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Liang Chen
Steven Chen
Articles (116)  | Author's Website |

Urbem's 'Wonderful Business' Series: NIC Inc.

A growing toll bridge business on the cloud with moderate risks

December 05, 2019 | About:

Kansas-based NIC Inc. (EGOV) is an American technology firm that enables governments to provide digital services to businesses and citizens, therefore enhancing efficiency and user experience. The company generates the majority of its sales from its primary outsourced portal businesses, which are mostly based on a transaction-based model (95% of FY2018 sales). In such a model, the company typically absorbs development costs but charges transaction commissions whenever end-users enjoy the online government services it builds. Thus, whenever you renew your vehicle registration, file tax returns or purchase national park tickets online, you contribute to this reliable small-ticket cash flow for NIC.

We think that NIC’s innovative business model provides the company with a substantial competitive gap against its peers. As the management points out, the high cost of IT development in a budget-constrained environment, the difficulty in acquiring resources for digital services and a lack of marketing expertise to promote the online service channel are three of the critical challenges facing the government these days. The transaction-based model is a good fit as it saves taxpayers’ money upfront, requires minimal use of government resources and ties the company’s business interests to the development of successful applications and services.

At Urbem, we believe that the critical factor for superior risk-adjusted returns lies in not only how big the competitive gap is, but also how durable it is. Does the business have a true economic moat around it?

With NIC, the company has consistently earned high ROICs over the last decade (see below), outperforming many traditional technology consulting firms (e.g. Accenture (ACN), IBM (IBM), Unisys (UIS)) ,software development giants (e.g. Microsoft (MSFT)) and digital transaction payment processors (e.g., ACI Worldwide (ACIW)).

In our opinion, such an extraordinary track record is attributable to NIC’s niche market focus and deep understanding of the government’s digital needs, its reputation earned through decades serving the government and some switching cost due to the multi-year contracts for transaction-based partnerships. By essence, NIC builds digital toll bridges for customers who have no substitute online.

"Historically, we have not faced significant competition from companies vying to provide transaction-funded enterprise-wide digital services to governments."

- NIC 2019 10-K

At Urbem, we favor businesses with a superior quality of revenue. The sales at NIC are highly predictable, as over 90% of them are recurring and mostly recession-proof. The digital services provided by NIC are mission-critical and generally not discretionary. Per the chart below, the company was able to increase both its revenue and operating income throughout the Great Recession.

Going forward, we believe that the company has a couple of long-term growth opportunities, including building more vertical services or signing up more states. We note that around half of the states have not joined the enterprise-wide partnership with NIC.

On the risk front, the loss of “toll bridges,” or customer churn, is a crucial aspect that investors should watch out for. Contracts can expire naturally or be terminated early by the partner for a cause. In this case, the government, possibly along with its contractors, would be entitled to take over the applications in place. Furthermore, at the end of FY2018, 45% of the company’s total revenue was earned from the 16 contracts that can be terminated by the partner without cause on a specified period of notice.

The business also has a high concentration risk, in our view, with LexisNexis Risk Solutions accounting for 19% of FY2018 revenue. This risk materialized recently as the company lost a significant contract with the Texas state (previously contributing to roughly 20% of total revenue).

Lastly, the total insider ownership is around 5%, which does not appear significant enough to us compared with other companies with a similar size. According to FactSet, Harry Herington, CEO, and Stephen Kovzan, Chief Financial Officer, respectively, own 1.27% and 0.34% of total shares outstanding.

Disclosure: The mention of any stock in this article does not constitute an investment recommendation; investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market; we own shares of NIC.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist.

Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

Steven can be reached at [email protected] or through LinkedIn.

Visit Steven Chen's Website

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