Greenhaven Road Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. Greenhaven’s estimated returns for the third quarter totaled approximately +50% net of fees and expenses. August was the best month in the partnership history. The net result is that both funds are up around 55% for the year, comparing favorably to the Russell 2000, which ended September down -8.7% year to date. You should check out Greenhaven Road Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Greenhaven Road Capital highlighted a few stocks and Audioeye Inc (NASDAQ:AEYE) is one of them. Audioeye Inc (NASDAQ:AEYE) is a software company. Year-to-date, Audioeye Inc (NASDAQ:AEYE) stock gained 311.9% and on November 4th it had a closing price of $19.32. Here is what Greenhaven Road Capital said:
“NEW INVESTMENT – AUDIOEYE
One of the interesting dynamics of buying stock in a company is that our downside is known. In the worst case, we can lose 100% of our investment. In the best case, we can make many multiples of our original investment. Our most recent investment has all the trappings of a dumpster fire. A CEO being demoted (check), another CEO being demoted after three months (check), replacing the head of sales (check), changing the business model (check), and a short report that outlines years of dysfunction (check).
So, what are we doing? Are we trying to prove that the most that we can lose is the 100% of the capital that we invest? Might lighting the money on fire be a quicker way to dispose of it? Just looking at the drama that I laid out above, I would assume that the health of the underlying business was moribund. If I had to predict the revenue and margin trends for a company with so much turmoil, I would assume that there is a race to see which can decline faster – the revenue or the margins? Would it surprise you to learn that in the quarter that the CEO was demoted, this dumpster fire saw sales increase by 116%, margins expand, and cash burn slow? In fact, the company has seen triple-digit revenue growth for the last three quarters. One might ask, what kind of numbers does the CEO have to put up to keep his/her job?
The company in question is AudioEye (AEYE) and the most favorable characterization is that it is a firm in transition. AudioEye is “the industry-leading digital accessibility software solution provider, delivering web accessibility compliance at all price points to businesses of all sizes.”
The Americans with Disabilities Act requires that websites be accessible to people with disabilities such as blindness. This may not be a simple task, and compliance has been very low (sub-3%) historically. However, in the last three years, there has been a significant increase in the number of lawsuits against companies for ignoring their legal obligations. In addition to being the right thing to do and most likely good for business, there are compliance tailwinds. AudioEye has had multiple incarnations, but with regards to making websites accessible, they had a labor-intensive, very high-touch offering that was appropriate for large companies like ADP. It was effectively a mix of professional services and technology, with gross margins in the 50% range serving larger customers. This is not a particularly attractive or scalable business.
A changing cast of B and C players with an unscalable and unattractive business model does not sound like a very good place to invest a portion of my life savings or yours. What is going on? It can really be boiled down to David Moradi. He has had a colorful episode in his personal life, which you can Google, but he has also worked as an investor at Soros and Pequot, firms with tremendous track records. His family office, Sero Capital, owns almost half of AudioEye, and he joined the board in 2019 before recently becoming the interim CEO in August. While I am not a fan of investors as CEOs, I think David realizes that there is a very large opportunity and he is highly motivated to seize it. He is the source of urgency, the driving force behind the management changes, margin improvement, and product changes. The strategy that Moradi is trying to implement is simple. By working with large clients on labor-intensive projects to identify and rectify website issues that impede access, AudioEye has built a large database of issues and remediations. As the database grows, the opportunity to automate increases, the labor component decreases, and the opportunity to serve smaller customers in a more hands-off manner improves.
AudioEye has seen an explosion in customer count, growing from 6,000 to over 20,000 this year alone. To date, their biggest growth engine has been vertical integration partners in finance, education, automotive, marketing, and government. These vertical integration partners provide industry-specific website templates for smaller players to use.
The vertical integration partner goes to their membership highlighting recent lawsuits around digital accessibility, and for a nominal fee (shared between AEYE and the vertical integration partner) they turn on AudioEye. Because the vertical integrators have standardized platforms, the customers can be profitable customers at very low prices (ARPUs).
In addition to further penetrating the vertical integrators, there are two very large growth levers that AudioEye can pull. The first one is a freemium model, which they are currently experimenting with (they call it marketplace). The company raised capital at the end of August and is now in a position to pursue it more aggressively. The even larger opportunity is for “native integrations,” where AudioEye is offered as an add-on for hosting companies like Wix or Squarespace on a revenue share basis with the hosting company. For this to be successful, there is technical work to be done, as well as a further growth of the database of issues. Currently, approximately 50% of issues can be resolved in an automated fashion, up from 20% a year ago. An improved technical team was brought on this year.
David Moradi owns tens of millions of dollars’ worth of stock, and is now on the board and serving as interim CEO. I think it is fair to say that he cares. He has articulated a strategy that I think makes a lot of sense, and he has taken several concrete steps towards realizing the strategy. The stock trades at approximately 8X the last quarter annualized monthly recurring revenue. Even if growth decelerates, we have a very high likelihood of getting revenue growth and multiple expansion. The company is approaching breakeven and will be able to choose between taking additional capital and investing in growth. People build businesses, and David is in the process of driving a large upgrade in the talent and resources. We can be scared off by some of the historical issues, and perhaps that would be prudent, but the siren song of triple-digit growth, single-digit multiple EV/S, a long runway for growth, and very high returns on marketing spend are too hard to ignore. Yes, there is a chance we lose money, but there is also the set-up to make multiples on our capital. If this works, David Moradi will be the biggest beneficiary and the one most responsible, as it should be.”
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