Digimarc ESG Edge
10th January 2022
Edison Edge: Methodology
Edison’s ESG Edge analysis aims to move away from historical data and focus on forward looking drivers and indicators. Our ESG Edge scores are derived in collaboration with our partner Rebalance and follow eight core sustainability reporting frameworks and guidelines in addition to the Cambridge Impact Framework. We follow this up with management and employee interviews to validate our findings and get to the narrative behind the data. Our findings are condensed in this report to focus on key ESG drivers, transition opportunities and risks for the company.
Digimarc Corporation (DMRC) is a pioneer of digital watermarking solutions, which enable a more efficient, reliable and economical means of automatic identification. DMRC’s technology can be used to apply a unique identifier to virtually all media objects, including product packaging, commercial print, audio and video, and this identifier can be automatically identified by an enabled ecosystem of industrial scanners, smartphones and other interfaces. The technology features:
- Digimarc Watermark: a data carrier that is generally visibly imperceptible to people and can be repeated many times over the surface of different media objects (as highlighted above).
- Digimarc Discover: a software programme for computing devices and network interfaces that recognises and decodes indicia of the identity media (including, among others, Digimarc Watermark, quick response (QR) codes, universal product codes).
- Digimarc Verify: a suite of software tools used to inspect and verify that the discovery of media is accurate and effective.
Exhibit 1: Digital watermarking
End use applications for the Digimarc watermarks are broad. As explained further in this report, DMRC has revisited its product strategy under new management in 2021 and will initially prioritise the solutions for authentication/anti-counterfeit, online brand protection, recycling and product cloud, with further development in its product portfolio to come. DMRC’s innovative solutions can be used to address major sustainability challenges, including more efficient recycling of plastics. Once the packaging has entered a waste sorting facility the digital watermark can be detected and decoded by a standard high-resolution camera on the sorting line. The transferred attributes (eg type of plastics used and composition, or food versus non-food) means the packaging can then be sorted into corresponding streams.
Importantly, DMRC’s digital watermarking is the selected technology in the Digital Watermarks Initiative HolyGrail 2.0 (HG 2.0) launched in September 2020, aimed at improving sortation to create higher-quality recycling rates for packaging in the European Union (EU). HG 2.0 is driven by the European Brands Association (AIM), powered by the Alliance to End Plastic Waste, and backed by 130+ companies and organisations from the packaging value chain, including Danone, Nestle, Pepsico and Procter & Gamble. We describe HG 2.0 and its progress so far later in the note.
Innovation is the cornerstone of DMRC’s business model and management highlights that the portfolio, which comprises more than 1.1k granted and pending patents, underpins DMRC’s competitive positioning in the sector. In 2020, R&D and engineering expenses represented c 72% of DMRC’s sales (versus an average 69% between FY16 and FY19).
Riley McCormack was appointed CEO in April 2021 and became its largest shareholder in September 2020 when TCM Strategic Partners (TCM), fully owned and managed by McCormack, acquired c 22% of DMRC’s shares (21% at 10 January 2022, after factoring in the first tranche of EVRYTHNG stock, based on Refinitiv data). At 10 December 2021, DMRC had 221 full-time employees, according to management, and it is headquartered in Beaverton, Oregon in the United States. The company was founded in 1995, listed on Nasdaq in 1999 and spun off the ‘New Digimarc’ in 2008 after it sold its core business, a card identification system, for US$315m.
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In November 2021, DMRC entered into a definitive agreement to acquire London-based product-cloud platform EVRYTHNG in a stock transaction, with the total consideration split into two tranches. The first tranche, worth US$50m of stock less closing costs occurred in early January 2022 and DMRC expects the second tranche to range between nil and US$50m in September 2022, subject to meeting specified deal criteria. EVRYTHNG’s platform assigns each product a digital identity, used to track and trace consumer products and has partnered with DMRC for five years before the deal. According to management, this acquisition allows DMRC to provide a complete solution set to its customers, making it possible to gather and apply traceability data from across the product lifecycle.
Adoption is key to growth
DMRC generates revenues through either service- or subscription-based sales, operating globally in government and commercial markets. Service revenues are currently the biggest contributor to total group revenue (58% of FY20 revenue), with most of this coming from its long-term contract with a consortium of central banks which is due to expire in 2024 with a possible five-year extension (as part of this contract, its technology has been used to deter banknote counterfeiting for over 20 years).
However, management anticipates that subscriptions will become the primary revenue driver, assisted by the revisited product strategy in 2021, with commercial sales expected to be the primary source of this growth (they represented c 39% of its FY20 revenue). This strategy is underpinned by the capabilities of DMRC’s technologies to provide solutions to supply chain operations, brand integrity and security, and recycling. If successful, a higher level of subscription revenue could have a positive impact on margins, reflected by a subscription gross margin of 79% versus a service gross margin of 58% in FY20. That said, uncertainty remains around this pivot, as many of its customers are new to its products.
