ZK International's Pullback Could Be An Opportunity To Buy
Summary
- Shares of ZK International have pulled back by more than 50% since peaking in March. This could be a good opportunity to buy.
- The company has diversified into new lines of business after investing in the iGaming industry. It also has several products on its blockchain R&D lab.
- Its bottom line suffered last year amid lower ASPs forced by the Covid-19 pandemic. The company is targeting a return to normality but new Covid variants could be a problem.
- However, the iGaming business could be a game-changer if projected industry growth rates and MaximBet’s ambitions, in which it has a 25% stake, come to fruition.
ZK International (NASDAQ:ZKIN) is a leading provider of high-performance stainless steel products. The company is looking to leverage opportunities in emerging industries to boost long-term growth. ZK has made key acquisitions and partnerships in recent months that could see it achieve this goal. The company is betting big on the potential breakout of the iGaming industry after making a $50 million investment last month. It has also tapped into blockchain R&D after launching an NFT, crypto derivatives, and stablecoin trading platforms. Shares of the company have pulled back significantly from the 51-week high reached on March 22 creating what could be a huge opportunity for investors.
Business overview
ZK International has reinvented itself over the last few years to focus more on digital technologies. This will help to augment its stainless steel business in the long run.
The company launched xSigma Corp in 2018, which has since focused on investments in non-fungible token (NFT) technologies, DeFi, and crypto derivatives markets. This unit is poised to benefit significantly from the rapidly growing popularity of NFTs. The xSigma NFT marketplace beta is scheduled to launch in Q3 this year on the Ethereum blockchain. There are also plans to integrate with Polkadot in the near future.
This year, xSigma launched xSigma Entertainment as a separate unit to focus on the iGaming industry. The company invested $50 million in MaximBet, a sportsbook platform launched by the popular magazine Maxim in conjunction with digital gaming company Carousel Group. This investment grants ZK a 25% stake in the sports betting platform.
ZK is also targeting the golf betting market following the purchase of live golf betting software, which will serve as an enterprise solution to iGaming operators. The live demo has already launched with a Beta version scheduled to debut in Q3 this year.
ZK’s high-performance stainless steel business continued to grow last year, but profit margins suffered due to a combination of unfavorable revenue mix and lower average selling price. The stainless steel business operates in two major verticals, the stainless steel coil, and strip and stainless steel piping and fitting products.
Financials overview
In the company’s fiscal year 2020 results announced in February, ZK posted a top-line improvement of 36% to $86.85 million year-over-year. In 2019, ZK posted a top line of $63.88 million. However, gross profit plunged 74.8% to just 4.5% down from 24.5% in the previous year due to an unfavorable sales mix.
The company said that it witnessed a massive growth in low margin revenues from the stainless steel coil and strip products while sales from high margin products, the stainless steel piping unit fell significantly.
This resulted in a gross profit of just $3.94 million compared to $15.64 million reported in the fiscal year 2019. ZK posted a net loss of $0.83 million or $0.05 per share compared to a net profit of $8.11 million or $0.49 earnings per share.
Mr. Jiancong Huang, Chairman and CEO of ZK said that the stainless steel and carbon pipe value chain was adversely affected by the Covid-19 pandemic. But the company still managed to grow its overall top-line to record revenues. Huang attributed this to the company’s strong product quality and customer recognition among the end customers.
“However, margins and profitability deteriorated in the fiscal year 2020 as a result of significantly decreased ASP for our products and increased sales of lower-margin stainless steel coil and strip products as a percentage of total sales,” he added.
The company is now looking towards an improvement in the bottom line to match the performance of its top line in the coming quarters.
From the perspective of expense management, ZK managed to cut expenditures across all the main categories including sales and marketing, general and admin, and R&D. Total operating expenses came in at $5.82 million down 16.4% from the previous year.
The company’s diversification to digital products could see it improve its profit margins significantly in the coming years. Its stainless steel coil products had a gross margin of just 0.15% last year while stainless steel piping and fitting unit averaged 7.58%. ZK said that part of the low gross margins was due to discounts offered to customers earlier last year amid the Covid pandemic.
Why xSigma could be a game-changer
ZK has built a strong portfolio of digital businesses through xSigma corp. Some of these units have already started to bear some fruit while more are scheduled to go live within the next couple of quarters. This could improve ZK’s value proposition as it seeks to gain market share in key breakout industries.
MaximBet and iGaming
The regulated iGaming market is expected to generate over $10 billion in annual sales in the US by the year 2025. ZK’s xSigma Entertainment has invested $50 million in MaximBet, a US sportsbook platform to try to capitalize on this growth. On the other hand, the global market size which crossed $55 billion in 2019 continues to grow at a CAGR value of 16.5%. It is expected to be worth nearly $90 billion by 2023 after surpassing the $65 billion mark in 2020.
