Hunting For Compounders - Kape Technologies

28th Jan '21 by Jack Brumby

14 comments 8264 reads

Kape Technologies (LON:KAPE) , it’s fair to say, divides opinion. On the one hand, it’s growing at pace, but on the other it is majority-backed by a colourful billionaire and comes with some pretty hard-to-decipher accounts.

At a recent Mello Bash, I was asked to look into this mid cap technology stock and owner of the CyberGhost VPN brand. Either this is a great investment opportunity in a high growth market, or it could go badly wrong.

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My initial view is that Kape Technologies is probably well-placed to grow for many years to come. It will do this via organic investment and acquisitions. Given that, I think it is probably attractively priced at 17.2x forecast earnings and 4.1x forecast sales.

But I qualify my view due to accounting issues which I have so far failed to resolve. And because of that I continue to rule it out as an investment.

There’s no two ways about it: Kape’s accounts are hard to understand. Perhaps Kape holders on the site can give some insights.

As I see it, underlying performance is obscured by:

The recent shift in strategy and reporting segments,
Subsequent material acquisitions,
Adjusted cash flow accounting,
Adjusted EBITDA measures, and
Accounting for contracts.

Complicated accounts put me off. It seems I’m not alone - the Mello panel quickly identified these issues and the company was deemed a clear majority ‘Sell’ in the eyes of the c500-strong audience.

It would be great to get some views on this one because if these doubts over the accounting can be legitimately explained, then we are probably looking at a high growth company that is being discounted by the market due to it being in the ‘too difficult’ tray (or worse) for many investors.

Kape: a brief summary

Kape is a digital security software provider that focuses on protecting consumers and their personal data as they go about their daily digital lives. These security products are designed for big, growing global consumer markets.

The group has successfully transitioned to a SaaS model and boasts strong revenue visibility and EBITDA growth. With its focus on customer service, Kape is also achieving strong customer retention of around 80%.

Its operating segments are Digital Privacy and Digital Security.

The Digital Privacy market is a fast growing area and the COVID pandemic has increased internet usage. The VPN market exceeded $25bn in 2019…

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Simon Rowan

28th Jan '21

On the usage side, its been pretty mixed. When I first started using their PIA it was very good, and customer service was ok too. Both seemed to deteriorate over the year. I thought it might have had something to do with having anti virus software from AVST. Turns out they have been in the process of upgrading their equipment. At least I can use it again now and all the messages about needing to confirm my identity have stopped.

You have a choice of connection through many different sites around the world which is quite fun. At one stage I could only connect via Australia. I started getting bombarded with adverts from Australia. I have to say this didn't happen from connections around Europe or America.

One of the really annoying side effects of using VPNs is you tend to get blocked from media sites like BBC, youtube etc. So I have to disable it and remember to reconnect when I want to go back to being hidden, for financial transactions etc. Governments are also not very keen on these because they fear it hides many criminal activities.

I have had many discussions about how necessary a VPN really is. Its a bit like insurance . Sort of scared into having it. Cant say I ever had a problem before I started using one.

Its a fast moving market. Nearly all providers offer massive deals 70% off (only if you sign up in 10 seconds) . There are at least 700 different brands out there and recently free ones are appearing.

Kape have obviously seen this coming and are now bundling up with their own anti virus software.

Having had Avst for years and recently trialed their aptly named 'Hidemyass" Vpn I will probably switch to them on renewal. There was an issue with AVST last year, they got pinged for selling data traffic from their customers and having sold Jumpsot the side shoot for this purpose to ASCL for 35 million, they had to buy it back and close it down after a tech mag pointed out there might be a conflict of interest! no, surely not.

Its a huge market, but becoming a very crowded market place. Have made a few bob from trading Kape this year. I can't see that happening again this year and most of all if you guys can't quite get to grips with the accounts, not much chance for the rest of us. Very grateful to you for reviewing and making me think a lot harder about it!

portugull

Jack I watched your presentation on Monday having recently bought an Annual Pass for Mello .I was really put off by Leon Boros who I hold in very high regard. He was very clear he would not touch it.

At 2.50 today I sold my entire position and when I read your report later I felt vindicated. Prior to building the position I have just sold I had done well on £KAPE first time round having bought in 2019 and sold in late April 2020.

I got out this time for a minuscule loss and only time will tell but I have learnt if in doubt sell while you can. Thank you for a really forensic dissection of the accounts .

