You know it had to come eventually - banks know what you buy with your debit and credit cards and that's information that can be sold! It's a bit sad as ads will intrude into yet another part of your routine. And again you didn't ask for it, but you'll be getting it all the same. Cardlytics (CDLX) works with banks to develop promotions and coupons for customers based on their purchase history. What you buy is a great source of information about what you might like to buy in the future - especially when offered a special promotion or discount. [Use these links to jump into the CDLX roadshow deck.]

As you can see in the picture below the way it works is similar to how retail applications like CVS and Starbucks operate. But in this case, it’s your bank so the range of offers is broader and can come from stores that you haven’t done business with in the past. In this way, it's a bit more like how Groupon (GRPN) behaves.

Cardlytics can access up to 55 million consumers using their actual spending as a basis to distribute additional offers and rewards. They do this in "partnership" with the financial institutions who get a cut (~50%) of the action.

Good Points

Cardlytics offers more effective online advertising since they can target real spenders with bank accounts. Lots of advertising is wasted on people without any money to spend.

The offer is a very clear incremental business opportunity for advertisers. For example, a restaurant chain can target customers that visit competitors. A retailer can target customers who have spent there but not been back in a while. These are situations where a discount or promotion is money well spent.

Agreements with banks and payment processors take time and after years of expansion, CDLX has built a "moat" around their business.

Long-term leverage in the business model - The company has been able to grow without having to increase staff. This suggests that continued expansion will drive increased ROIC which is good news for investors. The chart below shows their growth in customer accounts versus total employees.

(Click on image to enlarge)

Bad Points

Mediocre gross margins - Cardlytics pays 50% of their revenue to the banks and financial institutions which caps their gross margin. Their long-term model (see below) proposes they can achieve 20-25% operating margins but it’s not clear that they have room to get them that high. We’re modeling 15-20%.

Slow growth - The top line has been growing at 20-25% which seems disappointing for a product that claims “30 to 1” returns on marketing spend. Management shows misleading “CAGR” figures of 62% but that only works because it’s from a low base in 2012. Part of the reason may be that ARPU has remained flat which could be a temporary condition. We’d be more comfortable with the story if the top line was growing more like 40-50%. In the most recent two quarters, YoY revenue growth has been close to zero. 

Unclear market size - Although the company boasts a $11B TAM it is based on six levels of assumptions about market expansion. It’s easy to see how a key advertiser like Denny’s would continue to use Cardlytics for a small slice of their overall marketing budget but hard to justify how much more they would do. The platform is valuable but only as a niche in an overall marketing strategy.

How does it all work out?

Cardlytics has a powerful data asset and a real business. We think the TAM may be closer to $1B than $11B but that still gives the company plenty of room to grow.

At the mid-point of the proposed range, the market cap will be $280M which is only 2x revenues. If revenue growth snaps back in Q1 and Q2 investors will feel more comfortable.

For reference GroupOn (GRPN) trades at 1x revenues and has a market capitalization of $3B. Their gross margins are similar to CRLX and their operating income is running at 5% of sales.

We're including two different versions of our QuickIV model - one at 15% long-term margins and one at 20%. Both argue for a higher stock price at 4x or 6x revenue which is reasonable. The one caveat is that CDLX has to start putting up solid YoY growth on the top line. Otherwise at a lower multiple - say 20x and with an operating margin target of 10% - the shares are fully valued at $15.

Some of the potential upside stems from the fact that CDLX might be worth more in the hands of a larger company that could use their data more broadly.

QuickIV Models

(Click on image to enlarge)

(Click on image to enlarge)