Locafy: A Fat Pitch

$LCFY report

Thesis

Locafy is at a pivot point. It is a pivot in terms of strategy as it leaps forward in its transition from ‘just another SEO company’ to a global publisher with SEO capabilities. It is also a pivot in terms of financials, given that it’ll be at least near cash flow breakeven by next summer and might generate over half its market cap in earnings if things go as planned.

This feels like a fat pitch to me. Locafy has 5-, 10- or even 20- bagging potential. On the flip side, the downside seems small. The business will look stronger by the summer, and the market does not seem to have priced in the upside from this huge deal. I’m swinging big on this one.

Introduction

Locafy is undergoing a significant transformation in its business model, evolving from a pure Search Engine Optimisation (SEO) technology provider to a global publisher that leverages proprietary SEO technology. This strategic shift involves creating, owning and hosting digital assets where they can publish content while utilising their SEO expertise to ensure high search rankings for the published material.

Locafy’s SEO Technology

Locafy’s strategy regarding SEO focuses on optimising for five key things:

1. Entity-Based SEO: Locafy's technology focuses on Entity-Based SEO, which targets the highest-order keyword or reference point attributed by search engines to establish a website's context. This approach allows for optimisation across multiple keywords through a singular entity.

2. Rapid Results: Locafy's solutions typically deliver results within 30 days, significantly faster than traditional SEO methods, which can take up to 9-12 months.

3. Cost-Effectiveness: The company offers solutions starting from a few hundred dollars per month with no lock-in contracts, making it accessible to a wide range of businesses.

4. Scalability: Locafy's technology allows for rapid scaling across markets and clients with minimal marginal costs.

5. Automated Updates: The company can quickly adapt to search algorithm changes and implement updates across all clients simultaneously.

The following five steps summarise how Locafy achieves comprehensive, automated SEO.

• Content Curation: The initial step is creating or gathering high-quality, unique content relevant to a business. This content forms the foundation for all subsequent steps and is crucial for establishing relevance in the eyes of search engines.

• Listing Creation: Locafy uses the curated content in business listings on Locafy’s owned directories, such as Hotfrog. This step helps establish a consistent online presence for the business.

• Content Syndication: The same content is then syndicated to various third-party properties, including directories, apps, and maps. This process increases the business's online footprint and helps build relevance and authority in Google's eyes.

• AI-Powered Page Generation: Locafy's platform can generate AI-powered sites using initial content. These pages are designed to rank well in search results and can be published on Locafy's owned properties or other high-authority domains.

• Google Business Profile Optimization: This step involves optimising the business's Google Business Profile using the same core content. This optimisation helps increase the business's prominence in local search results, potentially improving visibility in the Google Map Pack.

The Transition from SEO to Publisher

Locafy's transition to becoming a publisher has its roots in the company's early foundation. For years, Locafy has owned Hotfrog, a global online business directory, along with other Australian-focused directories such as AussieWeb, PinkPages, and SuperPages. These assets formed the bedrock of Locafy's publishing capabilities, containing over 46 million business listings and an email database of approximately 245,000 subscribers. Initially, these directories were primarily used as supplementary tools to assist with SEO rather than as core publishing platforms.

I see Locafy's acquisition of Scoop's digital assets in Feb 2024 as a significant step in its transition to becoming a global publisher. Locafy expanded its content portfolio with 15 high-quality magazine titles, leveraging Scoop's established brand authority in the Australian luxury market, and allowing Locafy to implement its proprietary technology to optimise these assets for SEO success. By controlling Scoop's online portfolio, Locafy can create new revenue streams through advertising opportunities, moving beyond its traditional SaaS model. The company plans to replicate this strategy by acquiring and revitalising underperforming websites in niche publishing sectors, positioning itself as both a content owner and publisher.

The next step (or leap) in this direction came from their evolving partnership with a major U.S. media company. The partnership began in January 2023 when they were contacted for help with declining traffic. This led to initial trials and discussions about boosting article prominence. In June 2023, after successful trials, Locafy signed a contract to deploy their Keystone technology to national advertisers, though progress remained slow. The landscape shifted dramatically between March and May 2024 when Google implemented policy changes regarding sponsored content (most prominently site reputation abuse), forcing many media companies, including Locafy's partner, to remove articles from their websites after the traffic fell off a cliff. In response, Locafy proposed several new approaches to their media partner, including publishing content on Locafy-owned domains. Almost astonishingly, the media partner agreed to hand over its and clients’ assets to Locafy and let it republish the articles. Of course, end clients also need to permit the move of their assets, but this should not be an issue given that the end clients are already paying the publisher for a service that doesn’t work anymore; Locafy has a solution and the partner is recommending the move.

