Nearmap (NEA) – BUY

Introduction

We hope you enjoyed our first article where we took a deep dive into listed data centre operator Next DC. We have been pleased to see the stock perform well for our readers, with the share price rallying strongly after the release of NXT’s half year results (up 24% since our post vs. the All Ordinaries Index up 1%). Our goal at Little Hedge is to provide free, easy to understand, comprehensive and insightful research to everyday Australians on small cap stocks. Something that we found lacking in the Australian investor community. Our next article will be an in depth look at Australia’s most prominent provider of photo maps and geospatial data, Nearmap (NEA). Hopefully you find our analysis insightful, please subscribe to our newsletter and let us know what you think in the comments section below. Enjoy! Created with Highstock 5.0.7 Mar ’16 May ’16 Jul ’16 Sep ’16 Nov ’16 Jan ’17 Mar ’17 May ’16 Sep ’16 Jan ’17 $0.20 $0.40 $0.60 $0.80 $1.00

Business overview

Nearmap is the market leading provider of aerial photography and supplemental geographic data in Australia having been listed on the ASX since 2000. They have developed proprietary camera hardware and software to provide photo maps of the Australian population which is used by the government, construction, utilities, and insurance sectors on a subscription basis with frequent photo map updates provided by Nearmap’s low altitude aircraft. NEA has a market capitalisation of ~$170m making it just outside the range of the ASX300 and flirting with an inclusion into the index in the future. In late 2014 Nearmap announced it was making the brave step of attacking the US market with a bold prediction of $30m to $50m in sales generated from the US by December 2017. Performance in the US market was initially challenging and delivered results well below expectations (annual contracts of $3m) and eventually resulted in the sacking of their CEO Simon Crowther in 2015, one year after announcing their expansion plans. Whilst the first two years of the USA expansion didn’t live up to the hype, a recent capital raising ($20m at 70 cents per share), continued investment in camera technology, a new CEO and a bulked up US sales force see them now well placed to disrupt and capture a slice of the larger American market in the same way they did in Australia over the past 5 years.

Why we like it

NEA is operating in a growth sector The GIS (Geographic Information Systems) industry has come of age over the past decade with Google Maps and Google Earth becoming an integral part of day to day life for consumers. Alongside these retail applications, commercial aerial imagery has also found a growing business need with Government, SME, and Corporate customers embedding the use of aerial imagery into their operations. The global market for aerial imaging was valued at US$1.1bn in 2014 and is forecast to grow at a CAGR of 13.5% from 2015 to 2023 reaching a value of US$3.3bn by 2023 (Aerial Imaging Market – Global Industry Analysis, Size, Share, Growth, Trends and Forecast 2015 – 2023). The US market is huge Nearmap is estimated to hold around a 15% share of the geospatial image market in Australia which is valued at $30m. Even if NEA are unable to match the market share position that they have achieved in Australia, the scope of the opportunity in the US is so large that achieving just a third of the market share that they currently enjoy in Australia represents significant value and upside. The US market is estimated to be 10x the size of the market in Australia, with a 5% market share to NEA representing $100m of annual contracts, essentially quadrupling group revenue. The US market leader is ripe for disruption The current market leader in the US is EagleView, who has held a dominant position in the country since their founding in 2008. EagleView was subject to a blocked $650m USD takeover proposal in 2014 from Verisek Analytics due to antitrust concerns which highlighted the dominance of Eagleview’s market position at the time in the insurance sector. Eventually EagleView was sold to private equity firm Vista Equity Partners in 2015 for an estimated $715m USD which was then followed by the installation of an external CEO Bill Bunker in 2016. EagleView has been operating without a serious competitor for the bulk of it’s life and has only recently begun investment in an improved imagery capture program via a partnership with Australian company Spookfish. NEA on the other hand has years of experience with next gen capture technology in Australia and has prioritised development of open APIs, integration into world leading GIS software, and a cloud based delivery platform which is many years ahead of EagleView’s “one report at a time” delivery system. Nearmap’s product is damn good NEA are genuine innovators in the GIS market having been recognised as the best new content provider by Esri in 2017 (Esri is the publisher of ArcGIS and is the world leader in GIS analytics). Nearmap integrates into the Esri product suite seamlessly as well as providing open APIs to technology developers and cloud browser access to users. NEA have pursued strategic partnerships where they provide ongoing geospatial imagery to leading analytics providers such as Cape Analytics and Omniearth embedding Nearmap at the forefront of future GIS innovation. The product offering of Nearmap is regarded as the best globally and receives strong positive feedback from a range of customers both in Australia and the USA. The four key customer segments that NEA has been growing in are. Government – monitoring government assets, road conditions, planning approvals Solar – roof measurements, shade estimates, quoting installations without site visit Construction – capturing site changes through time, accurate measurements of development areas, predicting the impact of weather events Insurance – reduce number of site visits, assess property condition remotely, confirm materials of buildings,

