Description

RSI is a very high quality SaaS business that has been consistently posting organic revenue growth of 40-50%+ for over two years now, a significant runway for future growth, has 85-90% recurring revenues, no customer concentration, high switching costs, is cash flow breakeven and about to become profitable, yet trades at the extraordinarily low valuation of 0.7x 2016 revenues and 0.8x gross profits.

The company’s size and liquidity make it more suitable for personal accounts.  Shares trade as RSY on the TSX Venture Exchange in Canada and as RSYFF on OTC Markets in the US.

Overview

RSI International Systems is a provider of the cloud-based property management system (PMS), RoomKeyPMS.  Property management systems are comprehensive software products that essentially handle all aspects of a hotel’s operations, include reservations, revenue management, guest engagement, sales, catering, etc.  A typical customer will have one or more properties with 75 to 200 rooms each and will pay around $5 per room per month for access to the base system with additional recurring fees for add-on modules sold by partner companies.

RoomKeyPMS is specifically focused on the independent hotel market (boutiques, regional chains, etc) in North America.  As such, RSI doesn’t really compete directly with many of the large PMS providers that you are likely already familiar with like Oracle (Micros-Fidelio/Opera), Infor (HMS), and Agilysys, who target the larger branded chains with higher-priced products.   By contrast, the PMS market for independent hotels is highly fragmented with dozens of sub-scale competitors and over the last few years RSI has emerged as the leader in this market.

While there around 50,000 to 60,000 hotel properties in North America, RoomKeyPMS is focused on the 10,000 to 12,000 unbranded hotels in North America.  With around 750 properties using RoomKeyPMS today (around 85% of which are in North America), RSI still only has a 5-6% share of this market and a long runway for future growth.

Consistent 40-50% organic growth

RoomKey’s most impressive attribute is the consistency with which it has grown organically at very high rates for the last several years (revenue CAGR over this period of 50%+).  This consistency is most evident in the number of properties using RoomKeyPMS, which has steadily grown by around 30% every quarter.  I’ve estimated this property count over time based on various disclosures made by management in their MD&As:

• Q3 2015 --- 756 --- +33% growth

• Q2 2015 --- 703 --- +29%

• Q1 2015 --- 675 --- +29%

• Q4 2014 --- 612 --- +30%

• Q3 2014 --- 568 --- +30%

• Q2 2014 --- 545 --- +33%

• Q1 2014 --- 525 --- +34%

• Q4 2013 --- 470 --- +26%
  
  

RoomKeyPMS’ annualized organic revenue growth over the last two years has actually exceeded 50%, well in excess of property count growth, due to two factors.  

First of all, as the company has grown they have been increasingly targeting larger hotel properties; while a typical new customer used to have around 100-room properties, that figure has generally moved up to the 150-175 room range now.  With revenues tied to room count and not property count, it has obviously resulted in revenues growing much faster than property count.  

Secondly, the company has also been driving revenues per room higher by increasingly selling additional partner products to their customer base.  Functionality enabled by these products includes enhanced revenue management, mobile engagement, POS, reservation systems, etc.  They are now up to around 15 partner products that integrate with RoomKeyPMS and are essentially sold to the customer base as add-on modules.  These products also generate recurring revenues as the company is paid monthly, although unlike the base platform fees they are generally transactional (tied to bookings) and so this revenue stream has a bit of seasonality to it.

RoomKey revenues have grown much faster than property count due to those factors, as you can see from the data below.  I’ve used TTM revenues due to the seasonality added by the partner products:

• Q3 2015 --- $4.3 M --- +43% growth

• Q2 2015 --- $3.9 M --- +38%

• Q1 2015 --- $3.8 M --- +51%

• Q4 2014 --- $3.3 M --- +46%

• Q3 2014 --- $3.0 M --- +62%

• Q2 2014 --- $2.8 M --- +71%

• Q1 2014 --- $2.5 M --- +58%

• Q4 2013 --- $2.3 M --- +37%
  
  
  

Additional growth opportunities in gaming, international, and acquisitions

RoomKey’s growth has been driven by a focus on the North American independent hotel market, and with only 5-6% share in an extremely fragmented market they still have a long runway here.  There are three additional significant growth opportunities, however, at least one of which they appear to now be focusing on in 2016, in gaming, international expansion, and acquisitions.

