Well.i.am

I've mentioned 7digital before on my blog since I inadvertently acquired shares in this company through an investment in UBC Media. 7digital reversed into UBC media in 2014. I have carefully watched the progress of 7digital since the reversal, and recently started increasing my holding in the company.

For an overview of what 7digital actually does and for an idea about the size of the opportunity that exists, I'd recommend watching the following interview with CEO Simon Cole:-

https://vimeo.com/152277844

Let's deal with the risks first. 7digital has been loss making to date and is likely to report further losses this year. Cash burn has also been an issue, and this year the company reported a cash outflow from operating activities of £4.7m (2014: outflow £6.3m). Cash on the balance sheet at the end of December was around £1.66m.

Clearly, unless cash burn is reducing significantly then the company will need to raise more cash otherwise they could be in trouble.

Why I have invested then? Several reasons.

I love the business model which seems to be gaining considerable traction and the company is anticipating that it will be generating profits by the end of this year. Monthly recurring revenues are growing strongly, as are gross margins which suggests that cash burn will rapidly reduce. If all goes to plan then in future years 7digital will be highly cash generative and visibility of earnings will be strong. Eventually, it could throw off cash for further investments and hopefully dividends.

Interestingly, the "going concern" statement does not hint at a further cash raise, although in my opinion it can't be discounted. However, either way, if the company can reach cash flow positive without a raise then that would be a superb achievement, but even if a raise is necessary then it's likely to be for a relatively small amount and would be seen as a positive since they have re-iterated  their belief that they will start to turn a profit at the end of this year. It's also worth remembering that 7digital is debt free.

7digital is currently valued at around £8.5m which could be a price anomaly caused be two recent events. IMG were a major share holder in 7digital. IMG's woes meant that they decided to offload their entire shareholding. This was followed closely by the departure of Ben Drury (founder of 7digital) who resigned to pursue other non-competitive opportunities. Drury was another large share holder. He also decided to offload his shareholding. Both these events caused a slump in the share price. The good news is that the shares have been taken up by Henderson and Miton Group.

Returning to the market opportunity for 7digital, it's worth noting that they are operating in an area where barriers to entry are high. From the annual report:-

"Our unmatched combination of market leading technology, broad music rights and deep industry relationships can create significant barriers to entry for others in the sector."

This week, news that one of their main competitors, Omnifone, has gone into administration gives 7digital a further fillip since it provides a real opportunity for them to become the dominant force in this exciting and growing market place.

Again from the finals:-

"Our pipeline is strong, with a healthy number of current customers looking to expand their activities and, as of the year end, discussions were underway with over 60 new prospects across a range of services and geographies."

Since then the recent trading statement has indicated that six of these have been converted already with a total value of £3.9m. On Thursday they also released details of a contract win with musical.ly and a further strengthening of their relationship with i.am+.

Finally, referring back to Simon Cole's interview, if they can capture even 30% of their market, estimated to be £0.25 billion in the next three years, with gross margins already approaching 70%, strong recurring revenues and a reasonably tight grip on expenditure then some simple mathematics will tell you just how massive the company could be. Of course you should always bear in mind that this is a new space that they are expanding into, and hence estimating the market opportunity is quite difficult. As ever, do your own research. Are you going to invest? Well.i.am.