Textura Corporation (NYSE: TXTR) enjoyed a very successful IPO in 2013, with share prices eventually climbing to three times the IPO price of $15 (trading at $29.50 currently). Short-seller Citron Research, however, has strongly claimed that Textura’s stock price, and the support it enjoys from investment banks, is based on fraud and investors’ misunderstanding of the complexities and realities of construction payment and the construction market. The questions and allegations posed by Citron contemplate more than just the question of the true ultimate value of the stock – they also bite at the fundamental nature of Textura’s business model and addressable market.
Citron Research has published multiple reports on Textura and what Citron perceives as a drastic overvaluing of Textura’s stock. While at least some of the impetus behind the claims is likely self-serving, Citron is, after all, a short-seller, the number and severity of the allegations could be significant. The claims presented by Citron are as varied as they are numerous, ranging from lying to the SEC and failing to disclose the CEO’s involvement in an alleged pump-and-dump stock scheme prior to signing on with Textura, to vastly exaggerating metrics to confuse investors and an unsustainable business model.
While the background and alleged dealings of the Textura CEO and affiliates make for an interesting read, this overview of Citron’s reports will focus on the allegations and issues related to Textura’s business model, market, and performance.
Can Textura Keep Users?
Potential problems with Textura’s business model have been outlined by this blog before. With Textura positioning itself, whether intentionally or unintentionally, as a tool with which big GCs can out-leverage the subcontractors that are required to actually pay for the platform, it may be too difficult for subcontractors to like Textura – even a little bit. This issue can easily lead to potential problems with subcontractor churn – and remember – subcontractors are the ultimate end-users of the CPM system from which Textura obtains the bulk of its revenue.
[Textura] revised the disclosure . . . to remove . . . “high client retention.” This problem of user churn has not gone unnoticed. As noted previously, the ultimate end users of the platform find Textura difficult to like, or even deal with. The American Subcontractors’ Association has noted “gripes” about Textura’s CPM, and notes that it “allows general contractors to be unduly rigid in the processing of payments”. The marginalization of subcontractor’s and minimization of subcontractor complaints is mirrored in Textura shareholder Goudy-Park Capital’s comment that “[i]f a subcontractor is unhappy, the GC will just go to the next subcontractor down the line.” While the largest GCs on the largest construction projects may indeed be able to follow that approach, it cuts off a significant portion of the market. In fact, Textura’s largest shareholder may be worried that Textura is stuck in the cyclical field of large commercial construction and is unable to get out and expand outside this field.
This likely comes as no surprise to Textura itself because, as Citron points out, Textura acknowledged this exact type of problem after questioning by the SEC. Textura’s original registration statement leading up to its IPO stated the following:
Recurring revenue model with high visibility. Our solutions historically have exhibited a predictable pattern of fee generation from projects managed on our system; our large portfolio of clients has resulted in a predictable number of projects; and we have experienced high client retention . . .
However, Citron notes that, when Textura was requested by the SEC to provide “specific quantitative disclosures” regarding the high retention of users, Textura provided no supporting data but instead responded in the following manner:
The Company acknowledges the Staff’s comment and has revised the disclosure on page 3 and elsewhere in the prospectus to remove the disclosure regarding “high client retention”.
The struggle to retain users could be a significant problem for a software/technology company, and Textura may be increasing end-user churn by its own business model.
Can Textura’s Business Model Make Profit?
Another potentially significant problem for software/technology companies is the ability to not only grow and increase top lien revenue, but to do so in a way that gives proof that the business model can eventually become profitable. It’s true that (quick) profitability is not the end-all that some may think (after all take a look at Amazon and its stock price), but long periods of large losses, and losses that increase percentage-wise more than revenue grows can be cause for concern. Citron notes that Textura’s revenue is growing, but that Textura’s losses are growing by more – specifically from 2012 to 2013 revenues were up 64% but losses were up 109%. In fact, Textura itself has noted in SEC documents that it has incurred “significant losses in each period since [its] inception in 2004” and had “an accumulated deficit of $169.9 million”. Textura continued by noting that it expected “losses to continue for the foreseeable future” and that “[Textura] cannot assure you that [it] will achieve profitability in the future, nor that, if [it does] become profitable, [it] will sustain profitability”.
Why is this? Citron has set forth multiple reasons it alleges may be the answer to that question.
In likely unbelievable news to subcontractors, however, Citron believes that subs have been underpaying for CPM, sometimes substantially One significant factor that Citron cites in relation to Textura’s revenue model is what Citron alleges is “fraudulent representation . . . about gross margins of their flagship product”. Texture’s flagship product is CPM, which accounts for around 60% to 65% of the company’s total revenues. Textura, and many analysts, claim that the CPM revenue is based on a total of about 16 basis points of the total contract value (4 from the GC and 12 from the subcontractors). In what is likely interesting and unbelievable news to subcontractors, however, Citron believes that subs have been underpaying for CPM, sometimes substantially. Analysis from Citron claims that Textura has never actually obtained even half that amount, and that the actual revenue of the CPM hovers pretty steadily at around 6 basis points. Citron alleges that this discrepancy is due to misunderstanding of the construction industry, specifically construction payment, and “special deal” pricing that drastically reduces the revenue obtained from large projects.
