Red Violet from Cogint
Summary
(12 Mar 2018) This high risk spinoff is not suitable for most investors. Any money committed to this spinoff will not be backed by a healthy margin of safety at this time. The company's future operations require significant growth over a short period to make this a great investment.
Parent Ticker: COGT
Announced Record Date: 19 Mar 2018
Announced Distribution Date: 26 Mar 2018
Anticipated Ticker: RDVT
Business
The company provides solutions to organizations in the risk management industry. It offers CORE, a data fusion platform that provides mission-critical information about individuals, businesses, and assets for banking and financial services companies, insurance companies, healthcare companies, law enforcement and government, the collection industry, law firms, retail, telecommunications companies, and corporate security and investigative firms.
Parent Child comparison
The parent company, Cogint, provides information and performance marketing solutions to its customers. Red Violet will operate its data fusion platform for risk management primarily in the banking and financial industries. Both companies sell cloud-based products. Both companies do not pay a dividend nor do they anticipate doing so in the foreseeable future.
Spin Ratio
1 share for every 6 shares of COGT
Cash Flow
The upcoming spinoff, Red Violet, will have begin its life as an individual company with $9.6 Million in contractual obligations from lease agreemenets, litigation settlements, and data licensing agreements.
Cash Position
The spinoff includes a provision that Cogint, the parent company, will provide Red Violet with $20 Million cash upon separation.
Revenue Projections
Red Violet will most likely have revenues of 12-16 Million next year.
Break even
As with many new companies, the only way to value them is to calculate their break even. The current growth rates for RDVT, although impressive would not show a breakeven by 2020. At this stage the company's growth rates are extremely fast with 84% increase in revenues last year, sales of $4.6 grew to $8.6. The problem is that the cost to create this additional revenue appears to be growing almost as fast with cost of revenue growing from $4.3 to $7 and sales and marketing expenses from $2.8 to $4.4. The company's general and administrative expenses grew from $9.7 to $17.5. These costs preclude the $9.6 in contractual obligations next year. The management team claims that the cash position upon spinoff with the 20 contribution by Cogint will be sufficient to cover all cash needs for the next twelve months. However, Red Violet may not reach breakeven for the next 36 even if it grows at an extremely fast rate nearly doubling each year for three years and maintains the same general and administrative expenses or it significantly reduces its cost structure. Management's past track record with Cogint indicates that the growth story seems more likely than a fiscal discipline story.
Management Actions
Upon completing the spinoff, Cogint management claims that COGT will be profitable from day one. This is peculiar statement to make given that the CEO, CFO and CIO all will leave COGT for RDVT upon spinoff. Why make such a move when this is what they achieved over the past few years? Perhaps there is more opportunity than meets the eye why else would they leave a cash positive startup for one that has only produces significant losses? It may be possible that they recognize that the costs after the first year will significantly diminish as they pay off the rest of the litigation costs associated with the TRADS litigation settlement. The costs associated with this will end in 2018 after the balance of $4 Million is paid. A quick study of Cogint's history shows that the CFO increased the number of shares outstanding from 7.3 Million in 2014 to 53.6 Million in 2016. His willingness to deplete current shareholder ownership seems to be out of alignment with shareholder interests. The CEO and CFO receive a significant portion of their annual income from company interests valued at approximately 5x their annual salaries or more.
Activist Investor Activity
Activist investor activity appears unreported.
Peer Comparison
Among their claimed peers: Palantir, RELX Group, Transunion, and Thompson Reuters; Red Violet is the only company without positive cash flow. This list put forth in the Form 10-12B, seems a little starstruck. Red Violet's sales are a minute fraction of the sales these other companies generate.
Opinion
This risky spinoff has attracted the senior leadership of the parent company, Cogint. When the spinoff occurs, the CEO, CFO, and CIO will leave their positions at Cogint to lead Red Violet. They will receive approximately 1.1% additional interest in the company prior to the spinoff due to an accelerated payout of their restricted stock units with Cogint. Interested parties should understand that their investment in this company will be similar to the seed funding a new company receives from angel investors and that their chance of getting return from investing in this company is possible and may be highly lucrative; however, at this juncture it is extremely risky lacking positive cash flows from operations.
