Heading into the final month of the year, join Brian Stoffel as he shares with host Emily Flippen the one mid-cap stock he'd never give up.
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This video was recorded on Dec. 01, 2021.
Emily Flippen: Welcome to Industry Focus. Today is Wednesday, December 1st, and I'm your host, Emily Flippen. Today I am joined by Motley Fool contributor Brian Stoffel, and he's going to be sharing with us the one mid-cap stock you'd have to pry from his cold dead hands in [2022], if that's not a lead in, I don't know what is. Brian, thank you for joining.
Brian Stoffel: Thanks for having me, Emily.
Emily Flippen: I love this company when you reach out to me and said that this was a stock that stood out to you heading into the new year. This was also one that stood out to me, one of my highest conviction holdings at this point in time. I think this would be a really fun episode. I'm interested to hear your perspective on this business. Without any further ado, what is this stock and why do you like it so much?
Brian Stoffel: Yeah, and it is one of my highest conviction holdings as well. The stock is Axon Enterprise, ticker symbol A-X-O-N, and if it's OK, I'll give a brief timeline of this company. It started in the 1990s as TASER International. The stun guns that you see police use, that's produced by this company and it was known as TASER International for really long time. But starting a little over 10 years ago, they branched out. One thing to note is that from the very beginning this company's mission has been to protect life. It's one of my favorite mission statements of any company I've covered. One way that they thought they could do a good job of protecting life was by developing body cameras, Axon body cameras. They switched their name to Axon in 2017 to highlight that they were more than just the taser company. But the real key from an investing standpoint is all of the software solutions that the company has been able to offer because of the body cameras and the tasers. For instance, they have products like evidence.com and that is where police officer downloads his or her footage and then all of that footage is stored and it is searchable on evidence.com, searchable in ways that are almost mind-boggling to me.
They have Axon Records, which means that the paperwork that police officers fill out and I didn't know this, Emily, but police officers spend 2/3 of their time filling out paperwork and Axon, I think correctly said, hey, relations between police officers and the communities that they serve aren't the greatest sometimes, and part of that could be that they're not in the community unless they're responding to an emergency. If they are in the community and they're just part of it that improves relationships. Axon Records ins to use AI to auto-fill much of the paperwork based on the audio and the visuals that they get from the body cameras, and that reduces the amount of time spent on paperwork. The number of applications that they can use for the software is mind-boggling. I mean, just to put it in perspective, they also have Axon Dispatch, which allows a dispatcher to see real-time where everyone is. The way that I like to think about it is like 10 years ago when I've watched 24 and you'd see where different people were when they were responding to a situation similar to that, but I am just going to throw this out there. It is so useful that the country of Chile used one of these software solutions to monitor the supply chain of COVID vaccines in the past year. This isn't just for United States Police Departments.
Emily Flippen: I think that's where a lot of investors may be getting confused about this business. If they are familiar with Axon, what they're probably familiar with Axon is not just a taser is but the body cameras. They are used by the vast majority of police forces in the US. If you keep up with the recent news, anytime you hear reference to controversies with the police forces here in the US, there's a very strong chance that those controversies were captured using equipment that Axon makes, whether it'd be tasers or body cameras or Records Management Solutions, again, evidenced.com. All of this business for the last decade or so, has largely been focused on the domestic opportunity. I think where investors have struggled with this business is thinking, OK, well there so saturated within the domestic market, what is next for them?
Only recently has this business really started consciously going after that international opportunity, which is a massive market. International growth is one of the biggest reasons why I think investors should consider owning this stock. Less than a quarter of Axon's total sales come from international sales right now, but it's growing much faster. The most recent quarter, domestic sales grew 34 percent, which is outstanding. To be clear, 34 percent is nothing to scoff at. But international sales grew 70 percent, and management said that International opportunities alone expand their addressable market by 70 percent. International opportunities is when you look at where the market cap at this company could go. I think a lot of it comes down to how well can they execute on selling their products internationally.