Gaming obviously comprises a large % of the lodging industry, but it is not a market that RSI has historically had much of a presence in.  That all changed in November 2015, however, when they announced the launch of RoomKey Gaming, a partnership with SkyWire, a Las Vegas based POS company focused on the gaming market.  Right now they are targeting RoomKey Gaming at the ~1100 properties in the North American first nations gaming market, and management believes this is low-hanging fruit for the company to pursue.  

Importantly, SkyWire is very well incented to make RoomKey Gaming a great success.  Not only will SkyWire obviously generate revenues for themselves from the partnership, but Skywire also owns around 19% of RSI as they purchased 6 million of the 12.5 million shares that RSI issued when they were raising funds in 2014 to help fund their aggressive growth.  While the success of this partnership remains to be seen, I believe its prospects are strong and importantly any contribution it makes in 2016 should be incremental to the core North American independent hotel business that has been driving growth.

International is presently 15% of the business, but the potential exists for it to be significantly larger.  Right now the company has been seeing very strong traction in the US and so they have been (and likely for the foreseeable future will be) focused there, but in the future I think the company will inevitably start to place more sales efforts abroad.  Asia, in particular, is a market that I think the company is in a strong position to pursue eventually.  RSI’s Chairman, Heng Fai Chan, is an extremely wealthy Singapore-based businessman that owns 23% of the company and has extensive relationships in Asia.

Finally, because the independent hotel PMS market is so highly fragmented, there are dozens of potential acquisition opportunities that I believe can be done at attractive prices to augment growth and create significant value.  The business has very high barriers to entry because under a SaaS-model competitors burn cash for a significant period of time until they have enough properties using their software to hit the breakeven point.  At 750 properties, RoomKey is just getting there now, and the vast majority of companies in the industry are nowhere near this size.

My understanding is that there are a significant number of sub-300 property PMSs that are likely losing money and could potentially be acquired at fairly low prices for their customer lists.  Management at RSI, however, is very conservative and risk averse and so I haven’t modelled in any acquisitions -- but I also wouldn’t rule out them embarking on this path eventually as RoomKey’s position in the market continues to strengthen.

Material mispricing due to both obscured revenue growth and depressed profitability

A little history on the company is needed to understand why the shares are so significantly mispriced today.

Back in 2011, RSI was a much smaller, significantly profitable business without a lot of growth.  RoomKey actually had 28% EBITDA margins -- doing just under $500k in EBITDA on $1.7 million in revenues.  Since 2011, however, two events occurred that served to mask the very significant growth and value creation that occurred over the last three years -- and as such have caused the shares to trade at a very large discount to their intrinsic value.

First of all, back in 2011 RSY acquired Veratta, a digital ad agency.  Although the acquisition brought them some good employees and helped them to rebuild their own website, there were no real synergies and the business never really made any money.  As a result, around the fall of 2013 they finally put this business into runoff and although Veratta had $700k in revenues in 2013 the business made a negligible contribution to 2014 (I believe less than $50k in revenues).  Furthermore, with the business in runoff, the company stopped providing segmented data (RoomKey and Veratta) in 2014 and just reported the consolidated results.  

Because of this change in reporting and the runoff of Veratta, I think the vast majority of investors that looked at RSY didn’t realize that RoomKey was posting fairly explosive revenue growth throughout the year because that growth was being masked in the reported numbers.  While the overall business posted a respectable but relatively pedestrian 13% growth in revenues in 2014, RoomKey itself actually grew 46%.  It wasn’t until Q2 2015 that they finally anniversaried Veratta and RoomKey’s revenue growth was fully reflected in the company’s reported revenue growth.  Even today I suspect that the majority of investors that have looked at RSY recently likely view the strong growth in recent quarters as potentially an outlier, when in fact once you strip out Veratta, RoomKey has actually been growing extremely fast and with a fair bit of consistency for over two years now.