Source: Company presentations
MaximBet is currently available in four US states. It plans to use the $50 million investment to expand to more states in the coming quarters.
MaximBet is targeting Maxim’s 1.7 million monthly digital platform visitors to try to grow its market share in the iGaming industry. The popularity of the Maxim brand could help MaximBet to penetrate the industry quicker than the time it would take an ordinary online betting startup.
Carousel Group, the other party involved in the launch of MaximBet runs licensed gaming operations across Europe, the US, and Latin America. The company has also entered into a multi-state partnership with Caesars Entertainment (CZR) to expand its market share in the US. This partnership could play a crucial role in building up MaximBet’s customer base.
In the US, the iGaming market is projected to be worth about $30 billion by the year 2030 up from just $1.4 billion in 2019, according to Macquarie Research. Other analysts also have high optimism about the industry. Jefferies has projected a market value of about $18 billion by 2023 while Goldman Sachs has a forecast of $30 billion by 2033.
The media is an important cog in the iGaming wheel of fortune
The Macquarie report also notes the key role that the media plays in promoting the industry. It uses the example of Score Media and Gaming (SCR), also the parent of Score Digital Sports Ventures, which includes TheScore. Its betting unit Barstool Sportsbook has become a hit in the gaming industry. Maxim magazine could play a similar role in augmenting MaximBet.
Macquarie gaming analyst Ched Beynon said these partnerships (between media companies and betting platforms) are driven more by need rather than choice. “A standard sportsbook operator usually lacks a media footprint, while media enterprises don’t have wagering exposure,” Beynon, wrote in a note to clients after upgrading Score’s rating to outperform.
The media widens the sportsbook’s addressable market by increasing exposure while media platforms can augment their revenues by claiming a share of the revenue generated from wagers.
Earlier this year, Macquarie posted a report saying that the legal online gaming industry will be accessible to 90% of the US population by 2025, up from about 36% last year. In the UK, the average betting adult spent about $93 in 2020. Macquarie predicts that the average betting US adult will spend about $50, which looks conservative.
ZK’s digital empire does not stop with iGaming. The company is also looking to tap into the rapidly growing blockchain industry. It has launched xSigma NFT Marketplace, xSigma Trading, and xSigma DEX with a view to becoming one of the most disruptive companies in the market.
The xSigma NFT Marketplace
The xSigma NFT Marketplace targets crypto-collectibles and the non-fungible token market, which continues to experience rapid growth. This platform will allow customers to create, sell and buy NFTs. The company is already on course to launch the Beta version of the platform this summer. It targets $10-$20 million monthly trading volume in the first year, which is approximately 3-5% of the current market.
Global cumulative NFT sales topped $1.1 billion during the first quarter of 2021 and the total market value is expected to grow 1,785% this year. Dappradar reported that NFT monthly sales hit a record of $475 million in March. However, the interest in the market has since stabilized with less activity in April.
Sports-related NFTs appear to have the highest demand according to data and this explains xSigma’s first two major listings. The company announced the launch of NFTs for NBA stars Dwight Howard and Michael Beasly late last month. The leading NFT platform NBA Top Shots averages a monthly sales volume of nearly $130 million while OpenSea’s figure is about $120 million.
This shows that with proper planning and marketing, xSigma’s NFT marketplace could easily begin to report high sales figures in the coming months. It also explains the ambitious projections that the company has put down for the platform’s first year.
Disruption of Crypto and CFD trading with xSigma Trading
ZK is using its blockchain R&D labs to launch a product that will bring more traders to the market. Currently, investors can buy and sell small-cap stocks on stock exchanges, but very few allow trading them via CFDs. And just like Robinhood has disrupted the stock brokerage market, ZK wants to disrupt the stock CFDs market by creating a platform where traders can access small-cap stocks.
Small-cap stocks are among the most popular investment instruments among retail investors - and ZK appears to have a product that could become the Robinhood of CFDs.
The xSigma DEX
This is a marketplace for stablecoins. The decentralized exchange was launched by xSigma labs in February. It passed $300 million in trading volume two months after launch, which is equivalent to about $5 million per day. ZK is targeting the $10B+ worth of monthly stablecoin swaps.
Curve Finance a major stablecoin averages $100 million in daily stablecoin volume. Its governance token CRV has a market cap of more than $800 million.
In reference, the xSigma (SIG) governance token has a market cap of $30 million and xSigma owns 30% of it, which is close to $10 million.
