When an e-commerce company suspects fraud in a purchase order, the quick fix is for it to deny the order. That, though, can lead to some genuine orders getting denied, which results in lost revenue and angry customers. Riskified's (RSKD -0.20%) tools for detecting fraudulent activity allow its e-commerce company clients to accept more orders while minimizing the risk of fraud.
Riskified's AI-based risk management platform is designed to provide a margin of safety for its clients while making e-commerce (in the company's words) "safe, accessible, and frictionless." With its stock trading down 30% from its all-time high, now could be the right time to invest.
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Riskified's platform
Eido Gal and Assaf Feldman launched Riskified in 2013 to improve e-commerce for merchants and consumers by creating a better fraudulent activity detection system. Older risk assessment models require sellers to ask many questions of their customers, which makes for a slow, meticulous process. Riskified reports its decisions essentially instantly, reducing transaction friction.
For its customers, Israel-based Riskified offers a route to higher revenues and lower operating costs. When retailers deny legitimate orders due to what they see as potential fraud, that represents lost revenue, but when they accept fraudulent orders, they are losing inventory, time, and money.
What makes Riskified unique in the risk assessment niche is its chargeback guarantee. If its system misidentifies a fraudulent order as a real one, the company will cover the client's losses related to the error.
With that guarantee, Riskified is putting its money where its mouth is -- and so far, that has proven quite effective. Riskified's cost of revenue -- which is made up primarily of chargeback expenses -- has been decreasing. In 2019, its cost of revenue was 50% of revenue; by Q2 2021, it had fallen to 40% of revenue.
Off to a strong start
Riskified's machine-learning system is clearly getting smarter and more accurate, and this is paying off on the top line -- revenues grew 47% year over year to $55.7 million in the second quarter. The company also increased the gross merchandise value (GMV) under its watch by 55% year over year to $21.5 billion. This GMV, along with monitoring 1 billion transactions allows Riskified to grow its data pile, which makes its platform smarter and more accurate.
Riskified faces plenty of competition from larger fraud protection companies like Ekata and Maxmind who have stronger brand recognition, but Riskified's brand is becoming more known as it gains customers -- especially bigger companies. Riskified's growth of GMV under its watch is also allowing the company to catch up with its competitors' longer operational histories. So while it's still an underdog, the company is gaining prevalence.
So far, Riskified's system is proving valuable to its customers: It has decreased its top 10 customers' operating expenses on average by 39% while increasing their revenues by 8%. It offers this value proposition to customers like Wayfair (W -8.36%), which has been able to securely expand into new markets such as the U.K., China, and Australia.
Riskified's management guidance forecasts $225 million in 2021 revenue, representing 32.5% growth. It is possible that growth could continue for a long time at similar levels given the outlook for e-commerce worldwide. Market research company eMarketer estimates that the global e-commerce market will grow from $4.3 trillion in GMV in 2020 to $6.4 trillion in GMV in 2024.
After reporting earnings -- beating revenue expectations and reporting strong growth -- the stock fell off of its highs, and it has been in a free-fall since. While nothing worrisome came from its earnings, the stock had risen before earnings just as dramatically as it fell after, leaving the stock price almost equal to the price a week before its earnings. The run-up before earnings was likely because it was a brand new IPO with lots of hype. Some popular companies like Veeva Systems (VEEV -0.29%) fell -- seemingly for no acute reason -- after reporting strong earnings, Riskified's reason for dropping was similar.
Riskified's risks
Riskified's AI is still young and will need to continue to prove itself. More data from e-commerce companies will be needed for the platform to learn. Investors will be able to gauge if it can hone its accuracy by following the company's cost of revenue.
The company also has faces customer concentration risk -- just two clients provided 28% of its revenue in Q1 2021. If Riskified were to lose either of them, it would create numerous challenges for the business. Not only would it lose a significant share of its revenue, but it would also lose a major stream of the data that it's using to make its AI stronger and more accurate.
Interested investors should keep an eye on this company's gross margin, customer concentration, and revenue growth. With a unique service that relieves a large share of the fraudulent transaction risk from its clients, Riskified is well-positioned to expand in a fast-growing sector. Considering that the stock has fallen off its highs, now could be a good buying opportunity.
