Axon Enterprises, Inc.

  • Axon Enterprises (Nasdaq: AAXN), the maker of the Taser stun gun, has been positioning itself more as SaaS provider of analytics through body cams to law enforcement agencies. With a history of SEC inquires, delinquent filings, and material weaknesses, we believe Axon will shock investors with significant earnings disappointment and increasing cash burn as it fails to scale beyond these niche businesses. Furthermore, we believe investors misunderstand Axon’s exposure to China tariffs, which will constrain margin growth, and its aggressive revenue recognition policies, which have pulled forward revenues. As part of our research, we spoke with a law enforcement expert at one of the 5 largest police departments in the US, a former Axon product executive, and a leading global competitor. With its shares and valuation trading near an all-time high, and analysts price targets of $72 (implying 9% upside), we think the risk/reward is terrible and believe investors should brace for 40% – 60% downside risk ($27.50 – $40.00).
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  • Taser’s core stun gun product is mature with limited domestic unit growth opportunities. A new Taser 7 introduction, over three years in development, is unlikely to materially change this trend aside from a short-term benefit
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  • Meanwhile, its faster growing Software and Sensors (including Axon Cloud) is experiencing a slowdown, while its margins are also contracting. We believe these trends will continue as costs escalate from offering unlimited video storage, and competition increases
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  • Now 5 years into the Taser 60 program introduced in 2014, and with the Taser having a 5yr expected life, we believe its early mover advantage is being eroded by competitors pricing and solutions on the software and sensor side. Axon’s best gains are now behind it
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  • Axon’s Q1 operating cash burn was the worst in its public history. In addition, Axon quietly increased its line of credit from $10m to $100m (without filing an 8-K), an odd move given it has $350m of cash on its balance sheet, no debt, and is forecasted to produce profits this year of $56m according to analyst projections
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  • Axon raised $234m of equity in June 2018 for no defined purpose, has spent only $5m on the plagued acquisition of VIEVU, and announced its intention to build a new HQ despite underlying Taser unit growth struggles. From our experience exposing Chinese financial schemes, capital raises for undefined purpose and suspect capex projects are significant red flags
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  • We believe Axon has concealed its dependence on Chinese imports. It removed the word “China” from its recent 10-K, but in Q1’19 said that “tariff and customs expenses” weighed on margins without quantifying the amount or country source
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  • Based on import records, we believe Axon has become increasingly dependent on China imports tied to the body cam business in the past few years, and given on-going tariffs, we believe these costs will weigh on margins, and could easily cause it to miss 2019E EBITDA by 10%. Based on our field research (not disclosed by Axon), we find some evidence it has implement upwards of 5% price increases in Q1’19, yet despite this increase, gross margins were still under pressure and missed company estimates by 250bps
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  • There are many data points to cast doubt on the accuracy of Axon’s margins beyond it having recently reported a material weakness tied to revenue recognition and cost of sales, fail to promptly address SEC comment letters, and have its CFO resign:
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  • Axon released its Taser 60 plan in 2014, allowing customers to save by bundling and paying for product and services over 5 yrs. Axon increasingly recognizes revenues under “multiple performance obligation” accounting tests which gives it discretion to decide the timing and value of revenue recognition. It claims its bundles have “stand-alone” value, and books revenue for hardware upfront. Bolstering our concerns, public contracts we’ve evaluated include no stated value for the hardware. We estimate this has inflated revenues by 6% – 9% in the past few years
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  • In addition, Axon has never disclosed errors or accounting issues tied to compensation expenses. However, Spruce Point has unearthed 401k plan filings at the IRS where Axon admits errors dating back to 2014. SEC reported expenses do not match IRS filings
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  • Axon’s $17m acquisition of VIEVU in May 2018, during a company reposting period, stoked a $1.8bn increase in market value. Based on our estimate, the market for bodycams is at best a $356m market, but the TAM is constrained, margins are shrinking and losses are accelerating
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  • Axon stated significant cost synergies as part of the deal rationale. However, more than a year later, Axon still operates a separate call center for VIEVU. Based on our work, it appears that sales declined sharply after the acquisition, while losses intensified. We believe there are no synergies, and VIEVU was a defensive acquisition to buy into the NY Police Dept. We also find that Axon took an enormous inventory reserve amounting to 70% of the total amount of inventory it acquired in the transaction
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  • Axon has rapidly inflated its Total Addressable Market (TAM) from $4.8bn (2016), $6.5bn (2017) to $8.4bn (2019). Yet, by closely analyzing assumptions, it becomes obvious that much of this TAM is largely unproven, and being exaggerated with unrealistic pricing assumptions:
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  • Axon Records / Dispatch: Significant entrenched competition in these critical areas will make it extremely difficult to crack this market. Axon has given the records away for free to try to whet customer appetite. However, the purchasing decision is not always tied to police chiefs, where they have their best relationships. We believe the market is dominated by Motorola, Tyler Technologies, and CentralSquare Technologies. These three players have largely consolidated the market through acquisitions, leaving Axon no alternatives to buy its way into the market, and punting its future on a greenfield development strategy with a high risk of failure
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  • Analysts’ average price targets for Axon is $72.30, or just 9% upside from the current price. A majority of analysts (9) are bullish, but there are five (5) that are neutral or expect Axon to perform in-line with the market. Four (4) brokers fail to offer a price target
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  • Analysts have bought into the narrative that Axon is a superior “razor / razor blade” model with a promising recurring revenue and cloud business. However, we believe this is a one-time boost from a move to the Taser 60 subscription model in 2014, that is now maturing five years into the program. All the while, future growth opportunities will remain challenging, and analysts have amnesia as it relates to Axon’s past SEC investigations, material weaknesses, and legal spats and view them as one-off “non-recurring” issues. Based on our recent findings, we beg to differ, and don’t believe that Axon is worthy of its super valuation of 7.4x, 46x, 65x 2019E sales, EBITDA and EPS, respectively
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  • Meanwhile a key executive and Board member recently departed, which we believe signals waning confidence in Axon’s future, and supports our case that Axon has a technology roadmap challenge, and constrained ability to acquire deeper penetration in its verticals. Axon’s EVP of World Wide Products, recruited from Apple, quietly left in less then two years. Brett Taylor, Chairman of Axon’s Technology Committee (and M&A Board member), also just resigned as disclosed on June 14th
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  • We believe a majority of the brokers pitch Axon’s stock to retail investors. Sophisticated institutional investors have been selling shares over time, side-by-side with insiders
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