By:
Alex Czachor, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
• NIC, Inc. (NASDAQ: EGOV) Provides digital government services that
helps governments use technology to provide services to businesses and
citizens.
• NIC currently holds 27
contracts, including multiple state governments. One of their largest contacts - Texas - is up
for re-bid this fall and if the company is unable to renew this contract it
would have a material impact on NIC’s earnings.
• Competition represents
a long term concern. Currently this is
not a concern as the company is facing little competition from big companies
such as IBM, MSFT, or ORCL. The lack of
interest may possibly be due to the specialized and small industry in which the
company is in, as it may not be profitable enough for the bigger players to
pursue. If the market grows, bigger
players may enter in resulting in the loss of market share for the company.
• The company currently
does not have a contract with at least a third of the states, potentially
creating an opportunity for growth.
• In FY’17 the company
won a contract with the state of Illinois, which will add up to $3 million in
revenue represented as a one-time spike in operating profit for the upcoming
year.
Key
points: With uncertainty looming around the company in regards
to the renewal of the Texas contract, the company was still able to provide
some good news to investors in FY’17.
The new contract with the state of Illinois represents a six-year
contract with an additional four one-year renewal periods extended through
2027. As soon as NIC is able to deliver
the initial phase of the permitting and
licensing systems to Illinois the company will then receive $2.4 mil, with an
additional $600k sometime in the 1H’18 when the remainder of the platform is
delivered. This can be seen as a
positive as it will create a one-time spike in operating profits, followed by
additional maintenance fees throughout the duration of the contract.
However, as of late the
company’s share price has experienced a bit of pressure due to the increase in
uncertainty surrounding the expiration of their contract with Texas. The Texas.gov contract represents approx. 20%
of NIC’s revenue and added an estimated 30% of operating profit as of FY’16,
making Texas one of their largest contracts.
Management believes that they will not be able to win the same contract
they had with Texas prior as Texas is looking to diversify its portfolio of
vendors. It is possible the company will
be able to save some pieces of the contract, but in the end will most likely
experience a decline in revenue contribution from the state.
Along with the loss of
one of their biggest clients, the company is also facing potential risk due to
their niche industry. With more
resources and firepower why is it that companies like IBM, MSFT, ACN, or ORCL
do not enter into this industry and compete with NIC. Due to their specific niche industry, its
business is extremely specialized and small and it wouldn’t be worth it for
large companies to enter into the market due to the lack of profitability. Moving forward if the company continues to
grow earnings, it is possible that one of these larger companies do look to
compete within this industry and with large R&D teams it would be
relatively easy to enter into the space and erode market share.
While the addition of the
Illinois contract can be seen as a positive, there still remains an overhang in
the stock until the Texas contract has been renegotiated. Further, it is likely that NIC will be
unsuccessful in retaining the total pie from Texas and because of this will
lose some share in the upcoming year.
With the recent wave of uncertainty looming around the company, NIC’s stock
has sold off 25.8% YTD.
What
has the stock done lately?
Since the company’s Q2
earnings report the share price has declined approx. ~12.2%. Even though top line came in above consensus
estimates, higher spending levels caused the company’s margins and profits to
dip. Resulting in the decline of
operating margins by 200 bps as well as a slight decline in both net income and
EPS. The inability to sustain margins
accompanied with the looming uncertainty surrounding the Texas.gov contract
resulted in the selloff following the Q2 report.
Past
Year Performance: Year-to-date NIC’s stock has declined
25.8% to its current price of $17.25.
During the year the company reached a 52-week high of $25.90 and a low
of $15.45. Investor uncertainty has
clearly been reflected in the company’s share price and with near term
headwinds it is unlikely that there will be any strong growth in the stock into
the foreseeable future.
 |
| Source: FactSet |
My
Takeaway
While the addition of a
new contract with the state of Illinois will benefit NIC, ultimately the
outcome of the renewal process with Texas.gov will dictate whether this stock
will prosper in the upcoming FY’18.
Texas.gov is said to be making a decision by the end of FY’17, and is
unlikely to fully renew their prior contract with NIC. As Texas is looking to diversify and add new
vendors, NIC’s top line will be negatively impacted due to the large exposure
the company had to the state ~Texas made up approx. a quarter of the company’s
FY’16 revenue~. Due to the strong
likelihood that Texas.gov diversifies and lessens its exposure to NIC coupled
with the continued uncertainty surrounding the stock as well as the lack of
strong near term growth opportunity’s it is recommended that the AIM small cap
equity fund should sell NIC (ticker: EGOV).