Management highlights that the acquisition of EVRYTHNG supports the company’s strategy by bringing a complete solution to market. DMRC expects the synergies of combining its advanced means of identification with EVRYTHNG’s pioneering traceability business intelligence into one solution to bring benefits to customers throughout the product lifecycle. Management highlights that the combined solution represents a particularly important step forward in tackling the plastics recycling challenge addressed by HG2.0, as accurate product identification coupled with a recycling product cloud is key to enable closed-loop recycling for brands.
In Exhibit 2 we summarise DMRC’s historical financials and Refinitiv consensus figures.
Gross profit margin (%)
Sustainability at DMRC at a glance
- DMRC’s platform is the selected technology in the Digital Watermarks Initiative HG 2.0 launched in September 2020. It aims to improve the sortation and higher-quality recycling rates for packaging in the European Union and is backed by industry leaders across the packaging life cycle.
- Innovation is the cornerstone of DMRC’s business model, supported by a portfolio of 1.1k granted and pending patents.
- Deterring banknote counterfeiting has historically represented a significant portion of DMRC’s sales (61% on average between FY16 and FY19).
- ESG Engagement & Corporate Communications officer joined DMRC’s
management team in August 2021, demonstrating the company’s commitment
to ESG integration.
- The lack of disclosure of some non-financial figures has affected the company’s ESG Edge score (the social score in particular). However, management has visibly improved its ESG disclosures in 2021, which we describe below, and has committed to publishing an ESG report in 2022 based on a materiality assessment and in line with industry standards, such as the Sustainability Accounting Standards Board (SASB).
- The company received a negative say-on-pay vote from its shareholders at the 2020 AGM, but it has recently adjusted its executive compensation programme.
- Major sustainability challenges create business opportunities for DMRC, including the use of digital watermarking in waste management (see more details later).
- CEO Riley McCormack, appointed in April 2021, is also DMRC’s largest shareholder, who brings the long-term perspective to DMRC’s management and strategy and is committed to advancing the sustainability related end use applications of DMRC’s technology.
- The announced acquisition of EVRYTHNG allows the combined company to offer a complete traceability, visibility, and authenticity solution across the entire product lifecycle, while expanding both companies’ geographic footprint.
- The usage of digital watermarks in recycling is still being tested and the outcomes are uncertain. That said, the Digital Watermarks Initiative HG 2.0 has made progress and the project moved to semi-industrial trials in September 2021 (see more details later).
- DMRC is loss-making, which may discourage specialised professionals from joining the team, especially amid intense competition in the labour market.
ESG Edge score
The environmental, social and governance (ESG) Edge Score that we have calculated for DMRC may look relatively low at first glance (c 2.1 in 2021, with 0 representing a poor performance and 5 an excellent performance), but we note it is in line with the top performers in our peer group (ie Adobe and Ocado Group, both at c 2.1) and is well ahead of the peer group average of c 1.5. Importantly, DMRC’s ESG Edge score visibly improved in 2021 (calculated based on the data included in the company’s ESG proxy release in May 2021) compared to 1.3 in 2020, largely driven by a higher Environmental score y-o-y (c 3.0 in 2021 versus 1.5 in 2020). We believe this trend may be supported going forward by DMRC’s commitment to improve ESG disclosure in 2022 and beyond. We describe DMRC’s performance relative to its peers and the major drivers for subsequent sub-scores in the following sections of this report.
Exhibit 3: ESG Edge score – DMRC versus peersSource: Rebalance, Edison Investment Research
Exhibit 4: DMRC’s ESG Edge score – 2021 versus 2020Source: Rebalance, Edison Investment Research
It is difficult to find close ESG comparators for DMRC, mainly because its competitors vary depending on the application of their products. Moreover, the bulk of DMRC’s revenue comes from the sale of counterfeiting and retail solutions at present, but its aspiration is to expand the usability of its technology to recycling as part of HG 2.0.
Therefore, our peer group includes software companies (ie Adobe, Mitek Systems and Zix), in line with DMRC’s business focus, but we have also included firms from other sectors, which we believe share some common characteristics with DMRC. These include Tomra, an industrial Norway based company providing solutions for waste management (in line with DMRC’s environmental focus) and Ocado Group, an online retailer that partners with Kroger, a large American retailer (in line with DMRC’s partnership with Walmart). Notably, Tomra develops add-on modules enabled by DMRC’s software for Tomra’s detection sorting units as part of HG 2.0. We believe that Adobe should be perceived as an aspirational peer for DMRC given its strong ESG profile (eg it has been a constituent of the Dow Jones Sustainability Index for the fifth consecutive year).
