Australia | Jul 14 2021
While the US is the real growth engine driving Nearmap forward, potentially costly US legal action, which could also impact sales momentum, gives the market cause for caution
-Overhang on Nearmap remains until US litigation resolved
-Brokers fear potential court case damages could be unduly large
-ACV momentum in the US expected to grow 50%-plus
By Mark Story
Due to increased investment in sales, marketing, and product, plus improving economic conditions, Nearmap’s ((NEA)) three key verticals, insurance, government, and roofing, delivered another record half of annual contract value guidance (ACV) growth in the US.
In light of strong ACV momentum in the US, which is expected to grow by 50%-plus year-on-year, the Australian aerial imaging company upgraded its FY21 ACV guidance to $128.2m.
Given the maturing sales productivity in A&NZ, where growth continues to below historical levels, the company is planning to step up investment in operational expenditure (opex) and capital expenditure (capex) materially in FY22 and FY23 to accelerate momentum in North American growth.
Jefferies Equity Research regards the roll-out of the now complete Hypercamera 3 as the most important piece of IP in Nearmap's kitbag, which will help to expand the company’s coverage across the US.
Litigation overhang
News of strong US growth momentum is welcome news for shareholders who watched the company’s share price tank -20%-plus earlier this year following revelations rival Eagleview was suing the company for alleged patent infringement.
Eagleview, along with another rival, Pictometry International, accused Nearmap of infringing their patents covering roof estimation software. This technology was brought into the business when Nearmap acquired Pushpin in December 2019.
Since then, Nearmap, which maintains allegations are fundamentally without merit, has also lodged a motion to dismiss two of Eagleview's eight claims due to lack of patent eligibility.
But while Nearmap believes the business will be able to successfully defend the patent infringement, brokers are considerably more cautious about the outcome, and the potential impact on the business.
While the potential impact on Nearmap’s North American operations may be small, brokers are concerned that potential damages could be disproportionately large. Citi, which has a Neutral recommendation on the stock and a price target of $2.35, continues to rate Nearmap as high-risk given the nature of these legal proceedings.
What concerns Citi the most is the potential impact the legal case could have on growth in the US. Should the company be unsuccessful in defending against the legal allegations, the broker suspects a higher-than-expected churn, customers downgrading contracts and/or lower than expected new sales.
At face value, Morgan Stanley, which has an Overweight rating and a $3.20 price target, cannot see strong US sales being impacted by the legal dispute. The broker assumes legal proceedings by Eagleview – eight years after Nearmap's US entry -were partly triggered by Australian company’s clear success on the US rival’s home turf, with ACV in North America up circa 2x in two years and growing.
However, the broker also believes that while roof estimation software is not a core part of the business, customer uncertainty due to this legal action is a lingering risk for Nearmap.
Encouragingly, Jefferies Equity Research cannot see any obvious signs that the litigation is having any client impact, with cash flows appearing to be better than the broker forecast for second half FY21.
Commenting on the legal dispute, Jefferies notes Nearmap has deep pockets to defend its position. Given that patent infringement litigation has been used tactically across other sectors, notably healthcare, Jefferies suspects the case with Nearmap will more than likely resolve in the company's favour.
Based on Macquarie’s initial reading of the filing, Nearmap is trying to strike out the claim on the basis that the patent is too broad-based.
While Macquarie is not a law firm, the broker is also incrementally comfortable with the legal case based on the recent defence filings. The broker points investors to consider differences to other successful claims by EagleView which incurred punitive payouts – where there was unmistakable evidence of information/IP sharing – in a downside/loss scenario.
Outlook
While the legal case may create an overhang until it is finally resolved, upgraded guidance by Nearmap suggests it has not yet impacted sales momentum or perception with existing customers. Macquarie, which has a Neutral rating, and a price target of $2.60, has it forecasts currently under review pending release of finalised FY21 result.
Due to the US growth trajectory, Citi is forecasting group ACV growth of 24% in FY22, and 40% growth over the medium term. The broker expects cash burn to step up materially in FY22 as the company rolls out Hyper Camera 3.
The broker has also upgraded ACV forecasts by 4% to 5% but lower FY21 earnings by -$1.6 million and -$3.1 million in FY22 to reflect higher costs.
Morgan Stanley expects mid-20% compound organic sales growth, with scope for 40%-plus cash earnings margins over the longer term. The broker expects Nearmap to step up investment in opex and capex materially in FY22 and FY23 and is now forecasting cash burn of -$28m and- $14m respectively.
However, with a gross profit payback of less than 12 months in North America in first half FY21, the broker believes Nearmap should push hard on investing in capture footprint, frequency, R&D, and sales team expansion.
There are two Neutral and one Overweight ratings on the database with a consensus target of $2.71 that suggests 19.7% upside to the last share price.
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