Brian Stoffel: I agree. But I would also say that much of those software solutions are relatively underpenetrated as well. Evidence.com, that is used by the vast majority of police departments. But if you look at the company's software webpage site, they have so many different solutions. Axon Records, for instance, that is a relatively new product. I know the Baltimore PD was one of the first to pick it up, and it needs to prove itself. It could be a huge driver in the future. But the other thing I want to add is that Axon really does play the long game. Here's what I mean, they bundle a whole bunch of their packages together. One thing that they will do is when Axon Records was coming out, Emily, they'd say, "Hey, get our taser bundle, get the Axon bundle, and it comes with evidence.com and your first year of Axon Records, totally free." They do that with all these new products that they roll out, and some people use them and some people choose not to. But the fact of the matter is that while it is getting a huge moat around it because of switching costs, that's not showing up on the income statement right away. It's important to know that.
Emily Flippen: A good forward-looking indicator for how those sales could pan out would be their net retention rate which is almost 120 percent in the quarter. That may not sound impressive to investors who are custom to hearing some insane numbers from really upcoming software companies. But to be clear, the market that Axon is competing in are government budgets, state-run or local budgets. These are not police forces that are run by private organizations, for the most part, so they don't have unlimited budget for these solutions. The fact that they're managing to expand is nearly 20 percent on top of retaining that growth that they had in the prior year is actually really compelling. To your point, Brian, when you look at dispatch and records management, both of which are initiatives that management sees panning out over the next 3-5 years, so a lot of growth still ahead of them. When you look at the biggest competitors in this space, there are no real software options. They're competing against literal paper and pen.
Brian Stoffel: Yeah. That is one of the risks that I think is worth pointing out. We didn't mention this in our notes but they were really just two big players in this market, specifically body cameras two or three years ago. The other is Vievu. I believe I'm pronouncing that right. There's a bit of controversy that Vievu got the New York City Police Department contract and Axon didn't, so Axon bought them. Now, they're a combined entity. There is a case with the FTC about needing to split them up. It has been sitting in the courts for a long time, there's not a whole lot of new news. I don't have any idea how you could logistically split them apart now because the New York City Police Department is using Axon's technology. But antitrust concerns are one thing to keep in mind. On the other hand, I remember my first-week getting training at the Motley Fool, I saw a video by Tom Gardner and he said, "The fact of the matter is it's probably a good thing to own the shares of a company that people think might have antitrust concerns because it's doing so well that it's just dominating its market."
Emily Flippen: That's very much the case in Axon. You add on this overlay of, I guess you could call it political turmoil but I don't think it exists just in the United States. I think it exists internationally. That Axon is providing what is increasingly a really necessary solution for people, police forces, and even private companies and consumers across the world. When you talk about potentially making legislation or changes in regulatory policy that can have such a visible and immediate impact on the transparency behind things like the use of force by police forces, it starts to become a conversation that's much more than just, well, is this an antitrust suit or is this not an antitrust suit? For that reason, to your point, I don't like to speculate on what may or may not happen with that case in particular. I'm not sure it actually matters to the fundamentals of what's going to drive Axon's performance. What stood out to me in the most recent quarter, and I'm really happy that management finally got around to updating this number was how they define their total addressable markets.
I have pitched Axon for services that I've worked on with The Motley Fool in the past, and the question that I get from those who work on services with me is, "Well, how big is this market?" If you try to make the numbers work for Axon, you'd quickly find out that you were making the implicit assumption that the market for Axon's opportunities were much bigger than the opportunity that management had laid out. That's a hard argument to make. You're saying, I understand the market opportunity more than management does. A lot of people I think were understandably skeptical saying, "If this business is really going to beat the market over the next 5-10 years, the market opportunity has to be bigger than the 27 billion that they laid out." In the most recent quarter, management finally [laughs] nearly doubled that market opportunity to $52 billion. Largely thanks to expansion into new geographies, new types of customers, so EMS solutions as well as those new products.
