ON24: Underpriced AI, Big Data SaaS Play

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Business Overview

ON24 (NYSE:ONTF) is a provider of technology solutions for interactive webinars, virtual events, and multimedia content experiences. Its flagship product is its videoconferencing tool, ON24 Webcast Elite, comparable to more popular solutions such as Zoom, Microsoft Teams or Webex. However, ON24 has been investing heavily to become a full-fledged Customer Relationship Management and 1st Party Data Management platform, recently incorporating AI into its product suite.

After reaching a peak of over 2 thousand customers in 2021, ON24 has seen a decline in its client base (1,916 in Q1 2023, 10% down vs. end of FY21). However, average revenue per customer continues showing steady growth, up 7% in Q1 2023 vs. Q1 2022. We believe that over time these trends are likely to continue - while it remains a pure-play videoconferencing provider, in the near-term ON24 will lose market share to more prominent competitors who benefit from network effects; however, as it transitions to a CRM and data management & intelligence platform, the customer base should eventually stabilize and average revenue per customer steadily grow through higher pricing and/or new add-on services. We see the latter already flowing through to financials to some extent - in Q1 2023, ASP for new customers increased YoY to its highest level in the last 4 quarters.

A particular driver of future growth should be the company's recently unveiled AI-Powered Optimization Suite, which includes audience segmenting and targeting capabilities, chatbots, feedback analysis, and both short-form and long-form generative content creation. While details of the business and financial impact of this new product remain unclear, we see significant potential in the combination of OpenAI's GPT technology and ON24's proprietary database of millions of human interactions gathered from over a decade of digital experiences.

Recent Financial Performance

In 2020, ON24 saw sharp ARR growth of 92%, followed by 14% in 2021. During this period, ON24 invested heavily in headcount - in 2022 sales & marketing reached 49% of sales, R&D 19%, and G&A 17%. This meant that for every dollar generated in revenue, 85 cents were already spent before, mostly on staff. As revenue contracted in 2022 and Q1 2023, the company was able to maintain strong gross margins despite some compression, with COGS remaining below 30% of sales, but the large, fixed cost base (previously mentioned 85%) of sales resulted in a negative 10% operating margin.

It's worth noting that the figures above are based on non-GAAP metrics - the company has steadily increased its GAAP to non-GAAP adjustments from $2.9m in FY20 to $41m in FY22, and $16m for Q1 2023 alone ($64m annualized). While in previous years the bulk of adjustments were explained by stock-based compensation (debatable but generally accepted adjustment given its non-cash nature), in Q1 2023, $3.1m are related to restructuring costs and $2.4m to shareholder activism. These $5.5m are not trivial - they represent 13% of Q1 2023 revenue and make the difference between a negative 10% operating margin (non-GAAP) and a negative 23% (GAAP). For valuation purposes, we exclude SBC but add back the company's other adjustments.

Financial Outlook

The company's latest guidance, as of March 31, 2023, was that it expects revenue of around $41.6m (midpoint of guidance range) for Q2. This would be roughly flat vs. Q1 - reflecting a turning point following 5 quarters of consecutively QoQ decline. We believe at this point the majority of churn will be behind the company and that it stands poised to stabilise topline in the next 2-3 quarters and resume growth from 2024. The renewed growth would likely be modest at first, driven by (i) marginal price increases on existing and new customers, and (ii) limited adoption of the new products - the latter should accelerate over time and become a key growth driver.

On profitability, the company expects a non-GAAP operating loss of c.$2.1m in Q2. This excludes c.$1.9m restructuring charges and a c.$1.4m adjustment for underutilized real estate - we include these figures and consider a "real" operating loss of $5.4m (13% negative margin). Nevertheless, this is a meaningful improvement of 10 percentage points over the Q1 figure. We expect this trajectory to accelerate as the company resumes its growth trajectory, while continuing to restrain costs.

For the full year, the company expects c.$164m revenue, implying roughly flat QoQ revenue for Q3 and Q4. Expected FY23 non-GAAP operating loss of c.$9m translates into a "real" loss of c.$22.8 (we assume $3m adjustments for Q3 and Q4 each, on top of $5.5m for Q1 and $3.3m for Q2).

We expect 2024 to be the real turning point for ON24. We model 10% topline growth to $180m, stable 76% gross margins resulting in $137m gross profit, and additional cost reductions of c.$2m per quarter to $140m operating expenses, resulting in a negligible $3m operating loss and slightly positive EBITDA of $2m. For 2025, we model continued 10% topline growth to $198m, 2pp margin improvement to $154m gross profit, and resumed headcount expansion at a rate of $1m per quarter, resulting in $10m operating income and $15m EBITDA. For 2026, maintaining the same trajectory, we expect $218m revenue, $174m gross profit, $24m operating income, and $30m EBITDA.

Liquidity

The company is fortunate to have raised a large amount of capital in 2021 at the peak of its share price performance, which explains its war chest of $316m in cash and marketable securities as of Q1. This stockpile could sustain the company for over 15 years at its current cash-burn rate of c.$5m excluding share buybacks, so solvency is not a concern. In fact, the company issued a special dividend of $1.09 per share ($50m total) in May 2023, part of a total $125m capital return program ending in Q1 2024. At the company's share price of $8.6 at the announcement, that represented a dividend yield of 13%. We expect additional capital to be returned to shareholders after concluding the current program.

Key Risks and Upside Drivers

We see further upside from a potential acquisition - its cash pile makes ON24 an attractive target for a leveraged acquisition by a financial investor, or consolidation by a competitor. In such a scenario, we would expect an upside of no less than 20% from the current share price based on historical precedents.

The main commercial risk is a slower-than-expected commercial adoption of ON24's new AI-powered tools, which are likely to face competing alternatives. ON24 appears to be taking the right steps and is moving fairly early, but well-funded competitors such as Salesforce (CRM), Microsoft (MSFT), and Zoom (ZM) will certainly pose a threat.

Additionally, the company may face higher-than-expected churn in the existing flagship videoconferencing solution. Q2 results on August 8th should provide helpful directional guidance on this front. Although expected, near-term earnings releases may continue exercising downward pressure on the stock in the absence of an extremely aggressive adoption curve on the new products that offsets the performance of the legacy suite, which we view as unlikely.

Valuation

We believe within 2 years ON24 will trade on forward EBITDA as profitability recovers, and that its multiple should converge directionally towards the 15x NTM EBITDA that we see in leading players with comparable business models (e.g., Salesforce 18x, Oracle (ORCL) 16x, DocuSign (DOCU) 15x, SAP (SAP) 15x).

We conservatively apply a multiple of 10x NTM EBITDA (significant discount to industry leaders named above) to derive a target $300m enterprise value by the end of 2025. This implies a $608m market cap as of today, including the company's cash balance of $316m. We include the cash balance because regardless of whether it is held in the balance sheet or distributed to shareholders, its value is attributable to any shareholders who purchase the stock now. With 45.9m shares outstanding, this implies a target price of $13.24 - 50% upside from the current level, or a 19% CAGR between today and the end of 2025.

Conclusion

Despite facing a decline in customers for its legacy videoconferencing solutions, ON24 is strategically pivoting into an AI-Powered Customer Relationship Management and 1st Party Data Management platform, which is a much more compelling business model. The launch of their new AI Optimization Suite, and their robust cash reserve to fund R&D and marketing, positions the company favorably for future growth, tapping into the AI adoption wave. While near-term share performance is unpredictable, based on conservative valuation parameters, we see potential for a 50% appreciation in value by the end of 2025.