Making it onto the Buffett-Munger list is not easily accomplished, but NIC Inc. (EGOV, Financial) has done it. The company specializes in building portals for governments. These portals allow citizens and businesses to communicate and interact with government agencies. For example, systems that allow citizens to purchase fishing licenses, and businesses to post compliance information.
The Buffett-Munger screener looks for companies with four key characteristics:
- High predictability, meaning they can consistently grow revenue and earnings;
- Competitive advantages (moat), allowing them to increase profit margins while growing;
- Little or no debt in a growing business; and
- Fair or undervalued based on PEPG (or PEG), which is the price-earnings ratio divided by average growth over the past five years.
We will assess NIC on these criteria and more to determine whether it would make a good Buffett-Munger company—and—a good investment.
History
1992: Creation of the Kansas Information Consortium; it signs a contract to provide Telnet access to the state of Kansas using a self-funded model.
1995: Subsidiaries sign up the states of Indiana and Kansas.
1998: The original company and all subsidiaries (5) are consolidated into the National Information Consortium.
1999: Two former state governors join the board of directors.
1999: The company goes public on Nasdaq, symbol EGOV.
2002: Name changes to NIC Inc.
2011: NIC makes its first appearance on Forbes list of the “100 Best Small Companies in America.”
2012: NIC is added to the S&P SmallCap 600 Index.
2015: The company is tasked with regulating medical marijuana in Hawaii and Maine, as well as recreational marijuana in Oregon.
History based on information at the company website.
NIC is a 24-year-old company that has grown organically, brought in influential people and has a leading place among observers of American small business.
NIC’s business
The company provides digital services to governments through two channels: its portal businesses and its software & services businesses. Despite having two channels, it has just one financial reporting segment (unless otherwise noted, information in this article comes from the company’s 10-K for 2015).
Portals are websites and applications that allow citizens and businesses to access government information, and to make secure transactions. Examples include applying for permits, retrieving government records and filing government-mandated forms.
NIC introduced what is called a self-funded model to the portals business. It absorbs the front-end costs involved in developing the infrastructure. Once the service launches, it and the government share the fees generated from online transactions. End users are the source of NIC’s revenues, which cover both initial costs and ongoing management and maintenance costs.
According to the company, this model has several benefits for its government partners, including reduction in financial and technological risks, increased operational efficiencies and getting a centralized, customer-focused online presence. For businesses and citizens, it means a fast, convenient and cost-effective means of interacting with government.
Given the upfront commitment by NIC, it is able to get multi-year contracts with its government partners. Each contract involves the use of a local subsidiary that operates with a high degree of autonomy.
In the software and services channel, the company says this business is made up of “subsidiaries that provide software development and services, other than outsourced portal services, to state and local governments as well as federal agencies.”
NIC Inc. has created a unique business model, one in which it focuses on government and creates a unique relationship with its customer/partner. While it is not one of the criteria for the Buffett-Munger Screener, this business is reasonably easy to understand (which Warren Buffett (Trades, Portfolio) likes).
Revenues
This chart shows NIC’s revenues for the 10 years ending in December 2015:
Breaking down the revenue flows, this excerpt from the 10-K for 2015 shows Interactive Government Services (IGS) and Driver History Records (DHR) account for the biggest contributions:
Note that IGS includes all sources of revenue except for Driver History Records.
This 10-K excerpt shows software and services accounted for just $19 million of revenue (although this channel is growing):
In its Third Quarter 2016 Investor Presentation, the company reported it has 4,500 federal, state and local government agency partners (customers).
A solid steady revenue growth line, with the bulk of that income from two sources, interactive government services and driver history records.
Competitors
The company says it does not face significant competition on enterprise-wide portal services, but does have intense competition from companies providing solutions to individual government agencies.
Named competitors, in the 10-K, include:
- Large systems integrators, including CGI (GIB, Financial) and Unisys (UIS, Financial);
- Large software applications developers, including Microsoft (MSFT, Financial) and Oracle (ORCL, Financial);
- Consulting firms, including IBM Corp. (IBM, Financial) and Accenture Ltd. (ACN, Financial);
- Digital transaction payment processors, including ACI Worldwide Inc. (ACIW, Financial) and Link2Gov Corp.;
- Software application developers, including Accela, FAST Enterprises and PCC Technology Group; and
- Other niche providers, such as Active Network (ACTV, Financial) and Brandt Information Services.
Hoover’s lists its three major competitors as Accenture Ltd. (ACN), Maximus Inc. (MMS, Financial), and IBM Global Services (IBM).
An interesting competitive profile. A range of competitors battle with NIC for the business of individual agencies, but on an enterprise-wide basis, it has a relatively open field to itself.
Moat
In his article, "NIC Inc: Waiting for this Fattened Stock to Fall and Why I Want to Buy It," Jae Jun writes of NIC, “They have already entrenched themselves with a moat by signing up the government as their customer and already having built so many portals already.” His argument reminds us of the famous business model created by Gillette over a hundred years ago: Sell a razor at a low price, or give it away, and then sell razor blades to the customer forever after.
Morningstar assigns the company Wide moat status.
In its 10-K, the company itself lists five competitive advantages:
- Unique understanding of government needs;
- The quality and fit of its digital government services;
- Speed and responsiveness to the needs of end-users (businesses and citizens);
- Cost-effectiveness; and
- An enterprise-wide approach.
Given the way in which it has entrenched itself, and the difficulty governments would face in moving to another vendor, a medium or wide moat seems an appropriate rating.
