Description

How much would you pay for a mission-critical, first mover with best-in-class software metrics growing at 30% YoY? Currently trading at 2.3x NTM sales, we think Blackline Safety (TSX: BLN) is a significantly undervalued and high quality business with a clear line of sight to a double in 3 years as the business transitions from hardware to SaaS. 

Thesis Summary

Blackline Safety is a provider of gas detection and safety monitoring to the energy, industrial, transportation, and CPG verticals. Blackline’s product suite includes the G6, G7, and G7 Exo gas detectors which are attached to subscription-based live monitoring and safety services. We believe that Blackline offers 100% upside over the next 3 years through a combination of 1) sustained 30% revenue growth as they continue to take share in a secularly growing industry, 2) improving margins and a swing to profitability from cost optimizations, operating leverage, and the sales mix shifting from hardware to SaaS, which should lead to 3) the multiple rerating from today’s level of 2.3x NTM sales closer to peers like MSA at ~4x NTM sales. 

History

Before we discuss the story further, we believe it’s important to cover management’s history in the gas detection market. Blackline’s CEO and founder, Cody Slater, invented the world’s first wireless area gas detector, the RigRat, in 1987 as an undergraduate at the University of Alberta. Mr. Slater subsequently founded BW Technologies to market the RigRat, following it up with several highly successful products. In 2004 BW Technologies was sold to First Technology and subsequently acquired by Honeywell in 2006. The same year BW was acquired by First Technology, Mr. Slater founded Blackline Safety.

Blackline released several GPS-enabled asset trackers over the next decade before pivoting back to the gas detection space with their first product, the G7, released in 2015. Relative to competing products from peers like Industrial Scientific, MSA, and Honeywell, the G7 was the first natively connected gas detector. For context, gas detectors have been largely unchanged over the past two decades, with incremental improvements focusing on improving battery life and smaller sensors rather than adding connectivity. The G7 included cellular/satellite capabilities in concert with several sensors which enabled fall detection, worker tracking, automatic compliance reporting, and facility-wide alerting/evacuation. The G7 quickly gained traction among blue-chip customers in the utility, energy, refining and CPG markets, with sales CAGR-ing at 39% from FY17-FY23. Competitors were slow to react, with only MSA releasing a like-for-like product in 2022 (and aborting another shortly after launch). Blackline followed up the G7 with a connected area gas monitor, the G7 EXO in 2020, and the lower-end G6 in 2023. 

So why does Blackline keep winning share? We believe there are a few key dynamics at play. For competitors like Honeywell and Industrial Scientific, gas detection is a minor part of the business - our understanding is that Honeywell is running their gas detection business for cash, while IndSci has failed to release competitively viable products. MSA is the closest competitor with one connected product offering, but as a century-old hardware company with minimal background in cloud-connected products, has struggled significantly with software. All three are losing customers to Blackline. Blackline has also been very active in improving their products, with features like gas bloom modeling and predictive maintenance recently introduced, as well as a refreshed G7 with improved hardware scheduled for release this year. As the industry continues to shift towards connected workers and increased safety regulation, we believe that Blackline is well-positioned to continue taking share for the foreseeable future. 

Why The Opportunity Exists

Shortly before Blackline was uplisted to the TSX in June 2021, costs began ballooning out of control. Much of this was due to the concurrent development of the G5, G6, and G8, as well as aggressive salesforce expansion. At the same time, China shutdowns and supply chain issues caused product gross margins to halve from the low-20s to 10% in Q1 22. The combination of compressing gross margins and rapid opex expansion cratered EBITDA margins, hitting -64% in FY22. In response, management instituted their first ever price increase of 15%, slowed the development of the G5 and G8, and began aggressively optimizing the cost structure. Since then, opex intensity has dropped from its peak of 133% of sales to 66%, while EBITDA margins have rapidly improved to just below breakeven.  The stock reached a low of $1.86 or 1.2x sales in late 2022, but has since recovered to ~$4.50 or 2.4x sales. 

