Spruce Point Capital Releases A Strong Sell Opinion on Kornit Digital Ltd. (Nasdaq: KRNT)
NEW YORK, May 7, 2019 /PRNewswire/ -- Report entitled "Teed Up And Printing Rebates" outlines how KRNT faces 75-85% downside risk to approximately $4.50 to $9.30 per share due to underappreciated risks associated with its Merch By Amazon relationship, highly questionable earnings quality highlighted by myriad accounting irregularities, and a valuation out of line with industry norms and the Company's own true growth prospects.
- Numerous Signs Of Challenges Ahead: Kornit's stock has more than doubled through the last twelve months on the back of strong 2018 results and management projections of sustained 20% annual sales growth. To much fanfare, Kornit signed an agreement with Amazon in January 2017 to sell digital printers to support the Merch by Amazon program. By mid-2017, Merch by Amazon would become Kornit's largest customer, but only after overcoming delays triggered by environmental permitting issues. Despite a strong start to the Merch initiative – which, analysts believe, gives Kornit a long growth runway – we believe US growth for the platform is now slowing as disgruntled merchants push back against repeated royalty cuts, alternative print-on-demand options proliferate, and as Amazon itself hedges its discussion of its fashion-related initiatives in its 10-K.
Our market research indicates that Amazon – which, per industry participants, has had a mixed experience with Kornit to date, largely due to a long-standing ink odor problem – would likely be interested in switching printing partners if a comparable replacement could be sourced. Our research has also uncovered that Amazon intends to expand Merch into Japan. Facing formidable local Japanese competitors, Kornit will at best exit this competition with low-margin business – but, at worst, will lose the business and give Amazon an opportunity to evaluate alternative printing partners. Kornit's Asia business has underdelivered historically, and we see no signs that it possesses, or is ramping up, the infrastructure necessary to support Merch in Japan. We believe that a potential loss in Japan for Kornit poses a material and underappreciated risk to future growth. Furthermore, Kornit obscures in its SEC filings that Cimpress (CMPR), owner of Vistaprint, is its second largest customer. Vistaprint's business is under pressure, having recently admitted business challenges earlier this year, and having replaced its CEO. This is another underappreciated risk to Kornit's growth story.
- Warrants, Rebates, And Price Discounts Raise Earnings, Cash Flow And Accounting Concerns: In order to win the highly-coveted Merch by Amazon business, Kornit provided Amazon with rebates, warrants, and, by our estimates, price discounts up to 50%. This triple-whammy of customer incentives greatly reduces the quality of earnings tied to Amazon – yet, as sales to Cimpress stagnate, Amazon represents a growing share of Kornit's revenue and cash flow. In fact, based on the terms of the warrant agreement we estimate over 100% of Kornit's FY18 cash flow was derived from Amazon. Accounting and disclosure issues surrounding these rebates and warrants – in particular, indications of possible warrant backdating – are cause for concern, particularly given the CFO's history with the MRV Communications (MRVC) option backdating scandal, and the fact that reported Amazon sales cannot be reconciled with shipping data. Given the widely-ignored risks associated with the Amazon business, the fact that Company results may be temporarily inflated by improper accounting, and recent turnover in both the CEO and CTO position, we believe that Kornit's popular growth narrative carries far more downside risks than the market appreciates.
- Already Priced For Perfection: Kornit's current valuation, already at the sell side's lofty average target of $28/sh, is at an all-time high and significantly above its long-term average multiples. It is also completely out of line with valuations of other low-tech computer and digital printing printer peers, currently ranging from 4x to 9x those of competitors. We believe that investors underestimate the risk that Merch by Amazon's global expansion excludes Kornit, and fail to appreciate that last year's cash flow expansion may compress from rebates and fewer Amazon orders. If Kornit received a more appropriate multiple closer to those of printing and computer equipment peers, and our concerns about Amazon come to fruition, Kornit shares could decline to $4.50 – $9.30 per share, for 75% – 85% downside from current levels.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Kornit Digital Ltd. and stands to benefit if its share price falls.
About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.