Secondly, when RoomKey started to gain a bit of traction in the market and the company was seeing strong returns on their sales and marketing dollars, they decided to materially ramp up their investment spending to drive faster growth.  Like many other SaaS businesses, there is a considerable upfront cost to growth as acquiring new customers and onboarding them is very expensive in the near-term and the benefits of that investment are realized only over time in the form of high contribution margin annuity streams.  The upfront cost of growth is so significant that customers in fact sign three year contracts for this very reason; SaaS PMS companies need to be certain of well more than a year’s worth of revenues to justify the upfront investment needed to acquire and onboard a new customer.

The strategy was very successful, and as you would expect it took a $1.7 million revenue, 28% EBITDA margin business temporarily into the loss column.  The business that was doing almost $500k in EBITDA profits in 2011 ended up troughing around $550k in EBITDA losses in 2014 and has been improving ever since; last quarter they were finally right around EBITDA breakeven again.

With the company consistently running modest EBITDA losses for the past several years (although cash flow breakeven this year due to growing deferred revenues), this has caused investors to overlook the significant value that’s been created by growth over the last several years.  One has to look beneath the surface and understand the cash flow dynamics of SaaS businesses to understand this, however, and given the company’s small market cap very few investors have noticed, thus materially depressing the share price far below intrinsic value.

Company is now at an inflection point which should serve as a strong catalyst

With the company finally around breakeven and on the cusp of profitability, I believe the stock is at a major inflection point.  I have observed from other microcap SaaS companies that they tend to see disproportionately large increases in share price once they move from losses/breakeven to even very modest profitability; I suspect that will be the case here, particularly considering how low the company’s revenue and gross profit multiples are.

Based on the current trajectory of the business they should finally start showing some modest profits in 2016 as SG&A grows slower than revenues.  If there was any prior question about their ability to reach profitability in 2016, I believe that the large and sudden increase in the USD vs the CAD since their most recent quarter has eliminated it.

RSI’s profitability in the near-term is significantly levered to the USD/CAD exchange as 80% of revenues are denominated in USD and almost all of the company’s costs are denominated in CAD.  The average USD/CAD exchange rate in Q3 was $1.31, and the decline of the CAD has increased this significantly to $1.42 today -- everything else being equal, that FX change alone should translate into an incremental $300-400k in EBITDA annually.

Valuation

The company should have ended 2015 with around $4.7 million in revenues and $4.1 million in gross profits.  I believe RSI should conservatively do at least $6.1 million in revenues in 2016, which is only 30% growth and well below their current rate of growth.  That level of revenues should generate around $5.3 million in gross profits.

With a current market cap of $5.7 million and an enterprise value of $4.5 million, that translates into a valuation of only 0.7x 2016 revenues and 0.8x gross profits (and 1.0x 2015 revenues and 1.1x gross profits).  That is an exceptionally low valuation for a high quality SaaS business that has consistently grown organically at 40-50%+ rates.  SaaS companies with similar growth characteristics more commonly trade for 6 to 10x revenues -- which would translate to a share price range of $1.00 to $1.60 based on projected 2016 revenues and fully diluting the shares.

Risks

• Execution - growing at high rates can make it difficult to maintain service standards, and a deterioration in service standards can lead to higher churn rates

• Competition - while competition over the last few years has been modest, competition could intensify in the future

• Economic - a slowdown in the economy would put pressure on customers and have ripple effects on RSI

• Foreign exchange - a decrease in the USD vs CAD would have an adverse impact on profitability

Catalyst

• Achieving profitability in 2016 after multiple years of modest losses
• Initiation of investor relations activities like presenting at investor conferences.  The company has already started improving the metrics they provide investors and detail provided in the MD&A over the past few quarters.
• Company is an acquisition target, especially in light of the focus at other PMS businesses to increase their mix of SaaS/recurring revenues.