Red Violet Q3 Earnings: Margin Growth Leaves Room For Further Upside

seekingalpha11-20

Red Violet shares have doubled since my initial recommendation following solid progress in the underlying business.Revenue was up 20% in Q3, with adjusted EBITDA margins rising to 35%, demonstrating ...

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I have since remained positive on the company even after its Q2 results as my thesis remained on track. While Q3 results continue to highlight the growth opportunity ahead, I recognize that the company is approaching fair value. Further upside will depend on its ability to successfully move upmarket and continue to harness the operating leverage in the business to drive higher margins. I conservatively forecast 15% annual growth for next year, with adjusted EBITDA margins reaching 36%. RDVT shares are still trading at a discount compared to relevant peers, which I believe is unjustified given the company's strong growth and margin expansion potential. Therefore, I maintain my Buy rating on the stock. Q3 Results Show Strong Growth and Rising Gross Margins Q3 revenue was up 20% year over year, with adjusted gross margins rising to 83%, a 400 basis point improvement versus the prior year period. The gains in gross margins stem from the operating leverage due to the fixed costs associated with data acquisition. Furthermore, the company added 266 IDI customers during the quarter which was slightly better than the 236 IDI customers added in Q2. This remains a key metric that investors should track to judge the success of the company's go-to-market strategy, especially as management continues to invest heavily in sales and marketing. The Forewarn product continued the momentum it has shown so far this year, with a 70% year-over-year increase and an 8% sequential increase in users on its platform. Underlying metrics such as gross retention remained healthy at 94%. The strong performance on the topline also translated to the bottom line with adjusted EBITDA coming in at $6.7 million, at a margin of 35%. This reflected a 100 basis point improvement versus the prior year period, a commendable achievement given the ramp-up in hiring in recent quarters. Look for Further Operating Leverage in Coming Quarters Although year-over-year growth has consistently exceeded 20% on average this year, maintaining this momentum will become more challenging unless the business can achieve stronger results by successfully penetrating large customers for the IDI product. Forewarn, which has been a key growth driver in 2024, is unlikely to sustain this level of growth next year, particularly due to the recent lack of signing large realtor associations. Going forward, I expect most revenue growth to come from the increased focus on moving upmarket, leveraging the expanded headcount the company has added in recent quarters, as shown in the figure below. Created from data available in the Q3 earnings report In a conservative scenario, I expect revenue to grow 15% next year, reaching $86 million, based on my estimate of $74.5 million for 2024. In a more optimistic scenario, where the company successfully executes its go-to-market strategy with large customers, I see revenue sustaining a 20% growth rate. While I anticipate further improvements in gross margins from the fixed costs associated with acquiring data from suppliers, operating expenses are likely to continue rising, particularly with higher personnel costs in Sales and Marketing. In Q3, Sales and Marketing expenses rose by $1.4 million or 43%, a growth rate I expect to persist in the coming quarters. Given this dynamic, I expect adjusted EBITDA margins in FY25 to still rise, to close to 36%. If revenue growth exceeds my conservative estimates, it will translate to much higher adjusted EBITDA margins given the operating leverage in the business. Given the company's strong financial position, with $36 million in cash and no debt, I remain optimistic as management is aggressively investing in sales and marketing to lift the company's growth profile while also broadening its customer base with a focus on tapping into the $10 billion market opportunity, starting with government agencies as the most attractive segment. Valuation I will base my valuation framework for RDVT stock on my expectations for next year's FCF. Assuming $9 million in annual capex spend for FY25, I see the business producing close to $22 million in FCF, based on my estimate of $31 million of adjusted EBITDA. Given the current market cap of $465 million, shares are trading at a Price/FCF multiple of 21. While this valuation appears attractive on an absolute basis, it is also at a discount compared to larger players in the data analytics space such as RELX (RELX), TransUnion (TRU), and Thomson Reuters (TRI), which all have forward-looking Price/FCF multiples well above 20, while growing at high single-digits rates on average. Given RDVT's significantly higher growth rates, longer growth runway, and potential for margin upside, I believe the company deserves to trade at a premium to these peers. Risks to Consider As I have highlighted in my previous write-ups covering the company, a risk I see is related to the high level of spending toward increasing the headcount in sales and marketing. Investors need to closely follow that this is in turn leading to higher revenue and that management is able to show an attractive return that will continue to lift margins along with future revenue growth. Q3 Financial Report As highlighted in the extract from the company's latest financial report, stock-based compensation (\"SBC\") remains a significant expense, with a sharp 21% year-over-year increase in Q3. Investors should closely monitor this cost to ensure that future returns are not diluted by excessive SBC issuance. Conclusion  At the current valuation of 21 times FCF, based on conservative estimates for next year, I believe there is still significant upside for investors, even after shares have doubled since my initial recommendation earlier this year. If growth continues near 20% next year, it would further validate that management's investments in expanding its sales and marketing teams are paying off. Given my positive outlook for the company, I maintain my Buy rating on the stock.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2484486191"}