Summary
Edgar Online (EDGR) is a small cap technology company that processes public filings from the SEC's EDGAR database and makes them available in various formats to investors. The company has never had a profitable year in its 14 year history (founded 1995, public in 1999). Nevertheless, it trades at an eye-popping 9x book and 40x EBITDA. Hope springs eternal, but I believe EDGR is overvalued.
The bull story
EDGR’s nosebleed valuation is largely credited to the company’s leadership in an emerging technology called XBRL (eXtensible Business Reporting Language). XBRL is a markup language that promises to transform SEC filings from documents to standardized data that can be processed more efficiently by computer programs. Spreadsheets can automatically pull in every number from the filing and “understand” what it means. Your integrated 3-statement spreadsheet model will automatically download and plug in numbers from the latest quarter. It will work not just for the income statement or the balance sheet, but for every number in every footnote. That means you can get an automatic comparison of the company’s backlog or number of customers (for instance) quarter over quarter, or year over year. You can do it for one company or the whole industry, all before reading the first line from the 10K. The potential applications are almost limitless.
To make XBRL work, someone is going to have to mark up all those 10Ks, i.e. pull out the numbers and classify them in a standard way. This seems like a lot of work. Why would any company want to make this investment? Because it’s been mandated by the SEC. The 500 largest US companies were covered by the mandate in 2009. 1,800 companies are covered in 2010 and all 10,300 reporting entities in 2011.
And that’s just Qs and Ks in the U.S. If you count filings for debt and mutual funds, and then count filings outside the U.S. you can get some truly large numbers. EDGR’s latest investor presentation puts the addressable market at about $2B (although that estimate tellingly omits the year in which they believe the market will get to that size). On top of that, there’s the market for translating, data-basing and reselling old filings in XBRL format - there’s another $5B, according to the company.
EDGR’s first XBRL product debuted in 2005 and it currently has 36% of the market for XBRL-based SEC filings (Q3’09 thru 8/3), including high-profile clients like Google (GOOG), Yahoo (YHOO) and Intel (INTC). If EDGR can maintain its share as the market grows, we would be looking at a $1B company. Much better than the $19m in revenue from the past 12 months.
EDGR’s business
Let’s step back from the hype: EDGR makes money three different ways:
- It sells Subscriptions to web-based tools that allow users to analyze SEC filings.
- It sells Data, i.e. SEC filings (raw, parsed and formatted) directly to the user’s systems.
- It helps US companies prepare XBRL filings for the SEC, as described above.
XBRL is the smallest segment at 28% of 2009 Q3 revenue. It’s growing fast but Subscriptions are shrinking almost as fast, so total revenue is growing slowly:
2008 Q3 | 2009 Q3 | |
Subscriptions | 2,127 | 1,585 |
Data and solutions | 2,110 | 2,179 |
XBRL filings | 464 | 1,478 |
Total revenue | 4,701 | 5,242 |
I believe the reason Subscriptions are shrinking also has to do with XBRL: EDGR’s original value proposition was to provide a superior user interface to that available on the SEC’s (free) EDGAR site. You could go to Edgar Online and download financial statements in spreadsheet-format, whereas on the SEC site you could only get the raw filing. Now you can download the spreadsheet format from the SEC site for the largest 500 companies who are filing in XBRL, and soon for the rest. I’ve tried that interface – it’s not half bad, and it’s going to get better. Also, thanks to XBRL, there are now various tools available (some free and open source, like the one from the SEC) that close enough to the Subscriptions offering where it counts. They are not as polished, but they are getting there. In other words, XBRL is undermining the value proposition of the Subscriptions business.
Competition
EDGR operates in a highly competitive environment. The Subscriptions and Data businesses compete with much larger and better capitalized companies, such as Thomson Reuters (TRI), Bloomberg, the big 3 rating agencies and even Factset (FDS).
The fledgling XBRL filing business (<1 year old) is also highly fragmented, contrary to the company’s PR. EDGR is in the top spot with 36% of filings in 2009 Q3 (according to the company). Bowne is in the second spot with 29% and self-filed returns make up 19% of the market, the third spot. Then there is the hodge-podge of small software vendors offering XBRL tools. And, there’s BusinessWire, which is owned by Berkshire Hathaway (BRK.A) and has just introduced an XBRL tool called CoreFiling.
Strategic problems with the bull story
The biggest problem with the story is strategic: It is just not possible to create the highly profitable software business that is implied by EDGR’s valuation based on a free, open, ubiquitous standard. Netscape and Red Hat (RHT) are two cases in point although the dot com graveyard is littered with others. This is the biggest reason why EDGR hasn’t been able to turn a profit yet.
EDGR simply does not add enough value with its services. The technology is basically a parser that converts text documents in a semi-standard format into financial data. There is no value-added content or intellectual property beyond this. As a former programmer and software entrepreneur, I can tell you creating this type of parser is far from rocket science. Yes, there are a lot of cases to work through, but it is just not that hard to do.
We can see just how little EDGR spent on its technology from the balance sheet: Capitalized software in 2009 Q3 totaled $250k plus $1.4m for “internal use.” In other words, you could replicate EDGR’s software, both internal and client-facing, for less than $1.7m. In reality, you could probably replicate EDGR’s software for considerably less, because when an open standard like XBRL matures, supporting vendors and tools develop (fashionably called an “ecosystem”) and it becomes much cheaper to create the same output XBRL document. This puts incumbents like EDGR at a disadvantage relative to newer vendors with cheaper technology. This type of development is an inevitable part of standardization. We can see it in action in almost every area of the software business. Making XBRL implementations cheap and widely available was also one of the SEC’s stated policy goals when it mandated XBRL. They will absolutely not allow one company to dominate.
My hunch is that EDGR has some automation advantages over its competitors which help explain its market leading position (by 5% points), but these advantages are very fleeting, not sustainable.
Catalyst: Deal with RR Donnelley
All of EDGR’s XBRL filings business comes through its partnership with RR Donnelley. Signed in 2008, this partnership makes EDGR the exclusive XBRL implementor for RR Donnelley (RRD) clients for a period of three years. Prices for year one were set up front. Prices for years two and three were supposed to be negotiated by Oct 2009 and 2010 respectively. What is interesting is that the Oct 2009 negotiation is behind schedule – year two prices have not been set yet. I think this is because RR Donnelley is realizing it has many alternatives to EDGR, and therefore deserves a much larger share of the revenue than it took in year one.
I believe this partnership is EDGR’s biggest asset as well as the first catalyst to bring its valuation down to earth. When the negotiation is done, I believe we will find EDGR needs RRD a lot more than the other way around.
Disclosure: No positions