The partnership between Locafy and a major publisher carries significant qualitative implications that extend beyond financial considerations. The deal validates Locafy's SEO technology and publishing capabilities, as it's remarkable that a prominent publisher would outsource what could be considered its core competency (publishing) to a small $9 million market cap company and entrusting Locafy with its valuable content. Given the risks associated with working with such a small company, especially in handing over assets, it implies either a large level of trust or desperation to solve a problem. If a larger, more reputable company could have solved the problem, they would have gone elsewhere. To that point, we were also able to verify that Locafy was the only company providing this service to the publisher and was the only one who could effectively solve the problem. This implies that Locafy has developed a unique and effective solution to a pressing problem in the digital publishing industry. This contract positions Locafy as a key player in helping recover lost revenue streams and underscores its transition from a traditional SEO provider to a global publisher.

A Transformational Deal

This contract’s first batch of articles is live, representing around $500k in annual revenue for Locafy. Assuming the first batch goes well, Locafy anticipates seeing full results from this initial wave after 90 days (though it could be faster), with revenue expected to start appearing in Q1 2025 (January-March). We learned from our recent interview (post announcement) that after this initial batch, Locafy expects to receive an order of magnitude more articles soon, representing the $6.5m announced. This is much faster than I anticipated at first. Locafy is already in possession of or has identified those additional articles and is waiting for the publisher and the end clients to approve the additional articles after this first phase.

There is potential to expand by publishing more articles from this media partner, potentially scaling to thousands of articles across various sectors. They also aim to replicate this strategy with other publishers.

The principal associated expenses came from developing the toolset Locafy needed. Thus, the marginal cost per article is extremely low, and the margins are very high. I would guess they are over 90%.

Locafy is currently running at an operating loss, but I believe they could be running near cash flow breakeven in 6 months. This would occur due to modest growth in the underlying business, the additional $500k from this contract, and a little more cost-cutting. That’s my pessimistic scenario.

In the optimistic scenario, this contract could add up to $5m in annual net income. The company is trading at a $9m market cap. This contract alone provides an enormous upside. Put a 10x multiple on those earnings, and the stock could easily have a $50m market cap by calendar Q2 results (fiscal Q4).

I’ll briefly mention that this isn’t the only deal management is working on. It’s entirely feasible for Locafy to close 1-2 more deals in the coming months while we wait for these revenues to ramp up, although I would conservatively assume those deals will be much smaller.

Investing Considerations

Momentum - Price

I like Locafy’s chart. Since I initiated on LCFY in mid-August (green circle), we’ve seen a series of higher highs and lower lows—a golden cross formed in mid-September, marking the stock’s momentum shift. The stock looks like it wants to go up.

Momentum - Fundamentals

This criteria is harder to assess for Locafy, given they have been transitioning strategies. That said, I like that revenues are almost certainly going up over the next two quarters, and I like all the cost-cutting they have been doing. The operational cash burn halved from $2.25m in FY2023 to $1.1m in FY2024 (FYI, their financial year ends in June).

Moat

Locafy is far from a monopoly in SEO, and it’s hard for a layman like me to determine if its SEO is best of class. There are some poor reviews out there. These generally say the same thing: Tools are good, but support is bad.

I believe these reviews need to be taken in the proper context. Locafy has effectively shifted its client base. They have historically been focused on direct sales aimed at smaller businesses. This is a difficult business for Locafy since small businesses require a lot of handholding, and Locafy doesn’t have the manpower to support them. This is a recipe for bad reviews. However, Locafy has shifted to focus on bigger fish. This has enabled Locafy to streamline its salesforce workforce and become highly lean. It’s easier to keep one customer happy than two hundred. Given their current context, this shift seems remarkably sensible to me.

This brings us to their moat. As I discussed earlier, they are uniquely positioned now as a publisher with SEO capability. They could do something for this global media company that the company couldn’t get elsewhere. It will be interesting to see if they can win more of this type of client.

Multi-bagger Potential

Based on the transformational deal alone, I could easily see Locafy being a 5-bagger by next summer. Furthermore, if they continue to deliver, Locafy could receive thousands of articles from the media company, albeit likely at a lower revenue per article, given they are a lower priority category for the media company.

Additionally, if they close a few other deals, this would increase earnings and the market’s trust in those earnings and the multiple attached. I’m not trying to get too ahead of myself, but it’s easy to imagine scenarios where this turns out to be a 10- or 20-bagger.

Margin of Safety

Let’s consider how this investment could go wrong.

1. What if the contract falls through? Locafy has a signed contract and is already starting the work. I struggle to believe a scenario in which they don’t get paid at least $500k for the initial articles they have already been given. Let’s also remember that the media company is incentivised to cooperate, as it is losing out on substantial revenues (far more than $6.5m) in the meantime.

2. What if the contract never reaches $6m? This is feasible. Let’s say Locafy never gets up to $6.5m; any number they get would still be significant. If they only get $3m, they’ll be far better financially than they are today. At least we don’t have to wait long.

