KIDOZ INC. (KDOZF) stock intrinsic value fair value estimate & owner earnings analysis

Kidoz Inc. runs a mobile advertising network for children, teens and families. App developers put the Kidoz software development kit into their apps. Kidoz then sells the ad space in those apps to brands and agencies. It targets ads by the content of the app, not by personal data, so the network complies with the U.S. Children's Online Privacy Protection Rule (COPPA) and Europe's GDPR rules for minors. The company names Disney, Hasbro and Lego among its advertisers, and it names SuperAwesome and Google's AdMob as competitors. The ad network came from the March 4, 2019 purchase of Kidoz Ltd., a private Israeli company. Before that, the company ran small online games businesses (Rooplay and social bingo sites) that lost $1.7 to $2.7 million a year. The parent company is incorporated in Anguilla and operates in Israel, Canada and the United Kingdom. Revenue rose from $4.5 million in 2019 to $7.1 million in 2020 and $12.5 million in 2021. In 2021, North America supplied $7.7 million and Western Europe $4.0 million. Sales are highly seasonal: about 47% of 2021 revenue came in the fourth quarter. The growth has not produced much cash for owners. We measure owner earnings as operating cash flow with short-term working-capital swings removed, minus stock-based pay, lease payments and the small amount of equipment spending needed to keep the business running. On that measure the business earned about $698,000 in 2020 and $533,000 in 2021, roughly half a cent per share, after losing about $1.07 million in 2019. For 2021 we counted two items as real costs: $660,000 of stock options, and $263,000 of shares and warrants paid to stock-promotion firms under a 'stock awareness' program. 2021 also included one-time staff bonuses that the company tied to the COVID period. We added back the roughly $556,000 a year of amortization on the technology and customer relationships bought with Kidoz Ltd. because it is a non-cash charge. The company already expenses its ongoing research and development ($1.7 million in 2021), and that spending is what keeps the technology current. The most recent figures available to us end on September 30, 2022, and they point the wrong way. Revenue for the first nine months of 2022 rose 27% to $8.3 million. However, gross margin fell from 45% to 37%, and research, sales and marketing costs grew faster than revenue. The nine-month net loss widened to $1.77 million from $0.97 million a year earlier, and each of the three quarters was worse than the same quarter a year before. Even with a strong fourth quarter, we estimate 2022 came in close to breakeven on our measure. We have no audited annual results after 2021, which is a significant limitation of this analysis. Our starting point is the median of 2019 to 2021, the years since the acquisition: about 0.4 cents per share, or roughly $533,000 a year. Owner earnings fell 24% in 2021, and the 2022 quarters give no dated reason to expect a rebound. The base case therefore starts about 25% lower, at $400,000 a year. It holds that level for ten years and then fades to nothing over the following ten. We fade it because the business has only two years of positive results, and ad-tech platforms need constant reinvestment to stay relevant. Discounted at 6%, the base case is worth about $3.8 million, or $0.029 per share. The bear case builds on concentrations the company has disclosed. Three customers supplied $7.3 million, or 58%, of 2021 revenue. The network also depends on the Google, Apple and Amazon app stores and on a small number of advertising agencies. In this case the 2022 cost pattern persists or a major agency is lost. The business then loses about $500,000 a year for four years before costs are cut back to breakeven, and nothing of value remains after that. In this case the business is worth less than nothing: future losses exceed future earnings by about $1.7 million, or $0.013 per share. That money would have to come from the roughly $1.8 million of cash held at September 30, 2022, or from issuing more shares. Debt does not add to this risk. Apart from ordinary payables, the only borrowing is a small Canadian government pandemic loan received in 2020 (about $47,000). The bull case assumes the company's own plans work. Revenue keeps growing as it did through 2022, and costs are controlled well enough that owner earnings return to the 2020 level of about $700,000. They then grow 10% a year for ten years to about $1.65 million. Because the network is built to meet child-privacy rules, that level holds for another decade. The bull case is worth about $14.6 million, or $0.111 per share. The margin-of-safety price is about $0.010 per share, a deep discount to the base case. The discount reflects the company's small size, its reliance on a few customers, the worsening 2022 trend and the long gap since the last audited results. The price applies only once audited results for a full year after 2022 show the business back to positive owner earnings. This estimate would be wrong if later results, which we have not seen, show the 2022 margin squeeze reversed and profits growing with revenue. It would also be wrong in the other direction if those results show the losses becoming permanent.