Nearmap: focused on scaling up

Impacts from COVID-19

The company has been tentative when discussing the impact of COVID-19. Because it is exposed to multiple companies and local governments across geographies, it’s reasonable to expect an impact. 

We see some near-term risks. NEA is exposed to small to medium-sized enterprises in areas such as construction and engineering, whose cash flows will likely be under pressure. In the worst case these customers could become insolvent, or at least look to downgrade or defer spending on aerial mapping. In addition, there will likely be fewer customers looking to add aerial imagery services, which will translate into a lower rate of new subscriptions. 

However, like many firms offering remote, cloud-hosted software services, NEA could see an uptick in consumption as some customers transition to working remotely. This would apply to local governments, for example. As such, government revenues – which account for about 20% of NEA’s total revenues – should prove relatively resilient. 

We’re also interested to see if the move to remote working drives customers to switch to a subscription service, given the cloud-hosted environment and flexibility it offers for those working from home. 

Weighing all of the above, while we anticipate some near-term pressure on NEA’s business and stock price, we remain optimistic about the company’s longer-term prospects.

How to value Nearmap

NEA doesn’t generate profit at a group level yet. However, this is a conscious trade-off that the management and board have made to grow and scale up the business offshore, in our view. If successful, this has potential to generate substantially more value for shareholders. 

We use several financial and operating metrics to assess Nearmap’s health and prospective returns, given its nascent status. The firm generates high gross margins of more than 90% in Australia and we expect it to deliver an EBITDA margin of more than 40% once its North America operation scales up. 

Since traditional profitability metrics provide limited group insights, we also scrutinise other measures to assess operational efficiency. We track success via growth in customer numbers combined with the lifetime value of those subscribers, and compare this to the cost of acquiring those customers. 

In its most recent half-year results, many of these metrics disappointed as the firm saw an increase in churn – meaning its annualised contracted value (ACV) was below market expectations. This resulted in the portfolio’s long-term value falling from the previous six-month period. In the near term, we can expect these metrics to reflect the pressure the company is under as a result of COVID-19. 

These are useful measuring sticks on the company’s progress. But on a three-year view we expect these metrics to improve materially, with underlying churn falling significantly below 10% and annualised revenue growth rising above 20%. Alongside margin growth, this would create a powerful combination and deliver strong prospective returns for shareholders with the patience and ability to ride out what could be a volatile 12 months.

Is a capital raising likely? 

A year ago I would not have expected this business to need to raise near-term capital, given the level of cash on its balance sheet and its history of robust execution. The management team had already provided guidance on the trajectory for cash flows within its existing balance sheet to break even. 

Much has changed since, however, with the company’s operating metrics disappointing investors. Moreover, in January it announced some churn in material customers from late 2019, which shook market confidence even before COVID-19 emerged. As things stand, we expect NEA to have $35 million to $40 million in cash on its balance sheet by year-end. Looking ahead, whether it can deliver a sustainable trajectory for the breakeven point of its cash flows will determine whether it needs to raise capital. 

This would require: (1) that it delivers guidance on annualised contract value on an exit-rate basis; and (2) that it adjusts its cost base to the level outlined at the end of April. Management has highlighted areas that will enable it to adjust the exit run-rate on costs, including a permanent 10% headcount reduction. This remains under management control and we would expect it to achieve this. However, weak economic activity in North America especially could have adverse customer outcomes and cause a delay in customer churn. Arguably this is outside of management control and hence makes us cautious. 

We would put the likelihood of NEA raising capital at about 25% at this stage. As we have seen in a number of cases since March, capital-raising can trigger a stock re-rating if it removes balance-sheet risk from investors’ minds. Even if management does not feel the need to raise capital, it may choose to do so pre-emptively to replenish its balance sheet as the stock is now trading at levels close to pre-COVID-19.

A roller-coaster ride for forecasts

Consensus forecasts for NEA have been a roller-coaster ride over the last 12 months. Expectations have come down materially as key metrics disappointed over the last few reporting periods, despite solid ACV growth in aggregate. 

As COVID-19 emerged and the market extrapolated weak economic conditions into revenues and took into account elevated risks around raising capital, the market sensed that it needed to reduce its growth expectations for NEA further. 

After the sharp sell-off in April, however, the firm announced plans for a cost restructure. Management recognised that the business needed to adjust costs and manage resources. This dampened the prospect of it needing to raise capital and prompted a rapid shift in market sentiment. As a result, the vast majority of sell-side analysts gave NEA a positive “buy” rating. 

Right now we can’t say the market is missing anything obvious in the near term. But looking beyond that we think NEA continues to offer strong return prospects over a three-year period. It has a proven, valued product and enjoys recurring revenues, modest concentration in customers, improving margins allied to a renewed focus on cost efficiency and growing market share. This should contribute to strong shareholder returns over three years.

What's in store for the rest of 2020

In many ways that will depend on the duration of COVID-19 and efficacy of government stimulus. Restrictions are being lifted or about to be lifted across numerous countries, with some returning to more regular working conditions. 

NEA was well-positioned prior to this pandemic, with a business model that was moving towards self-funded growth. It has a strong market position in New Zealand and Australia and a growing offshore presence in North America, albeit with a low single-digit US market share. So there remains plenty of room for growth. 

NEA was enjoying healthy subscriber growth prior to COVID-19. We expect these growth rates to slow in the near term. Nevertheless, we see robust structural growth drivers for high-quality and current aerial imagery delivered via the cloud, along with an ability to develop and monetise additional products. 

While the pandemic does pose some business risks, there is the potential that NEA products could see strong take-up, given how it facilitates elements of working remotely.

In summary

Nearmap provides cloud-based aerial imagery as a service. We are optimistic that it will deliver strong returns over a three-year horizon as customers continue to seek best-in-breed imagery solutions. 

We are confident that industry growth, an increasing market share and modest customer churn will drive attractive revenue growth over a three-year time-frame. 

Moreover, we expect NEA to deliver strong operating leverage and margin expansion as it scales up, enabling it to achieve self-funded growth and giving it the opportunity to accelerate organic growth by reinvesting at high incremental rates of return.

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