Brian Stoffel: Emily, I want to get to where that growth is coming from in a second but I just want to underline again that this is why I understand why people need to look at the total addressable market. It is also why I pay absolutely zero attention to the total addressable market, and most people think it's because I think that management would overstate a total addressable market but that's not it. It's because when we think about a total addressable market, we are implicitly making a prediction about the future. We are saying that the world tomorrow is going to be the same as the world today. Go back to December 31st, 2020, and read about total addressable markets for cloud companies, and you will see that all those predictions were off by an order of magnitude. Why? Because COVID hit. You might say, "Well, but we couldn't have known COVID would hit." Guess what? We don't know what's going to hit over the next five years either, so I pay zero attention to it. To me, I ask myself, was protecting life important in the past? Yes. Is it important today? Yes. Will it be important tomorrow? Yes. Does this company have a history of finding new ways to protect life? Yes. Game over. But I do think where those numbers come from are interesting.
Emily Flippen: Let's talk a little bit about that. I talked a lot about international expansion. But I think one of the hidden talents of this business, and this is a big question mark if they can execute on this but the hidden talent is pulling in customers that are not police forces. The easy addressable market internationally is pulling in people who use tasers, body cameras and records management, police forces. But management has increasingly pulled in contracts from other agencies. I mentioned EMS, so emergency medical services. These are businesses that can easily use that dispatch service to figure out where they need to be at what time, and selling these packages alongside things like GPS tracking and live streaming services. Imagining coming up to a wreck where a medical professional is wearing a body camera and is trying to service that person, they can get immediate help from somebody who is maybe more knowledgeable or an expert in that field who can tell them what they need to do to potentially save that person's life. This was an aspect of optionality that wasn't even in the cards, wasn't even on management's radar when it was just TASER International. I think about that optionality, EMS is just one example of the potential use cases of all of these products for the future.
Brian Stoffel: Yeah. I'll just throw out one more that's interesting is their VR investments, virtual reality. They have created a suite of products where officers undergo training for how to respond to different situations, and they're saying that they're getting a lot more traction there as well. But I think we should probably talk about the big addition which was that they are going after consumers like you and I. What do you think of that?
Emily Flippen: I have to be really honest is my first instinct when I heard the news that Rick Smith the co-founder and CEO of Axon wanted to go after the consumer market. My first reaction was just sheer horror. I read it as we want to put tasers in the hands of consumers. Let me just say, I'm a Texan, I grew up in Texas. I understand that the market for people who feel the need to defend themselves with firearms may not be the same market of people who are going out to buy tasers. Maybe there's some overlap there. But my mind first went to 18-year-olds who are goofing around their friends and felt the need to maybe go buy a taser and tase each other. Now, this is an extreme scenario. I'm half-joking when explaining this because I'm sure the go-to-market strategy for consumer products is not going to be let's give 18-year-olds tasers that are the same [laughs] strength as police forces. But it did get me thinking about the need to protect life for consumers. I think that there is some argument to be made that Axon is well-positioned to help to protect lives for people. Same way that they help protect life for police forces, why not do it on the consumer level? But I think the big question mark for me is just what does execution in this field look like? Because there's probably a right way to do this and there is definitely a wrong way.
Brian Stoffel: There's more than one wrong way to do it. I will say that as soon as I heard that too, I was personally very surprised. I immediately thought to myself, would I get one? I wouldn't. I went to my wife and I said, "Would you buy a taser?" She said, ''Where we live now, no. But when we used to live on U Street in Washington, DC, maybe I would have thought about it.'' I said in our notes before the program, this is like bridging the gap between mace and a firearm. But I think it's worth pointing out two things. One of those two things, a lot of people responded to me on Twitter about this is that internationally where gun laws are different, this might have a lot more appeal. Now, I don't know. I live part of the year in Costa Rica and we're in the rural, the countryside, so I don't have enough experience to know if this has appeal. When during the conference call, the analysts wanted to learn a little bit more about what they were doing and Rick Smith was a little bit coy. He just said, "Yes, tasers for people," but also quoting his words, "Personal safety mobile apps will also be a part of it." But he specifically said he's not going to reveal what that is. I'm curious because the company has clearly shown an ability to make a phenomenon pivot from being a manufacturer of stun guns to a provider of really AI software. So what could they do for the consumer? I'm not sure, but I'm very curious.