SEC Reports
Research Notes
Red Violet 2018 Stock Incentive Plan
Overview
The Board of cogint and cogint, as the sole stockholder of Red Violet, have approved the Red Violet 2018 Stock Incentive Plan (the “Plan”) pursuant to which upon completion of the Spin-off, Red Violet may issue up to 3,000,000 shares of its common stock. Red Violet’s primary purpose of the Plan is to attract, retain, reward, and motivate certain individuals by providing them with an opportunity to acquire or increase a proprietary interest in Red Violet’s and to incentivize them to expend maximum effort for Red Violet’s growth and success, so as to strengthen the mutuality of the interests between such individuals and the stockholders of Red Violet. As of the date of this information statement, no awards have been issued under the Plan.
The Spin-off is governed by a Separation and Distribution Agreement (the “Separation Agreement”), an Amended and Restated Tax Matters Agreement (the “Tax Matters Agreement”), an Employee Matters Agreement, and a Transition Services Agreement, each dated February 27, 2018, and each between cogint and Red Violet (collectively, the “Spin-off Documents”), which provide the terms and conditions of the separation of the two businesses and for the Spin-off, which include Red Violet’s right to request up to a $20.0 million cash contribution from cogint before the Spin-Off. Red Violet will be led by cogint’s current management team, including Derek Dubner, co-founder and Chief Executive Officer of cogint, serving as Chief Executive Officer of Red Violet and Michael Brauser, co-founder and Chairman of the Board of cogint, serving as Chairman of the Board of Red Violet. Upon completion of the Spin-off, Mr. Dubner and Mr. Brauser will resign from their respective positions with cogint.
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Our principal competitors in the big data and analytics sector include Palantir, RELX Group (LexisNexis), TransUnion, and Thomson Reuters. Current and potential competitors may have one or more of the following significant advantages:
- greater financial, technical and marketing resources;
- better name recognition;
- more comprehensive solutions;
- better or more extensive cooperative relationships; and
- larger customer base.
We cannot assure you that we will be able to compete successfully with our existing or new competitors. Some of our competitors may have, in relation to us, one or more of the following: longer operating histories, longer-standing relationships with end-user customers and greater customer service, public relations and other resources. As a result, these competitors may be able to more quickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, promotion and sale of their products and services. Additionally, it is likely that new competitors or alliances among existing competitors could emerge and rapidly acquire significant market share.
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Results of Operations
Year ended December 31, 2017 compared to the year ended December 31, 2016
Revenue. Revenue increased $4.0 million or 87% to $8.6 million for the year ended December 31, 2017, from $4.6 million for the year ended December 31, 2016. This increase was driven by strong growth in volume resulting from the continued staged release of our product suite, following our transformation from a development organization to a sales-driven organization beginning January 2017. During this time frame, our monthly sales increased from a $5.7 million annual run-rate for the month ended December 31, 2016, to a $11.5 million annual run-rate for the month ended December 31, 2017.
Cost of revenue (exclusive of depreciation and amortization). Cost of revenue increased $2.8 million or 64% to $7.1 million for the year ended December 31, 2017, from $4.3 million for the year ended December 31, 2016. Our cost of revenue primarily includes data acquisition costs. Data acquisition costs consist primarily of the costs to acquire data either on a transactional basis or through flat-fee data licensing agreements, including unlimited usage agreements. We continue to expand our relationships with our key data suppliers, including our largest data supplier, which accounted for approximately 43% of our total data acquisition costs for the year ended December 31, 2017, compared to approximately 29% for the year ended December 31, 2016. Other cost of revenue includes expenses related to third-party infrastructure fees.
We continued to develop our baseline data repository in anticipation of completing the development of our full suite of risk management products during the development periods. As the construct of our data costs is a flat-fee, unlimited usage model, the cost of revenue as a percentage of revenue decreased to 82% for the year ended December 31, 2017 from 94% for the year ended December 31, 2016, as a result of the scaling. We expect that the cost of revenue as a percentage of revenue will continue to decrease over the coming years as our revenue increases. Historically, at scale, the industry business model’s cost of revenue will trend between 15% and 30% as a percentage of revenue.
Sales and marketing expenses. Sales and marketing expenses increased $1.6 million or 57% to $4.4 million for the year ended December 31, 2017, from $2.8 million for the year ended December 31, 2016. The increase was mainly the result of increased headcount as we continue to invest in the expansion of our sales organization. Sales and marketing expenses consist of salaries and benefits, advertising and marketing, traveling expenses, and share-based compensation expense, incurred by our sales team. Included in sales and marketing expenses was non-cash share-based compensation expense of $0.3 million and $0.1 million for the years ended December 31, 2017 and 2016, respectively.
