Datawind: Connecting The Emerging Markets One $50 Tablet At A Time

Summary

• DataWind is a small $43m market cap company developing hardware and Internet connectivity solutions focused on emerging markets.
• Its proprietary data compression solution has allowed DataWind to market its low cost tablets to these markets.
• DataWind has started bundling Internet access, mobile apps and targeted advertising with its hardware solutions.
• DataWind has finally reached positive quarterly Adjusted EBITDA and reduced its cash burn.
• A recent financing has helped to shore up its balance sheet while potentially giving clues that DataWind is hitting scale in its business model.

Please note that DataWind reports in Canadian dollars and trades on the TSX exchange as ticker DW.TO with greater liquidity. All amounts in this article will be denoted in CAD$.

DataWind Inc. (OTC:DWDZF) is a leading provider of low-cost technology and hardware to support the adoption of technology and Internet connectivity to the over 4 billion people worldwide who don't currently have Internet access.

We often forget in the developed world the connectedness we have now with such large mobile networks and wireless infrastructure on air, land and sea. However, many still don't have access.

7 countries alone have over 100m+ people with no Internet (Pakistan, India, China, Nigeria, Bangladesh, Indonesia, and Brazil). Some of these we think of as quite developed, but this can be often only the upper management. Many of these countries continue to have a large rural population that may not currently have access to the Internet or cannot afford it. This is the market DataWind is attempting to address.

DataWind was founded as a private company in 2000 by two brothers, Suneet Singh Tuli and Raja Singh Tuli, who are both active in the company as CEO and CTO respectively; they hold 4% and 9% of the outstanding shares. DataWind went public in its current form in July of 2014.

Historically, DataWind has focused on trying to get low-cost hardware out to those that can't afford the higher-end machines common in most developed countries. These tablets and smartphones cost the customer between $30-$120. However, as these represent one-time sales only, it is difficult to generate real growth, as the hardware replacement cycles are not as accelerated as they are in the developed world.

However, the company has been further developing its business model to develop a recurring revenue stream - Internet access. As part of a "razor/blade" type business model, in July of 2015, the company started including one year of unlimited internet access on each device. The goal of this is to get people accustomed to having Internet access and then to re-subscribe each year, with nominal incremental cost to DataWind while providing a steady recurrence of revenue.

One of the obvious issues that could be considered here is how these cheaper hardware could possibly process Internet bulk as fast as required. Fortunately, this is where DataWind's competitive advantage is:

Source: Company Presentation

Now, while their data compression may not have a Weissman score, it is crucial for DataWind's hardware to work. Broadband costs are simply too expensive (27% of gross income according to DataWind's research) in many of the countries where their technology will be rolled out. People in these countries need a cost effective system, which, by design, will not be robust enough to handle traditional data.

DataWind's technology is able to compress data in a significant scale. The average webpage size is 1.7MB; their technology reduces its size to 0.085MB, roughly 20x as small. With the data thus compressed, users are able to have a positive Internet experience, even on less than robust networks.

DataWind completes the process by providing the wireless infrastructure on top of the existing internet structure available in the region. They essentially buy up data at wholesale rates and then resell with a margin on top. DataWind is beginning to gain traction with key carriers in these markets, partnering with Reliance & Telenor in India and Airtel Nigeria in Nigeria, proofing out their concept.

They are also adding the ability to sell advertising and content through their Internet access and mobile app. I believe this will be the true "razor" to the Internet access "blade" in their business model, especially as some of their markets that already have started to adopt Internet commerce (i.e. India, China, Brazil) improve their basic infrastructure in the years ahead.

Financial Performance

With many of its revenues occurring in emerging markets (the vast majority in India with over 90% of their total revenues), I wanted to familiarize myself with their revenue recognition policies. I had read several SA articles on Net 1 UEPS Technologies (UEPS), whose accounting practices (among many other things) were red flags for the business they were conducting in emerging markets.

DataWind has none of these issues that I can see as they are selling into well-known entities (major Indian telecoms) that are not related parties. In their Q3 financial statement notes, the company clearly outlines their methods for revenue recognition:

At the time the device is picked up by the third party distribution company for cash on delivery sales

At the time when the retailer receives delivery for retail sales.