Emily Flippen: I'm also very curious. The reason why I think that when you talk about the consumer market investors like myself shouldn't get too hung up on the idea of tasers as part of that is because as Smith did say that they believe the consumer market will be bigger than the law enforcement market. The only way that comes to fruition is if you're offering a product that is much bigger than just a one-time sale of stun gun or of a body camera. We're talking about software for the masses, useful to everyone regardless of whether or not they want to carry a firearm, regardless of whether or not they want to carry pepper spray or even in some cases, I suppose a taser. For that reason, I think that there is wheels turning here behind the scenes for management, thinking about how can we use this technology that we still have effectively dispatched for government agencies and the private market for consumers. I don't know what it looks like. If I had to guess, I think this is also something alongside their dispatch and records management that is 3-5 years out at the earliest. But I like the fact that management is thinking about this optionality, and I'll be super happy if I'm proven wrong on that.
Brian Stoffel: Absolutely. I'm very curious to continue owning and following the stock. Also, I'm very interested to see what the software solution looks like.
Emily Flippen: Me too. I will have to say one thing that I think is worth noting. I've always found this an interesting aspect of this company, and I'm curious to hear your thoughts on it, is the founder CEO's compensation package. A number of years ago, Smith opted to not receive a salary-based paycheck and instead be compensated on the market cap of the business. Now there were a lot of rules put in place. Obviously, Axon couldn't go out and acquire a very large business to artificially inflate the market cap. So it's a diluted version. But the general thesis was Smith said, "Hey, I think Axon is going to be a much larger business in the future and I want to prove it and I want to put my money where my mouth is." So as notches of market cap increased, so did Smith's compensation largely stock-based, and that does cap out at about $15 billion. Earlier in November, we saw Axon have a pretty stellar quarter. The share price shot up above $15 billion pre-market, came back down post-market. It's around 12-13 today. But I wonder what happens to Smith's compensation package once Axon gets that $15 billion and stays there for a bit?
Brian Stoffel: When I think about this, here's what I think about. Patrick Smith, if you're listening, I love what your company has done, I think it's so important, so don't take offense to this. But in our notes we wrote, he can be a bit of a nut. But he really does believe in this mission of eradicating the bullet. I'm reminded of something that Morgan Housel said. Morgan was writing about Elon Musk. Morgan said, you can't get someone who's willing to break all the rules to accelerate our transition to sustainable energy because someone who's trying to actually do that has to be a little bit crazy because you don't get there by following all the rules. But you also are going to get the downside of crazy by getting someone who focuses like that. We've seen that play out over the last 10 years. He's accomplished way more than anyone thought he would, and we've seen what that crazy can look like. Now the whole reason I bring that up is to say that I believe that Smith has some of that too. I think he truly believes he's laid out a vision for what policing can look like by 2030, and it is vastly different than what we unfortunately have to see on the newsreels these days. I think that Axon can be an enormous force for good in that respect the same way the Tesla is.
The connection between these two is that Smith's compensation package has been exactly modeled after Musk's. In fact, Axon's Board of Directors when they announced the way that this was going to be done, said explicitly, we are modeling this after Elon Musk's package. All of that is to say that he might stick around, he might not. I would be surprised if he left because just in my bones, I feel like this matters to him a lot and he wants to be there to see it through. I wouldn't be surprised to see some new form of compensation package that also is tied to reaching certain goals till 2030. That's just a guess. Obviously, I don't know the gentlemen personally at all, but he is very passionate about seeing policing being very different by 2030.