monitor flood zones, improve underwriting accuracy. HyperCamera2 next generation imagery NEA has continued to invest in second generation hardware and software to improve efficiency in both the cost of capture, the rate of capture, and the processing and delivery of image files for customer use. HyperCamera2 is the new camera system being rolled out in the US and Australia which is capable of capturing up to 5,000 square kilometers a day per camera including the capture of 3D models and oblique images (aerial photography captured at precise angles to allow the calculation of height and depth). Once the HyperCamera2 system is rolled out to NEA’s fleet in 2018, NEA expects to be able to fly, capture, process and upload a land area the size of the state of the California in just over a week. Management are committed to the US expansion NEA appointed Patrick Quigley to an executive role based in the US at the beginning of 2016 with a mandate to lead the sales and marketing effort for the US expansion. This addition to the executive team shows that NEA is willing to make the long term commitment to the US expansion and are willing to deploy significant resources in order to succeed. This second attempt at cracking the US market seems to take into consideration the mistakes of the 2014 false start with much more realistic revenue and market share expectations being given in line with the Australian uptake during NEA’s early years. After raising $20m from Institutional investors late last year NEA is holding $28m of cash. This is enough to fund years of continued marketing and investment in the United States which means they are able to ride out initial cash flow volatility in early expansion years in order to capture enough market share to sustain the US operation.

Risks and challenges

The above said, no company is perfect and so we have considered some of the risk and potential downside on NEA below;

Corporate Governance and work culture NEA does not have a good track record of market transparency and corporate governance as evidenced by the following string of embarrassing market updates. CEO Simon Crowther massively over promises on US revenue delivery timeline – 13th October 2014

Simon Crowther gets sacked abruptly – 15th October 2015 Millions of free options given to new directors Ian Morris (with a strike of 39.5 cents) and Peter James (with a strike of 55.1 cents) – 3rd February 2016 Company denies strong market rumor of imminent capital raising – 21st November 2016 Company launches rumored capital raising – 24th November 2016

Glassdoor staff reviews show consistent negative bias (however showing some improvement under the new CEO Rob Newman) Unannounced changes in executive structure (General Manager of Australia John Biviano and CTO Paul Lapstun leaving the company) – 20th March 2017

Spookfish The US market leader EagleView has recently teamed up with Aussie tech company Spookfish in a partnership which sees Spookfish receive royalties for the use of their camera hardware and software in the US market. This is a much lower risk expansion strategy from Spookfish however it also limits the upside that they may be able to generate vs. direct competition that Nearmap is undertaking. Spookfish’s technology on paper is up to date with NEA’s, however in practice and at scale Spookfish is untested, whereas Nearmap have years of experience of capture and analytics using their proprietary technology.

Final verdict

Some analysts point to the Australian market experience as a proof of concept that an expansion into America is viable, however others remain wary that Australian firms rarely have success when making the jump into the largest economy in the world. It is important when analyzing a company to not get too caught up in the hype and emotion of a product you believe in. Whilst we do believe strongly in Nearmap’s product as well as the fundamental drivers of the GIS industry, concerns around corporate governance and market disclosure have plagued NEA for some time. Assessing the merits of an investment with a skeptical slant will only serve you well to protect from irrational investments in the long term, which is something we try to keep in mind at Little Hedge when analysing investments such as this. The NEA share price has taken an absolute battering recently as difficulties within the Australian executive team came to a head with two senior members leaving the company (General Manager of Australia John Biviano and CTO Paul Lapstun). This was not announced to the market. This is déjà vu for NEA shareholders as it was less than 2 years ago that then CEO Simon Crowther was unceremoniously booted from the company and replaced by Rob Newman with the promise of improved market transparency and governance. On valuation, we believe the current entry price represents great value for investors wishing to take advantage of the recent market panic. Whist we acknowledge that there remains the possibility of short term noise from recent management departures, we firmly believe that the recent share price rout leaves risk skewed sharply towards the upside. On balance we see the opportunities over the medium term from the US market to materially outweigh the short term volatility the stock has experienced in the past week, therefore we see the current share price representing an attractive entry point. At Little Hedge we have a medium term investment outlook which gives us 3-5 years to assess the performance of NEA’s rebooted expansion into the US. Over the next 3 years we expect the US operation to achieve revenue growth in line with that of the Australian operation during it’s early growth phase. We forecast revenue from the US to hit the originally predicted $30m to $50m by 2020. Little Hedge places a BUY rating on NEA at today’s market price of $0.45, and make an addition to the Little Hedge portfolio.

Disclosure: At the time of publishing, the author owned shares in NEA.