SaaS Shift And Public Sector Contracts Will Support Steadier Earnings Despite Margin Pressures

Catalysts

About i3 Verticals

i3 Verticals provides software and payment solutions focused on government, education and other regulated markets, with a growing emphasis on SaaS and transaction based offerings.

What are the underlying business or industry changes driving this perspective?

• Although SaaS revenue growth above 20% and recurring revenue at 8% point to healthier, more predictable top line contributions, the mix shift away from professional services creates a drag on short term adjusted EBITDA margin, which could limit earnings growth if cost alignment lags revenue.
• While the acquisition of the insurance verification provider adds a software business growing above 20% with EBITDA margin above 50%, integration risk and the shift from a primarily software model to a combined software and payments model could compress those margins and temper future EBITDA per share.
• Although demand for modernization in JusticeTech, transportation and regulatory and licensing markets is rising, project timing and the reliance on RFP driven cycles can keep professional services revenue uneven, which may weigh on near term revenue growth and margin stability even as long term contracts accumulate.
• While the emphasis on AI enabled features and unified data structures fits where public sector technology is heading, slow policy making, security requirements and inconsistent adoption across jurisdictions can delay monetization, keeping AI more of a cost item rather than a contributor to revenue and net margins in the near term.
• Although the company reports a strong balance sheet with US$37 million of cash, no debt and access to a US$400 million revolver for acquisitions and buybacks, paying around 15x EBITDA for high growth targets raises the bar for future deals, and overpaying for slower growing assets would pressure returns on invested capital and future earnings.

Assumptions

This narrative explores a more pessimistic perspective on i3 Verticals compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming i3 Verticals's revenue will grow by 7.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.2% today to 7.1% in 3 years time.
• The bearish analysts expect earnings to reach $19.1 million (and earnings per share of $0.48) by about February 2029, up from $2.5 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $22.1 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 26.1x on those 2029 earnings, down from 191.7x today. This future PE is greater than the current PE for the US Software industry at 24.2x.
• The bearish analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.4%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The shift toward long-term SaaS and transaction based contracts in public sector markets, with annual recurring revenue of US$169.6 million and 80% of quarterly revenue already coming from recurring sources, could support steadier cash generation and help lift earnings and net margins if this mix continues to grow.
• SaaS revenue growth above 24% for the quarter, with management expecting organic SaaS growth to stay north of 20% and additional SaaS contribution from the new acquisition, could support a higher long-run revenue base and potentially stronger earnings than implied by a flat share price view.
• The acquisition of an insurance verification provider growing above 20% with EBITDA margins above 50%, combined with the ability to cross sell into i3 Verticals' transportation and payments footprint across 30 states and 4 Canadian provinces, may support higher long-term revenue and EBITDA than currently assumed.
• Ongoing investments in JusticeTech, utilities, transportation and AI enabled features, along with project wins such as the West Virginia Supreme Court of Appeals and the Arizona Department of Real Estate, could translate into a larger contract base over time and support higher recurring revenue and net margins once upfront investment eases.
• A strong balance sheet with US$37 million of cash, no debt and access to a US$400 million revolver, together with active share repurchases when management views the stock as inexpensive, could support earnings per share growth through disciplined M&A and buybacks, challenging the idea that the share price stays flat.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for i3 Verticals is $22.0, which represents up to two standard deviations below the consensus price target of $31.33. This valuation is based on what can be assumed as the expectations of i3 Verticals's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $39.0, and the most bearish reporting a price target of just $22.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $267.3 million, earnings will come to $19.1 million, and it would be trading on a PE ratio of 26.1x, assuming you use a discount rate of 8.4%.
  
• Given the current share price of $21.79, the analyst price target of $22.0 is 1.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.