Emily Flippen: I completely agree. That actually is a great segue into my last question for you, which is, what breaks the thesis for Axon? We talked about this being a great mid cap opportunity, one you have to pry from your hands headed into 2022. But when I think about what ruins it for me, I will say if Rick Smith steps away, I think I will really have to think twice about this investment because his mission, eradicating the bullet, that is a big mission. I have a hard time imagining somebody who would step into his place with the willingness and the ferocity to execute upon that idea that will be necessary to make Axon a market beating investment for the next 5-10 years. So for me, I think that's a big one. But what else stands out to you as something that you think could be thesis-breaking for Axon?
Brian Stoffel: Well, I agree with you. I think that's part of it too. This has been a family ordeal. His dad helped them get off the ground and was on the board of directors until he passed away earlier this year. So this matters in his bones. But beyond that, I already called out the FTC case. I don't see that being necessarily thesis-breaking, but I also don't think that we can completely ignore it. The other is just a culture issue. Look, I've spent zero time in Axon's headquarters, and as someone who writes articles, I know how we can talk like we know what's going on and not really know what's going on. But I've read articles that raise my antenna a little bit about the culture that's present at Axon, and this is something you have to get right because you are dealing at the intersection. What Axon is trying and I think successfully doing is they are at the intersection of two groups that at least in the media are not getting along very well, and that is the police force and people who have gripes against the police force. The thing that's amazing is that the product works really well for those that are acting virtuously on each side. Making sure that the culture works is important for that too. So I look at yes, Rick Smith stepping down, but the culture is the other big one and those two might interplay as well.
Emily Flippen: That's so interesting because to be frank, I didn't even consider the culture as a risk, but I think that's a wonderful risk to point out. For me, I imagine risk here on two sides. One is the valuation of the business itself, so just the share price. This is a loftily valued business. They do have a subscription backlog of over two billion dollars. Keep that in mind if you're just looking at that revenue. But I do worry that if international expansion fails to catch on, even if the consumer market doesn't catch on like some investors expect it may, those could be things that show slowing growth which could hurt this business. However, I think the biggest risk is what you mentioned there, just regarding the core customer, the people that they're serving, and we can talk all day about how tasers are mostly non-lethal way of enforcing things like domestic security for police forces. But ultimately, we're talking about a very politicized issue that has people on either side of the fence, many of whom say to the extremes of, well, let's defund the police. Guess what? Defunding of the police is the defunding of Axon too. When you talk about removal of police budgets, that can hurt Axon, even the pullback, and police budgets can impact Axon. Now management will say, look, we're trying to fix a problem, we're not trying to be a part of the problem. But there's going to be issues in media especially if we start talking about going after the consumer market, about what role, if any, Axon has in some police brutality. If that comes to fruition, if that conversation is held, you can expect that this business in the stock will be very volatile results.
Brian Stoffel: I'll put it to you this way. The minute that their North star changes from protecting life, and that means everyone lives, means police officers' life, it means lives of those that are in the communities where the police officers are, the minute that it comes off of that is the minute that I'm out because there is enormous potential for abuse here. There's also enormous potential for good. I don't think you can have one without having the opportunity for the other. Right now, I believe in Smith and I believe in the mission. But if that changes, the tide can turn against them rather quickly.
Emily Flippen: That's a very eloquently said. But Brian, thank you so much for joining. This is a wonderful company. I can't wait to watch it for the next year, maybe have you on and we can circle back about how Axon has performed, see if it's still one of your top picks heading into 2023 next year or do believe we're basically already there, but for the time being, thank you for joining. Really wonderful conversation.
Brian Stoffel: Thanks for having me, Emily.
Emily Flippen: Listeners that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say hi, shoot us an email at [email protected] or tweet us @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned. So don't buy or sell anything based solely on what you hear. Thanks Tim Sparks for his work behind the screen today. For Brian Stoffel, I'm Emily Flippen. Thanks for listening and Fool on.
