Microcap investors harboring a taste for deep value stocks with a price-moving catalyst on the horizon should take a serious look at Smart Employee Benefits (CVE:SEB). With fiscal 2017 sales of the company’s business software solutions trending north of C$110mln, signed agreements (including option years) covering some $500mln of revenue, and a growing client base (200+ organizations and counting), the investment case begins with a top line in great shape.
Smart Employee Benefits serves a blue-chip list of Canadian businesses, including leading names in insurance, accounting, retail, manufacturing, transportation, banking and telecommunications. The majority of revenue comes from multi-year contracts under which Smart Employee Benefits SaaS solutions support business processes that CEO John McKimm terms “mission-critical.”
Examples include a custom software portal managing hundreds of millions of dollars in government grants, another portal that tracks all softwood lumber crossing from Canada to the U.S., and multiple interactive solutions that manage billions of dollars of transactions between suppliers, distributors and end-users.
Essentially, Smart Employee Benefits automates manual transactions by creating a customized data processing solution and infrastructure that addresses the entirety of a client’s data processing requirements. The environment provides for cost-effective processing, lower error rates, and real-time analytics to mention a few of the benefits -- all of which have the effect of reducing operating costs and improving management decisions with better information, reporting and analytics.
By business unit, Smart Employee Benefits’ revenues are divided into Technology Non-Benefits and Technology Benefits Processing. Non-Benefits accounts for approximately 87% of current sales, and Benefits makes up the remaining 13%. The softwood lumber and government grant examples fall under the Non-Benefits umbrella. Benefits is just what it sounds like – systems that underpin health and other benefit programs for corporate and government funded benefit plans.
“While both revenue streams have strong growth profiles, Benefits will be the engine of future EBITDA growth,” states McKimm. “Gross margins on the Benefits side will be in the 70% to 90% range depending on which solutions modules are deployed, versus a 19% average gross margin in our Non-Benefits business. We expect adjusted EBITDA to increase over 500% by the end of fiscal 2018.”
McKimm goes on to explain that opportunities in the existing Benefits client base hold the potential to increase annual revenue from a range of $44 per plan member to over $250 per plan member, the latter number coming into effect if a benefit plan deploys all of Smart Employee Benefits’ processing modules. McKimm also noted that clients are already spending this on multiple suppliers. SEB’s competitive advantage, states McKimm, is “One Processing Environment- All Benefits Types- One Benefit Card.”
Over 300,000 members of various benefits plans are managed using one or more of Smart Employee Benefits’ processing solutions. The objective, states McKimm, “is to transition clients to one processing environment, deploying all modules. This adds huge value for clients through cost savings, better service, lower error rates and enhanced reporting, more flexible plans, better analytics, etc.”
Simple math suggests that if per-member revenue on 300,000 people goes from $44 to per year to $250, processing revenues rise from their current $12 million range to over $75 million. This would take time, of course, but even moderate success in transitioning clients implies substantial earnings growth.
McKimm is putting his money where his mouth is, with he and related companies subscribing for over 40% of $7.2mln in equity financings conducted over the past several months, thereby maintaining his status as the company’s largest shareholder. Moreover, insiders and existing shareholders acquired over 80% of the new equity – an irrefutably strong endorsement of the company’s growth prospects.
Smart Employee Benefits has spent tens of millions of dollars to build its infrastructure and software solutions since McKimm founded the company in 2011. Two data centre environments, two disaster recovery sites, a bilingual contact centre, and over 15 partnerships with technology, benefits consulting and insurance companies are just some of the pillars making for a solid foundation. Employees and contractors total approximately 940, situated across seven offices in Canada, two in the Middle East and three in India.
The takeaway here is that the heavy up-front investment in infrastructure is complete. “With fixed costs covered, the profit margin on every additional dollar of revenue scales very quickly,” notes McKimm.
A few other numbers to note include the $8.1bln size of the benefits processing market in Canada, $22mln in new credit facilities with a major Canadian bank that reduces annual interest expense by approximately $1.5mln, and a market capitalization for Smart Employee Benefits that, in the $20mln range, is a mere 0.2X sales.
“We put a lot of money into building our benefits processing environment and that penalized our EBITDA in past years, which in turn hurt our share price,” says McKimm. “However, I believe we are now at a point of realizing extraordinary returns from this investment. Once our fixed costs are covered, the scalability of our benefits processing business is enormous.”
That potential expanded significantly earlier this month when the company announced an executed Letter of Agreement with Virginia-based NeST Technology Corp. The deal calls for Smart Employee Benefits and NeST to set up a 50/50 joint venture to develop benefit processing business in the United States.
Smart Employee Benefits will license its benefit processing solutions to the joint venture, receiving a fee of US$2.25mln from the joint company’s cash flow (US$250,000 will be capitalized for its 50% equity stake). Plans call for deploying the same client acquisition model that Smart Employee Benefits has successfully used in the Canadian market.
In addition, NeST will invest C$960,000 in Smart Employee Benefits as part of a larger overall equity offering of up to C$2 million.
On an adjusted EBITDA (excludes one-time costs associated with acquiring Aon Hewitt’s mid-market Canadian benefits administration business) basis, Smart Employee Benefits expects to be significantly in the black for fiscal 2017. It all points to the company’s shares offering tremendous value if McKimm delivers on his vision. Even though it has already posted growth numbers that would be the envy of most companies, Smart Employee Benefits might actually just be getting started.