Dojosan

Tried to trade it a few times and now given up. Prior to Teddy (the main shareholder shoving in $72mn to pay off the acquisition of PIA), the company's sentiment was pretty poor languishing around 150p. Prior to that, their autumn TU was pretty good - yet it was a pump and dump job. They then presented for U.S investors, saw a pick up of circa 10%-15% on the SP , after I sold off at a small loss. Sentiment started to change after the $100mn placing which Teddy, via another company put in $72mn. Stlll does not seem to be able to get pass 220p!

intuitive6191

"One of the really annoying side effects of using VPNs is you tend to get blocked from media sites like BBC, youtube etc."

I am not sure that this applies to all VPNs. There is a VPN for every situation depending on whether it's privacy, streaming etc that you favour.

Reviews of the leading contenders for VPNs can be found here. It's been a while since PIA has been mentioned.

It's a big potential market, but don't be surprised if the bulk of average users eventually use a browser based VPN as already developed by Firefox.

ridavies

29th Jan '21

Thank you Jack for that very thorough review. I held Kape Technologies (LON:KAPE) until the Mello evening. As you say there were some strong words used about the financials. As one of the earlier commenters here said, if the experts there At Mello cant understand the REAL profitability of the organisations, what chance do we have. I also sold all my holdings on Wed at a small loss, and slept more soundly. I have been a holder of a number stocks which Mr Sagi has been involved in. One was Xlmedia (LON:XLM) which I believe he was instrumental i setting up, and which traded up to over 200p before it fell off the shelf as mcuh fo the business fell away. Another was Playtech (LON:PTEC) which was doing very nicely. I had the shares at a SP of £10 at one time; Mr Sagi's company sold down its shareholdings in large sections which were readily snapped up by institutions at the time. Then the cash cow of the company, the Asian betting organisation 'managed' through a single main distributor, literally fell to bits and the company which for years had been - and in many ways still is - the gold standard provider of gambling software - fell very quickly. It changed from being my most profitable holding to my least quite quickly. It is recovering but it has been a hard road. So all in all, I am a sucker for my 3 entries into his world. All 3 have had good times, shown significant expansion, BUT there have been really big question marks and painful events in their recent history. So for me there wont be a fourth entry into that world.

mesb

Hi Jack. Interesting note, thank you. I watched their Capital Markets investor presentation last summer and was interested in the business. A lot of it was focused on the PIA business they'd bought in the US where it was explained that PIA had good product but was not really growing, so a key strategic rationale for KAPE to do the acquisition was to apply KAPE's (apparently better) existing user acquisition processes to drive growth in PIA - the subsequent RNS announcements last summer gave some info on how PIA was doing in growing users post-acquisition but I note more recently they have gone rather quiet on the detail of that growth in PIA specifically. So that, plus the fact the CEO still hardly holds any shares despite finally buying in during the recent placing, makes me sceptical now too.

WarrantStar

Thank Jack. Your pieces are always well worth a read. I like the saying "Sales are vanity, Profit is sanity, and cash is king." So, if there is a trend of rising profits (whether reported or adjusted) but a decent free cash flow never seems to materialize, then I will remain skeptical about the reality of the profits.

Since I posted yesterday I have read your piece again twice and unless I missed it you do not refer to the $100m Capital Raise which resulted in a $72m pay out to the previous owners of the PIA business which Kape bought in 2019. Would this transaction have a lot to do with the very complex and hard to understand Accounts?

FearlessFlyer67

If I could try and shed a light on what is going on here - you need to read the accounting policies note in the Annual Report and its starts to become a bit clearer what they are doing. Firstly, they sell services to customers for extended periods for say 2 years or three years. In terms of revenue recognition, it would appear that most of it is reasonably straight forward and the value of a three year contract would be recognised "straight-line" over the period i.e. a third, a third, a third in each year as the contract runs its course and this is not unreasonable.

However, the snag comes with what they are doing with cost of marketing and selling to secure those customers and contracts. Here the argument appears to be that at the very least these costs will be similarly spread over this same period and that goes against the accounting concept of prudence and more conservatively recognising costs as they are incurred. Furthermore, there is also reference to renewal rates being used to assess the appropriate carrying value and any required impairment of these costs, which would suggest to me that they may be further extending the period over which these costs to reflect lifetime customer value, based on the probability that a customer will just renew their contract for a further 2-3 years.