Citron notes that the Denver airport project, probably the most significant project on which Textura use was mandated, subcontractors were not directly charged for the use of Textura’s CPM. While this pricing scheme of charging the GCs a fee based on a percentage of bid price – built into the bid – is applauded by the American Subcontractors’ Association, it is decried by Citron. This pricing model was alleged to gain Textura somewhere in the ballpark of 1/20th of 1% of the total contract value (or 5 basis points) in top line revenue – much less than the 16 basis points Textura is supposed to charge.
This pricing issue could have significant impact on subcontractors. If the majority of the revenue generated by CPM is supposed to come from the subs – the real end-users – and the revenue is not high enough, it doesn’t take a rocket scientist to figure out a potential solution: Higher prices for the subcontractors that are generally footing the bill. With subcontractor’s already expressing discontent over paying for what they view as part of the GC’s overhead management costs, a hike in price is not likely to end up improving Textura / subcontractor relations. Given that rising prices on parties that are already at least partially marginalized by the platform may be an easy way to generate more revenue, and get closer in line with stated expectations, subcontractors should keep an eye out and be prepared for that possibility.
There are multiple potential sticking points set forth by Citron in reference to alleged overstatements of Textura’s addressable market. The construction industry is huge – there’s no getting around that. But, after portions are picked off here and there, the ending total can be smaller than originally anticipated. Textura, in an investor presentation, presented a current market addressed by current products of $4.4 billion, and an addressable market of $28 billion – predicated on:
- US Market of $1.3 trillion
- Global Market of $4.8 trillion
- Current Products representing approx. 34 basis points
- Global Opportunity of additional 55-60 basis points
With the flagship CPM pulling in a Citron-alleged ~6 basis points, it’s clear why Citron is hesitant to view the above as an accurate representation of the market size. Even disregarding the basis points discrepancy, however, (Textura may have product plans to expand its reach significantly) there is a potential problem with the ability of Textura to gain entry to, and generate CPM revenue from, segments of the construction industry other than large commercial construction.
Categories of construction with less subcontractor involvement . . . provide a correspondingly smaller amount of revenue to Textura, despite the total market size. It is unlikely that Textura will be able to, or wants to, penetrate residential construction. Textura notes as much in it S-1 filing by discussing the value of U.S. commercial construction (~$700 B) and excluding single-family residential construction. This has also been noted by Textura shareholders, as Northwater Capital has changed its role from providing venture support to activist noting that Textura is stuck in large commercial construction. Additionally, since most of Textura’s revenue is generated by the flagship CPM product, categories of construction with less subcontractor involvement, namely “Heavy” and “Civil Engineering”, provide a correspondingly smaller amount of revenue to Textura, despite the total market size.
With limited subcontractor use in certain construction segments that potentially add up to nearly 50% of the total non-residential construction market, the market size shrinks from the US Market of $1.3 trillion (as set forth in investor presentation) or $700 billion (contemplated by SEC filings) down to about $350 billion. Citron believes the situations even more dire when addressing the global market. With no European patent protection, and different construction laws, requirements, and practices in other countries, Citron is extremely skeptical of Textura’s ability to gain significant entry into foreign markets, at least as contemplated by Textura.
The Billion Dollar Question – And Why Subcontractors Should Care
At the higher end of its trading price (high $30s to low-to-mid $40s per share), Textura’s market cap was around a billion dollars. Citron believes that Textura stock is a sinking ship and will end up at $4 per share, at best. This is an enormous discrepancy, and the determination of which side of the equation ends up being right will have significant financial impact on the company and its shareholders. Is Textura limiting itself to a smaller market by its business plan? Are the revenue vs. loss numbers for the last 10 years indicative of the overall direction of the company? Is the high short interest in Textura a troubling sign?
All of these questions are difficult to answer – there’s a reason that people investing in individual stocks don’t make money 100% of the time. Businesses are sometimes difficult to gauge, and this can especially true of technology or Saas companies and products. Citron clearly believes that Textura stock will plummet, and has a significant financial stake in that outcome. Textura, and many analysts believe the other way, with a similar financial stake.
Since the majority of CPM revenue is supposed to be generated from subcontractors, it is those same subcontractors who would likely be most affected by a price adjustment. Finally, parties in the construction industry itself are the parties that will likely be bearing at least some cost in Textura’s fight to make sure its version is ultimately correct. Every business wants to grow revenue, and there are a couple ways to do that: 1) expand products / markets; or 2) raise prices. Since the majority of CPM revenue is supposed to be generated from subcontractors, it is those same subcontractors who would likely be most affected by a price adjustment. Even more than most businesses, perhaps, Textura may be in a position where significant revenue growth is needed to more align with the expectations of shareholders. This could be troublesome news for subcontractors for two reasons. One obvious reason is discussed above, in order to generate more revenue, Textura may be required to increase the amount charged to subcontractors for their mandated use of CPM. Another reason subcontractors should pay careful attention has more to do with the use of the Textura platform by GCs. Another way Textura could seek to raise revenue is by making the platform more attractive to the big GCs it appears to be built for and cater toward already. One way of potentially doing this is to make the platform more geared toward providing the top-tiered parties with greater leverage against the subcontractors. While Textura claims to be a neutral party, and not designed for the benefit of one side of the equation at the expense of the other, subcontractor gripes test that theory. If Textura decides to gain market share with GCs by appealing to a desire to out-leverage the lower-tiered parties, subcontractors may be put in a difficult position in which they are forced to pay for a product that would be a hindrance.
In any event, this will be an interesting and important story to watch – not only for Textura shareholders, but for subcontractors and others in the construction industry, as well.