We also think it’s worth diving a bit deeper into the implications of the 15% price increase on net dollar retention, as well as a potential point of confusion. Shortly after management implemented their price increase, net dollar retention began growing from its historical average of 105% to a recent high of 130% in Q1 2024 - many sell-side analysts seemed surprised by both the scale of the improvement and the guide for continued NDR growth through FY24. Our understanding is that contracts are 4 year lengths, meaning pricing takes that long to roll through the PnL. About 2/3s of the 25% growth in NDR came from organic seat expansion and service upselling, with the remaining third coming from pricing. This also implies that the next 2 years will see a ~7% tailwind as pricing is fully realized. 

Financials/Valuation

Blackline operates as a hardware-enabled SaaS company (HeSaaS). This essentially means that all gas detectors come with subscription services attached. Blackline offers several service tiers, ranging from basic compliance reporting for $15/month/device to 24/7 live monitoring and emergency services dispatch for $125/month/device.

This stream of software revenue comes in at 75% gross margins, with hardware going for high-20s (projected to grow to high-30s with scale/supplier improvements). Our expectation is that hardware will continue growing at a 25% CAGR (vs 32% L4Y) over the next 3 years, reaching $90mm in sales by FY26. We expect the software/service segment to grow at a 35% CAGR (vs 31% L4Y) as the new G6 and refreshed G7 drive additional services uptake, reaching $130mm in sales by FY26. Assuming minimal GM improvement and HSD opex growth (vs management’s LSD guide) gets us to $28mm of EBITDA/12% EBITDA margin in FY26. If we apply a mature safety hardware (MSA, FTV, HON) multiple of 15x EBITDA, we get an implied price of $5.61, a 26% premium to today’s price. However, this discounts the very high quality (100% gross retention, 130% net dollar retention, 75%+ GM) software segment and its inherent operating leverage potential; in fact, applying an MSA/FTV/HON 4x sales multiple to only the projected FY26 hardware sales gets you the entire EV of the firm today.

If we add a median cloud software sales multiple of 6.4x to software sales, we arrive at an implied price of $16.43, a 269% premium. The most likely outcome is obviously somewhere in the middle - but we think ultimately the numbers pencil out to a downside-protected stock with significant upside potential. For a “maximum” upside case, we can look to comps like AXON and IOT that trade >10x sales. Additionally, formers and management have mentioned being approached several times by interested acquirers - if we had a nickel for each time Mr. Slater’s gas detection company was acquired…

Risks

There are several risks to our thesis we think are worth mentioning. Opex controls have been a significant issue in the past - we believe management has internalized the lessons learned in FY21-22, and with the bulk of R&D for the G6/G7 refresh done and the SG&A structure optimized, we don’t believe there is significant reason for them to embark on another spending spree. Mr. Slater owns 2.5% of the company and is clear-eyed about getting the business to profitability. We are not as worried about competition - connected gas detectors are an extremely sticky product, as evidenced by the 100% gross retention, not to mention the significant training and hardware costs involved in replacing/deploying with a new provider. We believe even if MSA/IndSci release a competitive product, there is both enough white-space within the growing industry and untapped wallet share within Blackline’s existing F500 customer base to sustain meaningful growth. Blackline currently has ~$6mm of net debt with $53mm of capacity on a lease securitization facility and is guiding for positive FCF this year. 

The biggest issue by far is Blackline’s exchange, size, and commensurate illiquidity - Blackline trades just over $80k volume/day, and Canadian-listed microcaps have a long history of fraud and blowups. Based on our conversations with formers and competitors, and our anecdotal experience with the product, we have no doubt that Blackline is a real company with well-regarded management and products. Management has floated the idea of relisting to the US in the next few years, but it is not currently a priority. Size appropriately. 

Conclusion

On the whole, we view Blackline as a compelling “heads I lose nothing, tails I win” opportunity. We believe the current valuation ignores the potential of the software segment, while discounting the Blackline’s substantial first-mover advantage and their ability to drive continuous share gains in the face of lackadaisical and slow-moving competitors. Though our thesis does incorporate multiple expansion, even assuming a flat sales multiple the company should be able to grow revenues at 30%+ for the next several years. 

Catalyst

Profitability, US relisting, acquisition.