If we look at their sequential quarterly performance, we can see a definite trend emerging:

Source: Q3 2016 MD&A

The last 2 quarters have had positive Adjusted EBITDA (the September quarter had a $1.2m foreign currency translation loss that impacted its real performance) so they appear very close to turning real margins here as we have seen their margins increase each year along with revenues. The addition of high margin recurring revenue from Internet and value-added sales will also continue to expand this.

DataWind's cash flow has been improving each quarter:

Cash Flow By Quarter

in mCAD$	Q3 2016	Q2 2016	Q1 2016	Q4 2015	Q3 2015
Cash Flow from Operations (ex-WoC)	0.4	0.5	-1.8	-5.3	-1.8
Cash Flow from Operations (WoC)	-3.3	-3.3	-2.5	-2.7	-9.4
Cash Flow from Operations	-2.9	-2.8	-4.3	-8.0	-11.2

Click to enlarge

Source: Quarterly Filings

Note that cash flow from investing activities is very low at this point (less than $200 K annually) so I have excluded it as a discussion point at this time.

DataWind has improved its cash flows, especially the ex-Working Capital numbers. When a company is growing, it is normal to see a steady build in working capital as receivables and inventory growth will outpace payables in the short run as the company accumulates greater sales and stock to meet future sales. The fact that this rate has improved since Q4 2015 is a sign that they are managing their growth better and meeting their obligations.

Part of this will be due to their optimized supply chain, at least by geographic location. Their head office is in Canada, they have sub-contracted manufacturing to China, while the rest of manufacturing, sales support is in India. All are currently low cost countries to operate in, with their business units concentrated in geographic locations that have a strong competence in each area.

The improved performance represented by positive Adjusted EBITDA is a very good sign as well. The revenue run rate of $15m is roughly break even so anything above this level should substantially improve the bottom line. Additional revenue has added roughly 40% in margins so far. If we extrapolate an additional $1.5m in revenue from Q3 (10% quarter over quarter), we quickly get to a quarterly Adjusted EBITDA of $1.0m per quarter. Annualized out we have an EV/EBITDA multiple of roughly 13x. It isn't cheap, but for a company growing 10% per quarter, it is definitely low. As DataWind appears to be just hitting the tipping point of profitability, this may not serve as a good measure of valuation until it actually crosses over to cash flow positive.

So what is the rub? Financing. Currently, they have been able to exist on proceeds from several equity raises, starting with their IPO in 2014. However, DataWind has drawn down its cash balances to $4.2m at December 31, 2015 and has accumulated $13.2m in debt. This debt is currently bearing interest at 17% annually, with no current principal payments as it has been agreed to with a syndicated group of investors.

This is an incredibly high interest rate (resulting in interest costs of close to $2m annually), for which the company has gained essentially a flexible repayment schedule (in fact, there is no current repayment schedule even put in place). However, with just over $4.2m, at this rate they would have only about a quarter of cash flow available before they would need to obtain further financing.

As I was writing this article, it crossed the wire that DataWind was raising $2.6m from a private placement at $2.00 per share. This represented a dilution of almost 6% and, if its recent history is a guide, would only provide one more quarter of cash flow. There are two ways this can be viewed.

The first is that this was the only financing that they could obtain. I don't believe this to be the case, though. Even though they attached half warrants with the financing, they were only good for a year at a price of $2.80, 40% north of the subscription price. If they had wanted to raise more, I believe they could have extended the warrants out further to make the issuance more attractive or raised the size of the subscription at a lower price (below current market trading).

As a result I think that they have turned the corner operationally, likely involving higher revenues and close to break-even cash flow. They then would need this cash to cover their true working capital requirements rather than funding operational losses. Given they are 2/3 of the way through Q4, I suspect that they have a good idea how things are evolving and took the opportunity to raise some funds here.

No small cap is without warts and there is some definite risk here, despite how it appears to be setting up. If they do not continue to post positive cash flow or increasing revenues, there is a real risk to the shares here, as they will be likely facing a more dilutive finding or some sort of debt issuance to give them time to better execute.

Technically, DataWind is bouncing off of a low resistance point at around $1.75:

DW data by YCharts

With the financing at $2.00, at the price today, you are getting in at around the same price. I suspect the private placement could prove to be very lucrative if they are indeed at the inflection point of revenues as the warrant is essentially a free one-year call option on the Company. However, due to the small size of the placement, an investment in the current shares may serve one well enough. If you are risk averse, setting a stop at its low here of $1.75 will definitely minimize your risk, but you may miss out on the upside as a result.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DWDZF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.