Growth
NIC says, “Our business plan is to increase our revenues by delivering new services to a growing number of government entities within our existing contractual relationships and by signing long-term portal contracts with new government partners.” Breaking out those words:
- New services to
- An increasingly large pool of government entities with which it already has contracts and
- More long-term contracts for portals to new governmental customers/partners.
In its Investor Presentation, it notes three areas of potential growth: new services, new partners and federal opportunities:
NIC has several growth opportunities within and beyond its current base. Of particular interest is its aim of growing within the orbit of the federal government.
Other
NIC Inc. is incorporated in Delaware and headquartered in Olathe, Kansas.
It had 859 employees at the end of 2015.
Chairman and Chief Executive Officer Harry Herington, “By reason of his early involvement and efforts, Mr. Herington is considered a founder of NIC as it became a national company.”
The chief financial officer is Stephen M. Kovzan. Prior to joining NIC in 1999, he was a business assurance manager at PricewaterhouseCoopers LLP. (Officer information from Reuters.com)
Ownership
Four investing gurus followed by GuruFocus have ownership positions in NIC. Columbia Wanger (Trades, Portfolio) has the largest holding, 1,627,252 shares, which gives it an almost 2.5% stake. Jim Simons (Trades, Portfolio) owns nearly as many shares, while Joel Greenblatt (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio) have substantially smaller holdings.
Institutional investors (including hedge funds and pension funds) dominate the ownership circles of this company:
Also present is a modest number of short sellers, whose interest is currently in the middle of the range established over the past three years:
Also a solid showing by insiders (not unusual in a relatively young company). Chairman and CEO Herington owns 932,452 shares, which represents nearly a 1.5% share of ownership.
Although a small-cap company, NIC has strong backing from the institutional community and its own top officer.
NIC by the numbers
Capitalization of less than $2 billion; price nearing the 52-week high; strong ROA and ROE numbers; no dividend; expanded shares outstanding in 2015.
Financial strength
Ratings from the GuruFocus system come in at very good levels, 9 (out of 10) for financial strength and for profitability and growth:
As the table shows, NIC has no debt.
It appears to be doing an outstanding job of using the capital it has raised: the WACC vs ROIC icon shows a very high return on invested capital versus the weighted average cost of capital. GuruFocus notes, “NIC Inc. generates higher returns on investment than it costs the company to raise the capital needed for that investment. It is earning excess returns. A firm that expects to continue generating positive excess returns on new investments in the future will see its value increase as growth increases.”
As observed in the revenue section above, NIC has steadily grown its revenue over the past decade. While revenue continues to grow, that growth has slowed on a per share basis:
- Past 12 months: average revenue per share growth rate was 7.60% per year.
- Past 3 years: average revenue per share growth rate was 11.00% per year.
- Past 5 years: average revenue per share growth rate was 12.60% per year.
- Past 10 years: average revenue per share growth rate was 17.30% per year.
Earnings have also grown; this chart shows 10 years of EBITDA results:
As with revenue, NIC’s EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) shows slowing average growth rates on a per share basis:
- 12 months: 8.30% per year
- 3 years: 14.40% per year
- 5 years: 17.00% per year
- 10 years: 19.50% per year.
Free cash flow has also grown, although not so steadily:
While the per share metrics have shown a slowing trend, the operating margin has gone in the opposite direction. GuruFocus finds NIC’s operating margin now at the highest level it has been in the past 10 years:
Further, it reports NIC’s operating margin ranks higher than 90% of the 1883 companies in the Global Software - Application industry (Industry Median: 4.71 versus NIC: 24.18).
NIC is a company with strong financial, profitability and growth metrics. At the same time, it carries no long-term debt on its balance sheet.
Valuation
Because of the consistency with which it has grown its earnings, NIC enjoys a 4.5 (out of 5) Star rating for predictability at GuruFocus. This suggests the company is very likely to return capital gains to owners who hold it for the medium to long term.
The DCF fair value calculator comes in with a price that is 27% below the current price:
The company has a price-earnings (P/E) rating in the mid-30s, so it is not cheap compared to the market as a whole. On its own terms, its current rating is low compared with where it has been:
Comparing it with its peers, GuruFocus says its P/E Ratio(ttm) is ranked lower than 66% of them (the industry median is 24).
NIC’s PEG ratio (price-earnings divided by earnings growth) stands at 1.96, which puts it at the high end of the fair value range. Compared with its peers, it is right in the middle of PEG territory with its rating higher than 51% of companies in the Global Software – Applications industry.
Analysts followed by NASDAQ.com are generally on the fence about NIC:
Turning to a 12-month price target, the analysts’ consensus number is $23, about 9% below the closing price on Dec. 16 ($25.35).
The message from the experts is that NIC is currently overvalued, while the P/E and PEG suggest it is near fair value. But, this is also a 4.5-star predictability stock, so earnings may pull up the share price beyond expectations.
Conclusion
Based on this assessment, NIC Inc. does meet the four criteria needed to be a Buffett-Munger stock:
- Predictable and/or consistent revenue and earnings growth;
- A moat, which should allow growth and expanding margins;
- No long-term debt; and
- A stock this is fairly valued (or at least not overvalued).
As an investment, its suitability will depend on an investor’s preferences. With no dividend, it would not make an income investor’s short list.
A value investor will not find much of interest here; the stock price has been slightly depressed, but not enough to be undervalued.
However, it should suit long-term investors with a bias toward growth with safety. While some of its per share metrics have declined, overall it remains a predictable stock, it has a good moat, the confidence of institutional investors (as well as its CEO) and a clean balance sheet.
Disclosure: I do not own stock in any of the companies listed in the article, nor do I expect to buy any in the next 72 hours.
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