Date: 12/11/20

Price: $0.1451

Shares Outstanding: 67,353,690

Market Cap: $9.77 million

Debt: $0

Cash: $1.4 million

EV: $9.3 million

An investor once said about microcap stocks, “You really have three choices as a microcap to have a higher stock price. 1) Either grow rev quick (30%+) and its okay to earn a little, 2) Grow revenue small but grow the bottom line a lot or 3) The great ones grow the top and bottom quickly.” Would you believe that there is a company who main customers are children’s coloring book publishers (real coloring books, not apps) that fits the first category? Welcome to Nocopi Technologies (NNUP).

History and Product Overview

This company started the 80’s making a red-colored paper that couldn’t be copied or faxed. It was a great product for the pre-internet age. But then the internet came along and destroyed the need for a fax machine and NNUP’s product. The company later found a way to create an invisible ink product using its existing technology. That technology has been licensed by two children’s entertainment and publishing companies. The most successful of these two is Bendon, which licenses character from companies like Disney and DreamWorks to produce children’s coloring books. NNUP’s invisible ink technology allows for children to color, follow mazes, and play games with their favorite characters using a single pen.

Kids love these products because once they become obsessed with a story or a character, they want every toy associated that story or character. Parents love the product because the pen will not stain carpet or furniture. These products have thousands of five star reviews on Amazon and YouTube videos featuring these coloring books have millions of views. The highest number of views for a single video I have found so far is a woman coloring the Frozen book with over 50 million views!

These coloring books cost $5 – $8 per book and each book comes with its own pen. That pen is usually only good for a single book. Because children tend to be rough on toys, a problem parents have been running into is that the pen will dry out before the book is complete. There is away to revive these pens but it’s a 35-minute process. I don’t have any children yet, but I don’t imagine children have that much patience. Bendon now sells replacement markers. To provide some context on how popular these markers are, they are currently sold out on Amazon.

Revenue Model

NNUP generates revenue by licensing its invisible ink technology to publishers. NNUP receives a monthly or quarterly commission based on the number of units sold by the licensees. The contracts have a duration of three to five years. NNUP’s contracts with its two largest customers, which make up 55% and 18% of the company’s revenue, have contracts that expire in July of 2023 and October of 2022, respectively. While the company’s revenue is highly concentrated in two customers, there is little concern those customers will not renew their contracts. NNUP’s ink offers the best balance of quality and price. The products that are sold using NNUP’s ink are extremely popular.

The security business segment (8% of revenue) generates revenue in a similar way as the invisible ink business. The main customers are auto parts manufacturers and the retailer Staples, which uses NNUP’s technology on receipt paper.

Growth

Revenue grew 16% in 2018 and 39% in 2019. The company will grow revenue by ~30% in 2020. The products produced by NNUP’s customers are extremely popular. As more children’s movies and TV shows are made, NNUP should benefit.

Margins and cash flow

Because of the licensing business model, NNUP generates gross margins in the range of 67% – 71%. The company’s operating margin is ~30%. This business generates a tremendous amount of cash. The company’s free cash flow margin YTD is 39%. While only having a market cap of ~$10mm, it as almost $1.5mm of cash on its balance sheet and no debt. The cash can be used to increase its sales and marketing effort, but it can also be used to buy back its undervalued shares.

Competition

Crayola is the biggest name in the children’s coloring and drawing sector. But while it is the biggest company, has more products, and occupies more shelf space than any other competitor. While those metrics are a competitive advantage in the physical world, the digital world is a much more equal playing field when it comes to consumer goods. Crayola’s product that most closely resembles Bendon’s invisible ink coloring books is Crayola’s mess free line of markers. These are markets that draw on a page but not on fabric or walls.

There are some major differences between the first two products. First, Crayola’s product has multiple markers, each representing a different color. This creates a greater opportunity for markers to get lost. This also makes using them during travel more difficult. It is much easier for a child to have one marker than eight. In fact, Bendon’s invisible ink coloring books are mentioned as great for travel. While NNUP’s revenue has grown significantly during the global pandemic, it is likely that it will grow even more as families start traveling again in 2021.

While I am not sure why, Bendon’s invisible ink coloring books have a much larger presence on YouTube than Crayola’s There are dozens of videos with millions of views of people coloring in the coloring books. Crayola’s Mess Free products only have a few videos and only one with over a million views. Bendon’s invisible ink books also have thousands of more views on Amazon than Crayola.

Moat

NNUP’s moat is its intellectual property (IP). The company’s invisible ink is superior in quality to its competition and is offered at an attractive price to licensees. The company is a reliable manufacturer and has a very strong relationship with its customers. NNUP has recently hired new personnel and increased manufacturing capacity to meet expected increase in demand during the holiday season and 2021.

Valuation

This is not a complicated business. Its very easy to run different scenarios to understand the risk/reward currently being offered by the stock. Running a DCF valuation under the assumption that the company’s revenue growth flatlines, NNUP is worth $0.12/share (25% downside from its current price). My base case is that the company continues to grow at a high rate, but lower than it has historical and growth declines each year by ~3%. The base case scenario also assumes that the company’s share count increases by 2% annually. Based on those assumptions, the company is worth $0.29/share (79% upside from its current price). This is a very attractive risk/reward scenario, especially for a company with no debt and a lot of cash.

Investment Thesis

Based on quality of customer, balance sheet strength, and revenue growth, NNUP is currently undervalued by the market. It has a market cap of ~$10mm so it is very hard for people to invest in the company. The CEO should be making the rounds a couple of conferences in 2021 which should help bring awareness to the company.

The value of this company is much larger than its current trading price.