Kornit Digital Ltd. (Update 1)
- Spruce Point believes Kornit Digital (“the Company” or KRNT) saw 2018 revenues, and particularly cash flow, driven entirely by Amazon’s expansion of its Merch program, which are likely to taper based on a slow-down of program growth, and would leave a gaping hole in Kornit’s aggressive revenue growth strategy. Forensic evidence from warrants granted to Amazon suggests that 105% of 2018 operating cash flow came from Amazon gross payments, and a cessation of new orders and rebate incentives coming due will depress future results. In addition, we believe Amazon is expanding into Japan, and that Kornit is not well positioned to win. Investors’ faith in Kornit’s financial results needs to be evaluated relative to its CFO having been the CFO at MRV Communications, which suspended reliance on its financials related to an option-backdating scandal. With shares up 55% YTD and trading near all-time highs at a substantial premium to digital printing peers, Kornit has 75% – 85% downside risk ($4.50 – $9.30/ sh)
- Kornit’s revenues to Amazon were 17% in 2018, and grew substantially after Amazon faced environmental permitting delays in 2017. The sales to Amazon are primarily linked to printers supplied to its Merch by Amazon program, which allows merchants to design and sell printed shirts and sweaters, while outsourcing production and logistics to Amazon. Caution: Based on shipping records and weight tonnage, we can estimate unit printer shipments. We believe Kornit has discounted list prices to Amazon up to 50%. We also cannot accurately back into Kornit’s 2018 reported revenues, and have extreme concerns about the potential for revenue recognition issues.
- While the program enjoyed early success, Spruce Point believes US program growth has plateaued, and has hard evidence that printer orders delivered to Amazon in the US have dramatically slowed YTD 2019. Furthermore, we believe Kornit will lose Amazon’s next leg of expansion of the Merch program to Japan:
- Selling digital printers is akin to selling a commodity product in a hyper competitive industry. In order to entice Amazon, Kornit issued it cashless warrants (a weak form that requires no capital commitment by Amazon) for its stock, which should be viewed as price discounts and are netted against sales.
- Based on the warrant vesting formula, we can determine that total payments by Amazon to Kornit in 2018 were 105% of total 2018 operating cash flow. This suggests underlying organic cash flow decline from its remaining business.
- In addition to warrants (and price discounts to list price), Amazon also gets price rebates, and Kornit is not adequately disclosing the rebate terms in the contract or in the 20-F. This amounts to an effective “triple incentive” to win Amazon.
- Based on our research, we believe the rebates will kick-in up to a year afterwards, causing short-term inflation in Kornit’s cash flow, and will be a drag on Kornit’s operating cash flow in 2019.
- If Kornit received a multiple closer to printing and computer equipment peers, and our concerns about Amazon come to fruition, it’s easy to justify a price target of $4.50 – $9.30 or 75% – 85% downside risk.