General and administrative expenses. General and administrative expenses increased $7.8 million or 80% to $17.5 million for the year ended December 31, 2017, from $9.7 million for the year ended December 31, 2016. The increase was mainly the result of increased litigation costs, non-cash share-based compensation expense, and employee salaries and benefits. For the years ended December 31, 2017 and 2016, the amounts consisted mainly of litigation costs of $9.2 million and $2.5 million, including one-time accrual in connection with the TRADS Litigation Settlement, as defined in Note 11(c) to the “Consolidated and Combined Financial Statements” of this information statement, of $7.0 million and $0, non-cash share-based compensation expense of $2.6 million and $1.8 million, other professional fees of $1.0 million and $1.6 million, and employee salaries and benefits of $2.8 million and $1.7 million, respectively. Red Violet expects a significant reduction in litigation costs going forward, as a result of the TRADS Litigation Settlement.
Depreciation and amortization. Depreciation and amortization expenses increased $0.5 million or 87% to $1.1 million for the year ended December 31, 2017, from $0.6 million for the year ended December 31, 2016. The increase in depreciation and amortization for the year ended December 31, 2017 was mainly due to the amortization of intangible assets resulting from the software developed for internal use that became ready for its intended use since the second quarter of 2016.
Write-off of intangible assets. The write-off of intangible assets of $4.1 million for the year ended December 31, 2016 represented the write-off of the remaining balance of Purchased IP and capitalized litigation costs as a result of an unfavorable ruling in relation to the Purchased IP litigation. There was no write-off of intangible assets recognized for the year ended December 31, 2017.
Loss before income taxes. We had a loss before income taxes of $21.5 million and $16.9 million, including litigation costs of $9.2 million and $2.5 million, including a one-time accrual in connection with the TRADS Litigation Settlement of $7.0 million and $0, non-cash share-based compensation expense of $2.9 million and $1.8 million, depreciation and amortization of $1.1 million and $0.6 million, and write-off of intangible assets of $0 and $4.1 million, for the years ended December 31, 2017 and 2016, respectively. The increase in loss before income taxes for the year ended December 31, 2017 as compared to the corresponding period in 2016 was primarily due to the increase in litigation costs and share-based compensation expense, which were offset by the decrease in write-off of intangible assets.
Income taxes. Income tax benefit of $0 and $0 million was recognized for the years ended December 31, 2017 and 2016, respectively. A full valuation allowance on the deferred tax assets was recognized as of
December 31, 2017 and 2016. On December 22, 2017, the Act was enacted, with the statutory federal income tax rate lowered to 21% among other changes, effective on January 1, 2018. As a full valuation allowance was provided as of December 31, 2017, the Act does not have any material net impact on our consolidated and combined financial statements, however, certain income tax disclosures, including the re-measurement of deferred tax assets and liabilities and related valuation allowance, and the effective income tax rate reconciliation, are affected. See Note 8, “Income Taxes,” included in “Notes to Consolidated and Combined Financial Statements,” for details.
Net loss. A net loss of $21.5 million and $16.9 million was recognized for the years ended December 31, 2017 and 2016, respectively, as a result of the foregoing.
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(c) Contingency
On July 22, 2017, Red Violet entered into a settlement agreement with TransUnion and TRADS, settling all litigation with TransUnion and TRADS, as described below. Company subsidiary, IDI Holdings, will pay $7,000 to TRADS over the course of one year to settle all these matters (the “TRADS Litigation Settlement”). The terms of the settlement agreement are confidential. The Company recorded the expense of $7,000 in general and administrative expenses during the second quarter of 2017. As of December 31, 2017, the remaining unpaid balance of $4,000 was reflected in accrued expenses and other current liabilities in the consolidated and combined balance sheet.
cogint will continue with the accelerated spin-off of Red Violet, and expects to announce a record date for the spin-off within the next few weeks, subject to the SEC’s clearance of the Red Violet Registration Statement on Form 10 and meeting all other conditions to the spin-off. cogint’s Board of Directors has authorized management to establish a record date for the spin-off at the time all such conditions have been met and expects to declare a spin-off dividend of one share of Red Violet common stock for every four to five shares of cogint common stock held on the record date, subject to the requirements of the Delaware General Corporation Law.
"cogint experienced yet another breakthrough year in 2017 and an even stronger start to 2018," said Derek Dubner, CEO of cogint. "We are so confident in the spin-off path we are taking and the expected increase in shareholder value, that we are announcing today that we will be accelerating the spin-off of Red Violet. This spin-off will enable the investment community to more appropriately value our businesses, provide greater insight into the financial performance of each, will enable each business to make decisions best for its respective interests, including capital deployment, and will permit both to compete more effectively in their respective industries."