Shifting To High-Margin Software And Services Fuels Growth And Shareholder Value

Key Takeaways

• Shift towards higher-margin software revenue and strong ARR growth indicates a robust pipeline for future revenue and earnings enhancement.
  
• Investment in security product innovation and operational efficiency efforts aimed at reducing expenses could significantly increase market share and net income.
  
• Transition to a SaaS model, and seasonal revenue recognition challenges could threaten profitability and sales consistency, impacting future earnings expectations.

Catalysts

Designs, develops, and markets digital solutions for identity, authentication, and secure digital agreements worldwide.

• OneSpan's shift towards higher-margin software revenue is expected to improve net margins through a favorable product mix. This shift is evident as software and services now account for approximately 3/4 of total revenue, up from a 64% share three years ago.
  
• Strong Annual Recurring Revenue (ARR) growth, highlighted by a 15% increase to $165 million, indicates a robust pipeline that could drive future revenue growth and earnings as the company capitalizes on existing customer relationships and attracts new ones.
  
• The company's focus on operational excellence and cost reduction efforts, which resulted in $73.5 million in annualized savings, is likely to enhance net income and cash flow by reducing operational expenses and improving efficiency.
  
• OneSpan's investment in product innovation, especially in security enhancements and new product launches like FIDO hardware tokens, could capture additional market share and increase revenue from new and existing customers.
  
• The Board's upcoming review of cash generation and capital needs with a view toward returning capital to shareholders could result in shareholder-friendly actions such as dividends or share buybacks, potentially increasing earnings per share (EPS) and shareholder value.

Assumptions

• Analysts are assuming OneSpan's revenue will grow by 2.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 6.6% today to 23.0% in 3 years time.
• Analysts expect earnings to reach $62.0 million (and earnings per share of $1.58) by about September 2027, up from $16.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.2x on those 2027 earnings, down from 37.2x today. This future PE is lower than the current PE for the US Software industry at 38.8x.
• Analysts expect the number of shares outstanding to decline by 5.27% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.65%, as per the Simply Wall St company report.

Risks

• The potential decline in hardware revenues in the second half of the year compared to the prior year could reduce overall revenue and impact profitability.
  
• A reported expectation of maintenance revenue decline, largely due to the end of life of the Dealflo product and perpetual to term conversions, might negatively affect revenue stability and predictability.
  
• Seasonality impacts, particularly the third quarter typically not being a strong bookings quarter, could lead to uneven revenue recognition and possibly affect cash flow consistency.
  
• Risks associated with executing on the transition to a SaaS model, as indicated by the significant changes in revenue mix towards software and services, which if not managed well could impact profit margins and operational efficiency.
  
• The challenge of maintaining strong sales performance into the second half of the year, given the suggestion that some deals expected in Q3 were closed in Q2, potentially creating a high baseline for comparison and impacting future earnings growth expectations.

Valuation

• The analysts have a consensus price target of $16.33 for OneSpan based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $20.0, and the most bearish reporting a price target of just $14.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $269.5 million, earnings will come to $62.0 million, and it would be trading on a PE ratio of 10.2x, assuming you use a discount rate of 6.6%.
  
• Given the current share price of $16.04, the analyst's price target of $16.33 is 1.8% 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.