3. What if the customer never ramps past $500k? Again, this isn’t the end of the world. It’s not like the market is pricing in the contract (as evidenced by how little the stock price has moved, considering). With the $500k, a little more cost-cutting (already planned), and minor other revenue growth, LCFY goes from a loss-making company to a breakeven company. That doesn’t sound so bad.

4. What if the Locafy fails to deliver? This is always possible, but it strikes me as unlikely. Consider that Locafy has already engaged in multiple pilot tests, which have been highly successful. Of course, the solution isn’t going to work for every article, but I believe it will for the majority. Even if it only works for half the articles (an unnecessarily pessimistic outlook), end customers, the media company, and Locafy would all be happy to see those articles generating revenue again. Everyone wins if Locafy only half delivers.

5. Will Locafy need to raise to raise cash? I believe this to be unlikely. Between the $500k from the contract, further cost cuts, and slow revenue growth in the rest of the business, I could see Locafy being near cash flow breakeven in the next couple of quarters, even without a big ramp. Further, the balance sheet is about to receive a ~$500k injection from the Australian government through tax credits. The company has no long-term debt.

6. Will they raise cash anyway? Management seems highly reluctant to raise equity at the current depressed stock price. If they see an accretive acquisition and the stock is somewhere closer to fair value, management might seize the opportunity; I have no issue with that.

7. Bankruptcy? Honestly, this strikes me as somewhat absurd for all the reasons above. Not anytime in the near to medium term anyway. I mention it only because I’ve heard this risk mentioned on X.

8. Margin compression? Yes, this is possible. That said, the current multiple of around 2x sales seems reasonable, especially for a SaaS business with ultra-high margins at cash flow breakeven.

9. Fraud? The management team appears transparent (as discussed below). A few contracts have been delayed in the past but for understandable reasons. The stock enormously spiked in the summer for apparently no reason, caused by traders suddenly taking interest and low float. I see no red flags here.

10. Liquidity? The stock has low liquidity, though it has improved since the summer. If you manage multiple millions, I can see why entering or exiting this stock would take a while. I do not have that issue.

11. $9m market cap? I include it here because I’ve heard several people mention it. I do not consider market cap a relevant risk factor. If anything, it is an opportunity.

Management

I like management teams with skin in the game. This team certainly fits the bill, with the CEO, CFO, and chairman all holding notable shares.

Locafy's management team is well-qualified to lead the company's growth in the competitive SEO and digital publishing space.

• CEO and founder Gavin Burnett brings extensive experience in digital media and technology, having previously served as General Manager Digital at West Australian Newspapers Holdings and founded Empired, which became a BRW Top 10 company under his leadership and lead to him twice being an Ernst and Young Entrepreneur of the Year Finalist (Young category) 2003, 2004. I want to note that Gavin’s demeanour has notably changed since the summer. He’s much more upbeat and can’t help but smile in meetings. I believe these subtle body language changes are worth paying attention to.

• Jimmy Kelley, the Global Head of Search Technologies, is regarded as one of the world's leading SEO practitioners, with over 20 years of experience in the space. I was thoroughly impressed with Jimmy when speaking with him in person for over an hour about SEO, and I feel the technology side of the business is in capable hands.

• I haven’t had a chance to chat with Melvin Tan, the CFO. I don’t have much to say about him. The team seems very pleased with him; personally, I wish he’d pay more attention to detail to avoid minor errors in press releases.

• Collin Visaggio, Chairman, studied at Stanford GSB (exec programme) and was CFO of an oil company that eventually sold for $2.5bn. I found him to be sharp and conservative. I don’t believe he’d want to tarnish his record with Locafy unless he really believed it would be successful.

One complaint I hear occasionally is that Gavin, the CEO, is too optimistic. This strikes me as unfair. I like a CEO with optimism and a vision. He needs to drive the company forward. The two main risks of an (overly?) optimistic CEO are that investors won’t get a clear picture of reality and that the management may make non-conservative business decisions. After chatting with the chairman, Collin, I feel confident that he brings the conservativism that balances the team well. Additionally, I’ve known Gavin to share the positives and negatives transparently as they come up. I found a quote about him from 2007: “Gavin is one of the most ethical and honest people I have come across, both professionally and personally.” This matches my own experience so far.

Summary

There’s a lot to like about Locafy. It is transitioning from a crowded space into one where it does something unique. It has ultra-high margins accompanied by strong operating leverage potential. It is debt-free and approaching cash flow breakeven. Management has big ownership stakes. All that and it is trading at a mere 2x next year’s potential earnings. This stock could do very well, but it feels unlikely to go badly even if it doesn't.

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For more Locafy content, check out our latest interview with the CEO here.

Author’s Disclosure: I have a beneficial long position in the shares of LCFY either through stock ownership, options, or other derivatives. I wrote this post myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. I am not a licensed securities dealer, broker or US investment adviser or investment bank.

Breakout Investors’ Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Breakout Investors as a whole. Breakout Investors is not a licensed securities dealer, broker or US investment adviser or investment bank.