrastructure rather than bricks and mortar banking. The valuation being paid by venture capital firm Social Capital implies 13.6x 2025E forecast Adjusted Net Income on figures released by Social Capital. To provide a nearer term perspective, this implies a valuation of 13.9x 2020E Adjusted Net Revenue.

This means the buyer has already pre-paid for five full years of success culminating in projected results to be announced around now in 2026, at a 50%+ percent premium to current banking institutions’ one-year forward earnings. In the case of SoFi, the SPAC shell saw its value soar, meaning investors see more room above and beyond the premium’s baked in accomplishments. We would also note there are normal considerable growth milestones yet to be accomplished by SoFi that their growth relies upon, notably the receipt of a federal banking license.

In summation, we believe the market is entering a new period of non-standard valuations for best-in-class technology that delivers on customer expectations. We expect this will continue all through 2021 and into the foreseeable future.

We will leave with a parting thought: Merriam-Webster Dictionary has added the word “crowdfunding” for 2021. Things are developing so fast even the dictionary is trying to stay relevant.

KABN is potentially well-positioned to thrive in this fast-paced environment.

© 2021 Thomas Kennedy. All rights reserved. See Disclosure Statement

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