Valuation
From a valuation perspective, shares of ZK are currently trading at a price-sales ratio of about 1.31. The company’s top line could grow significantly when revenues from the new lines of business start trickling in.
But even at 1.31 P/S, the stock still looks relatively undervalued given the circumstances of last year, which hampered top-line and bottom-line growth. The company said that it issued massive cash discounts to try to drive sales up amid the pandemic.
Therefore, with the adverse effects of Covid fading, there could be a significant rebound in the company’s revenue from its stainless steel business.
ZK is in a strong position to deliver another low to mid-30s growth rate this year. A return to normal pricing will boost the average selling price, but could also reduce the sales volume. Therefore, there might not be a significant deviation from last year’s growth rate.
A conservative top-line growth of about 30% this year to $112 million should see a significant surge in the price, but more importantly, a return to profitability will help the company to generate higher cash flows, which will be attractive to investors. Using the current P/S ratio of about 1.31 implies that the company’s stock could be worth more than $7.50 or about $192 million in market cap within the next 12 months. That does not include the potential sales from its new lines of business.
Now, looking at the company’s 25% stake in MaximBet, this could be one of the best investments ZK has made in history. MaximBet wants to claim a sizeable share of the US iGaming market, which is projected to record $10 billion in annual sales by 2025. Even a conservative share of the market of 1% could imply $100 million in annual revenue. Score Media and Gaming currently trades at a P/S ratio of about 57.98, yet analysts are optimistic that the stock is massively undervalued. Using the same valuation multiples for MaximBet, this equates to a potential market value of nearly $5.8 billion in four years' time. This means that in a year’s time, MaximBet could be easily worth over $1 billion. This implies that ZK’s investment of $50 million for a 25% stake could be worth at least $250 million within the next 12 months.
On the other hand, the company’s NFT marketplace targets $10-$20M in monthly trading volume. For reference, Mark Cuban invested in Mintable, a similar platform, which reported $100k trading volume in Q1. Mintable is now valued at around $1 billion. OpenSea, which averages $119 million in monthly trading volume is also valued at just over $1 billion.
Therefore, it looks like there is more that goes to these valuations than just trading volumes. Investors are looking at the future prospects of the marketplaces and are willing to pay a hefty premium for the most exciting project.
Taking into consideration all the potential value propositions ($192 million core business, over $250 million from MaximBet, nearly $10 million from SIG, plus other units), ZK could easily be worth over $450 million, or roughly $18.00 per share within the next 12 months. This is more than three times its current value, but just about 23% above its all-time highs reached six weeks ago.
Risks
ZK is shifting strategy after diversifying to digital products. This is completely new territory for the high-performance stainless steel products manufacturer. This brings different challenges to the company’s management. Such ventures can easily turn out to be poor investments that never pay off. The company could also face tough challenges during market penetration. Some of its products are scheduled to launch in Q3, while others are already up and running through partnerships. The next few quarters will be crucial.
In a bid to overcome potential challenges, ZK has recruited wisely by bringing in industry experts for every new line of business introduced to its product mix. Its blockchain research and development unit, xSigma Corp., appointed Arpan Sood as the new CEO of the crypto trading platform xSigma Trader, in March. It also launched some of its new products in partnership with companies that are experts in the target industries.
The DeFi project governance token went down and the community isn’t growing as anticipated. However, the company announced its plans about porting the DEX to Binance Smart Chain, so it may have a new breath and potential for growth.
On the other hand, The NFT industry is packed with many projects, so it will be difficult for xSigma to differentiate on this market. However, access to capital and xSigma’s Human Resources look promising.
ZK’s steel business suffered a significant decline in profit margins last year. While the world is slowly returning to normality, the variant strains of Covid are becoming a challenge and some countries are still in partial lockdowns. Therefore, it is not guaranteed that all its customers will increase purchases in tandem with pre-pandemic levels this year.
ZK is a small-cap stock, which means that it comes with added risks of investing in thinly traded stocks. However, its stock price per share of close to $5.80 means that it is less likely to be manipulated like most small companies that trade at price below $1.00. Its average monthly volatility of about 12.5% supports this argument. The stock also has an average trading volume of 4.81 million for the last three months, which is impressive for a small-cap.
Conclusion
In summary, shares of ZK International appear to be potentially undervalued based on projected sales growth and investment in new lines of business. The company is trading several levels below its all-time highs of about $14.60 reached in March.
This creates a window of opportunity for investors looking for deep value and potential for aggressive growth. The company could be worth over $450 million or $18 per share in a year’s time. The next few quarters will be exciting to watch.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
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