Clear Secure: Strong Growth And Prudent Financial Management (NYSE:YOU)

Thesis

I rate Clear Secure (NYSE:YOU) as a ‘Buy’ due to its strong growth, prudent financial management, and modest valuation.

Company Overview

Clear Secure is a New York City-based developer of an identity verification platform. Clear aims to make identity verification a frictionless service. The company currently has two main product offerings: CLEAR Plus and CLEAR Verified. CLEAR Plus is a consumer aviation subscription service that allows users to verify their identity with their fingerprints and eyes and skip security lines. CLEAR Verified is their B2B offering that enables clients to facilitate secure and verified digital experiences. For example, Clear has a partnership with Microsoft (NASDAQ:MSFT) where LinkedIn users can verify their identity to enhance the credibility of their profile.

Clear was originally founded in 2003. However, the company was acquired out of bankruptcy in 2010 for just under $6 million. The purchasers, Caryn Seidman-Becker and Ken Cornick, currently serve as Clear’s CEO and CFO. Before Clear, Seidman-Becker was a hedge fund manager and Cornick was a Partner at Arience Capital.

Seidman-Becker and Cornick’s background in financial services is evident in how Clear operates. Their emphasis on financial metrics, as opposed to vanity KPIs is obvious. They closed their 2023 shareholder letter by stating, “As always, we remain focused on growing Members, Bookings, AND Free Cash Flow, while continuing to build a brand that Members AND partners trust and love.” Also, one of the first things that they choose to highlight in their shareholder letter is the total capital returned to shareholders. A company that’s led by individuals with this philosophy is encouraging for investors.

Financials

Clear’s 2023 revenue was $613.6 million, up 40.3% from the year prior. The company reported that membership on their platform grew 31% to over 20 million total members. Revenue growth is expected to be 25.3% in 2024. Clear has more than doubled revenue since going public in 2021.

From their revenue in 2023, Clear generated $379.6 million of gross profit. This represents gross margins of 61.8%, which is in line with the prior year’s gross margin of 62%. A factor in Clear’s cost of revenue is their revenue-sharing agreements with airports. Essentially, to place their ID verification services in airports, Clear agrees to pay airports a portion of the revenue that is generated. These agreements make Clear’s products a win-win-win for airports, consumers, and themselves.

In 2023, Clear recorded $22.2 million in operating income. This was up from the prior year’s total of -$133.3 million. So what contributed to the margin expansion? Higher revenue and lower costs.

Clear recognized almost $200 million more revenue in 2023 than the year prior, and managed to do so while spending close to $50 million less in operating expenses. This margin expansion indicates a bright future for the company. They have built a company with strong unit economics that allows them to scale with operating leverage.

Another factor that adds to Clear’s operating leverage is its customer acquisition model. Clear reports that their largest customer acquisition channel is from their branding and physical footprint within airports. In 2023, this channel represented 65% of member acquisitions in 2023. Essentially, Clear stations act as free billboards and advertising for travelers. Add in the fact that Clear has to pay the airports only when a customer signs up at one of their stations, and Clear has a customer acquisition channel with a negative cash conversion cycle. This is just one example of Clear’s strong unit economics.

2023 also marked Clear’s first full year of GAAP profitability. The company recorded $28.1 million in net income after recording net losses every other year.

Clear’s financial performance is strong on a cash basis as well. They generated $225 million of cash from operations, up 33.7% year-over-year. In addition, capital expenditures were only $25.6 million. Overall, levered free cash flow for the year was $190.7 million.

Their strong cash generation has allowed Clear’s management to focus on returning capital to shareholders. They repurchased $76.5 million of stock in 2023 and paid out $14.5 million of dividends. Also, they announced in late March that the board had approved a $100 million increase to its existing share repurchase program.

It’s refreshing to see a high-growth technology company with prudent financial management. Absent from Clear’s financials are exorbitant stock-based compensation plans and outrageous pay packages. Instead, management has opted to focus on the same metrics that investors care about – a breath of fresh air that I can get behind.

Valuation

As mentioned, Clear is expected to grow revenue by 25.3% in 2024. Growth in operating cash flow follows this same trend as it’s expected to grow by 26.3% over last year. Due to the organic nature of Clear’s in-airport customer acquisition channel, it would make sense that the number of airport travelers is a significant factor in the company’s growth from year to year. However, the U.S. Travel Association forecasts only a 3% increase in air travel for 2024. With this in mind, it’s impressive to see that Clear’s growth will be many times this growth rate in travel.