Suffice to say, as a holder who was sitting on a 70% gain having picked up the shares on the day the PIA acquisition was announced, it was not a difficult decision to sell my holding this week. Big thanks to Jack and Mello bash panel for bring this to my attention and hope this is helpful to other holders....

Andy Leadbetter

30th Jan '21

Hi all,

A really good piece and have very much enjoyed reading the comments. Ive been a holder of various Israeli tech based stocks since 2015 and its clear that Mr Sagi is a 'king pin' in the country and backs various organisations.

I've held (and still do hold) £plus, 888 Holdings (LON:888) and £kape. I did hold £xlm but no longer. Before discussing £kape any further, i just have a couple of observations.

I've attended Mello (although not a subscriber to the covid annual pass) and met Leon Boros & a number of the Mello/Stockopedia guys a few times - all very impressive and respected.

The first thing i would say is that many seem to distrust Israeli tech stocks - I appreciate a few may have been dodgy in the 80s/90s but i havent come accross one yet. Im also a student of David Ryan/Minervini and have attended his Master Trader Program etc

Everyone was very negative about £plus a few years ago - I bought a lot (i run a concentrated portfolio of 4-9 stocks max) at c240p - they are now above 1300p and have paid out much more than my initial stake in divis alone. The Company is a massive cash cow.

888 Holdings (LON:888) - Israeli mgt, based in Gib, major competitor to Playtech and gaming is their Forte, growing like crazy and in the US with partnerships with Caesars and power the World Series of Poker brand amongst others. The company is a massive cashcow.

Xlmedia (LON:XLM) - Met previous CEO a number of times, attended their investor presentation and held them all the way from 60p to over 200p but was far too late in selling them. They were a massive cashcow but got nailed by Google from an SEO perspective and also cookie tracking, industry consolidation, reduced marketing budgets nailed them. Im far from convinced i'll buy them again as its very clear that regardless of anything else - a seo ranking penalty from google and they are crippled - so its a firm no from me.

Regarding £kape, its a completely different company since 2017, its growing like crazy, is acquiring customers (ironically in a similar manner to plus500) ie expensive acquisition cost but lifetime value results in profitable customers.

The relatively recent volatility was because certain individuals knew about the capital raise at 150p - which was massively over subscribed btw. So its not a stock us punters are going to know much about via RNS's etc - thus price action is key.

I hold about 20% of my SIPP in £kape. I believe in the story, bought at c80p following reading a write up in SCSW. Given exposure to US, i expect them to grow significantly and may even list in the US. I'd buy a load more if they went south of 160p as they are likely to do more capital raises in future and they've already said they are going to do another acquisition in H1 21. Its not a stock for the faint hearted but Im a buyer.

My other major holding that fits my criteria at present is £BOO. I bought it following their ESG scandal in July last year.I know Paul and fellow stocko subscribers really like it and thus it also fits the criteria i like.

Digitally led, strong growth no major overheads such as shops, pension liabilities, and high volumes of staff, offer strong cash generation and high ROCE (learned that from Terry Smith's most recent book).

I know the accounts for £kape dont show that yet - but in my opinion, the lack of the clear accounting story, results in market inefficiency and creates opportunity for others. I will hold until growth slows.

All my own thoughts and best of luck to all.

PeterW

My view on the capitalising of the marketing (client acquisition) costs, thus flattering profits over cash flow, mirrors that of other comments here. However I would add that an 80% retention rate is not that fantastic and it is clearly a competitive market, getting more so over time. Unless the retention rate goes up or the cost of client acquisition goes down then cash generation will remain elusive. Thanks for pointing this out Mello Monday and Leon. I didn't do my homework properly and have sold out for an undeserved profit.

Best, Peter

Albertos

31st Jan '21

There is no such thing as the "prudence concept" in accounting. That died long ago as International Standards moved to fair value accounting. You're actually not allowed to be prudent anymore.

SSAP 2 died many years ago.

Leo Lin2

1st Feb '21

Insiders holding more than 60% . I am not concerned with accounting. As long as the growth story is continuing, I will hold it tight and buy more. Target price 240p end of year.

Gromley

Wow. Just wow!

If that works, you should definitely write a guru book on the investment strategy.

Hunting for compounders - Kape Technologies

Kape: a brief summary

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Jack Brumby

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