This article analyzes OneSpan’s (NASDAQ:OSPN) 2Q24 results and earnings call. It also revisits the company’s valuation and my Hold rating from May 2024, which has been maintained since June 2022 when I started covering the company.

OneSpan’s 1H24 has been very good on the cost side, as the company has materialized tremendous cost reductions (including close to a 50% workforce reduction), with no visible deterioration of customer service, product quality, or sales growth. In 2Q24, the company continued to post growth, albeit only expanding services to existing customers without new logo wins and doing some renewals earlier than anticipated, which implies that revenue comparables will be negative in 2H24.

The company’s stock is now about 25% more expensive than when I considered it fairly valued in May 2024. I still consider the valuation fair, given that the company has maintained controlled expenses. I still do not consider the price opportunistic, given that the stock provides an earnings yield of about 5% and, therefore, requires growth above what it is currently delivering to match my required rate of return. I prefer to err on the conservative side in this case and maintain my Hold. Other readers, however, might be comfortable with a lower expected return and consider the stock a Buy at these prices.

2Q24 maintains good momentum

Costs controlled: The most interesting factor behind OneSpan’s recent performance has been the impressive cost cuts the company has materialized. OpEx was 35% lower in 1H24, and gross margins were 500 basis points higher. The workforce has been reduced by close to half.

In this respect, 2Q24 maintained a quarterly OpEx trend of around $30/31 million, which is very salutary. Although OpEx may raise in 2H24 (potentially for bonuses and higher D&A), the company is in line to post $75 million in annualized savings.

No meaningful decrease in quality of work: When a company sheds a big percentage of its workforce, it may start to show problems in service, sales, or product development. Although I have not interviewed individual customers, there are some indications that this is not true. For example, reviews on the software comparison site G2 are overwhelmingly positive in 1H24. The company recently launched two products (the FX1 Bio authenticator and the Sign Platform). Regarding the sales function, the situation is not as great, as we will see below.

Temporary high growth: Looking at 1H24, we see high growth of 13% in 1Q24 and 9% in 2Q24. This is particularly true for Digital Agreements, which are 25% and 30%, respectively. That growth has come from customer expansion and higher net retention (above 110% in 2Q24), as explained in both earning calls and the MD&A. However, during both calls, management commented that these quarters saw renewals happen earlier than expected, therefore taking some growth from 2H24. In fact, if we compare the guided revenue for 2H24 ($117 million at the midpoint) with 2H23’s revenue (about $122 million), then management is telling us that OneSpan’s revenue will shrink in 2H24, and that; therefore, it will post NRR below 100%.

For the year, and based on management’s guidance, revenue growth is much more muted than 9/13%, at only 4.5%. This is partly caused by the company being unable to land new logos. There is no mention of new customers in the MD&A comments, and management didn’t mention those wins during the calls either. This may have to do with focusing the smaller sales team more on signing renewals and less on expansion. We will need to see how this evolves in future quarters. The same dynamics that make SaaS revenue somewhat sticky also make it harder to steal customers from competitors (like DocuSign or Adobe). The transition costs are high, particularly for high-stakes processes like authentication and e-signing.

Temporary Profitable Digital Agreements: Another interesting development was the first quarter of (adjusted) operating profitability for the DA segment. The segment posted a small loss, which was caused by a non-recurring impairment (from the blockchain TrustVault product, probably a remnant of the $1.8 million acquisition of Southbank Software in 1Q23). Without the impairment, the segment would have posted a $1.8 million operating profit.

Valuation is fair to opportunistic

The market liked these results, and OneSpan now trades 25% above where I considered it fairly valued in May 2024. However, I still believe the stock is fairly valued, albeit it should be cheaper to consider it opportunistic (but that depends on the reader’s required rate of return).

Let’s look at the company’s guided FCF for the year. It is $35 million before taxes (adj EBITDA of $55/60 million minus $12 million in CAPEX and $10 million in SBC), probably closer to $28 million after taxes. Compared to an EV of $540 million (current market cap of $610 million minus $70 million in cash expected by the end of the year), the expected yield is only 5%.

In my case, I think a company of OneSpan’s characteristics requires a return of at least 12%, implying that the remaining 7% has to come from growth. This is more than what OneSpan will deliver this year on the top line, and we have not seen signs of new customer expansion yet. However, we also have to consider a few other things.

First, OneSpan has a heavily fixed cost base (employees, offices, licenses, and capitalized software), which means it can leverage. The company’s COGS has been basically flat since FY22 (the recent jump includes the impairment of blockchain assets mentioned above), and the same can be said of OpEx, comparing 1Q24 and 2Q24, despite a 10% difference in revenues. This means top-line flows almost directly to earnings, where growth is leveraged. If the company can grow $11 million next year (4.5% from guided FY24), then operating income might grow as much as 30%.

The second factor is that Digital Agreements are growing and is also leveraging. Currently, the segment is smaller and therefore does not traction the topline figure as much, but as it grows it will increasingly do so. The 1H24 25/30% growth rates are influenced by the same timing factors as above. In order to continue posting those rates, the segment will need to reach $35 million in revenues in 2H24, compared with the already aided $29 million in 1H24, which seems unlikely. The real growth rate is probably closer to high single digits or low double digits.

Overall, though, I think OneSpan has the opportunity to deliver the growth necessary to reach a sufficient yield and, therefore, consider the stock fairly valued. Given that comparative growth rates will be lower in 2H24, potentially causing disappointment, and that the company has not yet driven client growth, I do not believe it is opportunistic at these prices. For that reason, I maintain my Hold rating. However, I will be very interested in potential dips after 3Q24 results or later.