Although Clear doesn’t provide a breakdown of revenue by product, it is reasonable to assume that growth in CLEAR Verified is a significant factor in the future revenue growth of the company. During their Q4 2023 earnings call, management discussed CLEAR Verified’s bright future. Their CEO noted the following:

CLEAR Verified continues to gain momentum. You cannot pick up the paper today or go online without reading about challenges that trusted identity can solve, whether it’s the need for age verification on social media, the problems caused by online anonymity, entire systems going down because of fraud or marketplaces where stolen goods are sold, a universal digital identity is the solution.

In healthcare, hospital systems are finding significant value in our identity platform. Our password reset, account creation and check-in products reduce operating costs, increase conversion and delight customers. CLEAR is uniquely positioned to become the trusted identity layer of the Internet.

I would concur with the sentiment of this take on the potential of CLEAR Verified. As the world becomes increasingly digital, the need for identity verification services will only become more apparent. There’s a reason the cybersecurity industry is expected to outpace the growth of the economy several times over. Companies are in dire need of these solutions, and Clear is well-positioned to capitalize on these strong tailwinds.

To add to Clear’s strong positioning, I would also argue that they have a competitive moat as airports and other venues where security is paramount are notoriously slow to adopt new technologies. Any company that wishes to compete with Clear in airports will have to be vetted, scrutinized, and audited before they can even attempt to take away market share.

With all these factors writing a strong narrative for Clear, I find their current valuation to be modest. Right now, the company is trading at a trailing EV/Revenue multiple of only 2.2x. Using forward revenues, their EV/Revenue multiple is only 1.8x.

Buying into a profitable, high-growth technology company that boasts prudent financial management and a strong competitive advantage at these valuation levels seems like a steal. Of course, it’s unlikely that Clear will have the valuation of an enterprise software company. After all, some of their business is subject to the highs and lows of the notoriously cyclical travel industry. But even factoring this in, Clear appears cheap.

Tripadvisor (NASDAQ:TRIP) can serve as an interesting comparison for Clear. Sure, the two are very different. But bears of Clear stock would assert that the company should be valued more like a travel company, and less like a security company that would demand higher valuation multiples. However, it’s interesting to see that Clear and Tripadvisor have almost identical EV/Revenue multiples, from both a trailing and forward standpoint, despite Clear boasting stronger revenue growth in the past year and moving forward. In addition, Clear is almost twice as cheap as Tripadvisor from a Price/Free Cash Flow perspective.

Even though I would be more inclined to value Clear in comparison to companies in the security/cybersecurity industry, the fact that they are undervalued even when compared to a software company in the travel industry signals that they are under-appreciated and mis-priced.

Catalysts

The primary reason why I rate Clear as a “Buy,’ as opposed to a ‘Strong Buy,’ is due to the lack of a clear catalyst for the stock. A boom in the travel industry could serve as a catalyst, but this doesn’t seem likely at the moment.

With this in mind, the most likely catalyst will be the company’s quarterly earnings releases. With strong tailwinds behind their CLEAR Verified product, Clear appears poised to beat guidance in the coming years. Furthermore, since going public in 2021, Clear has beat revenue and earnings estimates in every single quarter except for Q2 2021 when they missed on earnings. Management has demonstrated a strong tendency to underpromise and overdeliver, and it appears they are poised to continue to do so.

Risks

One key risk that investors should be aware of is the decline in CLEAR Plus’ net member retention. Annual CLEAR Plus net member retention in Q4 2023 was reported at 86.3%. While this is quite high for a B2C subscription service, it has declined over the last five consecutive quarters.

Annual net member retention for Q4 2022 was 91.9%, or almost 500 basis points higher than the most recent level. Although I don’t foresee this being a dealbreaker for Clear, it is a trend that investors should monitor in the coming quarters.

It’s also worth acknowledging that any lapse in airport or other security could lead to scrutiny of Clear’s platform. While this is a tangible risk, it’s also part of the cost of doing business in the security industry. For what it’s worth, the United States Department of Homeland Security has certified Clear as meeting the highest government standards for protecting sensitive data.

Conclusion

Since purchasing the company out of bankruptcy for only a few million dollars, management has built Clear into a great company. Clear is at an inflection point in their business where they are still growing quickly, but are now profitable on a GAAP basis. Their margins are expanding and management has demonstrated a commitment to return capital to shareholders-not only in word, but in action. Add in the strong tailwinds behind their products and a modest valuation, and it becomes clear that Clear deserves a ‘Buy’ rating.