IPO Analysis: InnerWorkings (INWK)

Story: Here's a nitty gritty back office play. InnerWorkings (NOT these guys) tag themselves as a "print procurement technology company." Every company has significant printing needs. Most companies satisfy some of that need in-house (e.g. the corner LaserJet), while some is outsourced (e.g. marketing materials or corporate reports, etc.). The outsourced printing market has traditionally been served by local players, and the market is quite distributed. In almost any town you will a printer, and perhaps many.

So the market has existed for many years, satisfied by small or distributed players. More recently, we have seen a lot of increased information efficiency due to the internet (vertical portals and B2B was all the rage in the dot-com blowup). Some of that seems to now be hitting both the printing industry and the public market. We liked VistaPrint (VPRT) for its ability to profitably serve the printing needs of small businesses.

InnerWorkings targets both small and large businesses as a middleman (rather than a printer, like VistaPrint). They have developed a network of ca. 2700 suppliers (e.g. printers, paper suppliers, etc.). Their main competitive moat is a database they have developed that in detail catalogues the capabilities of each of those suppliers, and allows them to optimize the match between supplier capabilities (and price) and the print-needing company clients. That all sounds imminently reasonable - a solid back-office play - but we have a couple of questions.

First, "optimization" gets bantered around pretty easily. Sometimes it means nothing more than an individual looking over some specs and deciding "these match." On the other hand, and I've done a lot of this is various different fields (e.g. ultrafast chemical physics, ozone monitoring, protein folding), really systematic and complete optimization between a goal and a universe of possibilities can be a very complex problem. They may not need a sophisticated solution, but the better the matches that they provide, the happier their clients will be, and the deeper will be their competitive moat. Second, how competitor proof is that database? Do they have exclusive licenses with their suppliers, or could another player easily come in and take half their business? First-mover advantage is often the opposite - a disadvantage. Once they prove that the print consolidation middle man market is a good profitable one, that could stimulate new competitive entrants that will learn from the first-mover, and target their products to undercut them. That's why the depth of the moat is key.

Company: From their initial prospectus, they've been gross, operational, and net income positive since at least 2003. Gross margins have run a bit better than 20% ($3.7M/$16.2M=23%, $8.4M/$38.9M=22%, and $15.6M/$76.9M=20%), OP margins (operating earnings/revenue) have run at ca. 5% ($0.765M/$16.2M=5%, $2.07M/$38.9M=5%, and $4.6M/$76.9M=6%), but OOP margins (operating earnings/gross revenue) have grown from 20% to 29% ($0.765M/$3.74M=20%, $2.07M/$8.40M=25%, and $4.60M/$15.60M=29%).

So of the money they keep, they are keeping more. That says their costs are expanding more slowly than their gross profits. which, coupled with top and bottom line growth, is just what we like.

Y/Y top line growth has slowed to about 100% for year end 2005 ($38.9M/$16.2M=140% and $76.9M/$38.9M=97%), but in absolute terms has expanded by about 67% (from $22.7M for '03-'04 to $38M for '04-'05). Similar measures show operating income more than doubling Y/Y ($2.07M/$0.765M=170% and $4.6M/$2.07M=122%), with small but healthy absolute growth ($1.3M and $2.5M).

On the other hand, looking at the Q/Q data (prospectus, pg 34), they have had fairly consistent revenue growth of about $3M each quarter, with a couple of small hiccups, until they have flatlined for the last 3 quarters (Q1 '04 -> Q1 '06, in $M: 5.3->8.6->9.9->15.2->12.4->18.7->23.5->22.2->22.4). So we're going to stop here. With no recent growth in their top line, we don't feel compelled to answer our earlier questions, or to look farther. Blah.

[Disclosure: currently long VPRT]