Market cap local ccy (m)
|Adobe||US$250,190||Information technology||Multinational computer software company|
|Impinj||US$1,907||Information technology||Manufacturer of radio-frequency identification devices and software|
|Mitek Systems||US$742||Information technology||Software company that specialises in digital identity verification and mobile capture built on artificial intelligence algorithms|
|Zix||US$482||Information technology||Provider of cloud email security, productivity and compliance solutions|
|Ocado Group||£11,638||Consumer discretionary||Online grocery solutions and logistics business that licenses its technology to grocery retailers around the world|
|Tomra||NOK82,165||Industrials||Provider of sensor-based solutions for optimal resource productivity|
|Digimarc||US$675||Information technology||Discussed above|
DMRC’s ESG Edge score of 2.1 in 2021 is visibly above the peer group average of c 1.5, driven by, its outperformance in the Environmental score (c 3.0 for DMRC versus 2.1 for its peers). This is supported, among others, by DMRC’s Scope 1 greenhouse gases emissions (ie direct emissions from owned or controlled sources), and Scope 2 greenhouse gases emissions (ie indirect emissions associated with the purchase of electricity, steam, heating and cooling consumed by the company) at zero and negligible, respectively, while its peers did not disclose detail in this area.
Moreover, DMRC posted a higher Governance score than its peers (c 2.3 for DMRC versus 1.9 for its peers), backed by a relatively strong audit metric that we calculate in our scoring system. At the same time, DMRC’s Social score of 1.3 is slightly below the peer group average of 1.4, mostly affected by the limited disclosure of non-financial information that we assess in our scoring system. We describe DMRC’s performance relative to its peers in more detail in the following sections of this report.
|Company||ESG Edge score||Environmental score (35%)*||Social score (35%)*||Governance score (20%)*||Socio-political score (10%)*|
|Peer group average||1.5||1.2||1.4||1.9||1.5|
Source: Rebalance. Note: *Figures in brackets indicate the weighting of sub-scores in the ESG Edge score.
Digital watermarking and sustainability
Selected technology provider in the Digital Watermarks Initiative HG 2.0
In September 2020, the Digimarc Platform was selected as the technology of HG 2.0, which aims to prove 1) the technical viability of digital watermarks for accurate sorting of packaging waste, and 2) the economic viability of the business case at large scale in the European Union.
HG 2.0 is the continuation of the HG 1.0 initiative led by the Ellen MacArthur Foundation between 2016 and 2019. HG 1.0 found digital watermarks to be the more promising technology to improve consumer recycling compared with chemical tracers and developed a basic proof-of-concept on a test sorting line. At present there are no recycling plants equipped with the cameras needed to detect the digital watermarks and HG 2.0 aims to move the project from prototype to market adoption stage (see details below).
HG 2.0 is driven by AIM, powered by the Alliance to End Plastic Waste and backed by 130+ companies and organisations from the packaging value chain, including the leadership team, which we present in Exhibit 7.
Exhibit 7: HG 2.0 leadership team
Working towards a circular economy for packaging
In the prototype phase (Phase I) of HG 2.0, machine vendors Pellenc ST and Tomra worked with DMRC to develop a functional add-on module for the detection sorting units, which they will combine with the existing near infra-red (NIR) sorters. The system is being tested for speed, accuracy and detection efficiency during semi-industrial trials (Phase II) launched in September 2021. Controlled tests using industrial-sized equipment and the Pellenc ST/DMRC began in October 2021 at the Amager Resource Centre sorting centre in Copenhagen, while the Tomra/DMRC module will be tested in Germany in 2022.
After a successful completion of the semi-industrial tests, brands and retailers plan to bring the products enhanced with digital watermarks to the market in Denmark, France and Germany by H122 (Phase III). As part of the Phase III, Pellenc ST and Tomra will deploy their functional prototypes in commercial sorting and recycling facilities in five locations in France and Germany, which will determine the reliability and performance of the systems. Phase III is expected to run until Q322, when the final public report on HG 2.0 is expected to be published, outlining the techno-economic analysis of using digital watermark technology to sort packaging waste. DMRC highlights that to date, the data have demonstrated that digital watermarking is an effective technology for identification of plastics in the recycling stream. The companies and organisations that support HG 2.0 hope the trials completed as part of the project will encourage participants in the value chain to adopt digital watermarking technology and that the project will inspire more countries and waste management operators to implement this new sorting technology.
With this initiative, HG 2.0 hopes to support the EU’s efforts aimed at the elimination of problematic or unnecessary single-use plastics, with its major 2030 targets in this area including:
- 100% of plastic packaging to be reusable, easily recyclable, or compostable;
- 55% of plastic packaging to be recycled effectively; and
- 30% average recycled content across all plastic beverage bottles.
Digital watermarks throughout the product lifecycle
Digital watermarks may not only encode a ‘digital recycling passport’ to packaging, but also carry other attributes, which can bring multiple benefits across the remaining stages of the packaging life (Exhibit 8). While the end-use cases are broad and DMRC was able to propagate the use of its technology across different sectors over recent years, it has decided to revisit its product strategy under new management in 2021. At its first Annual Product Strategy Meeting in September 2021, the company determined the criteria that it will use to identify and prioritise all potential solution candidates to be included in its offering and developed an initial set of solutions on which it will focus. These include product authentication/anti counterfeit, online brand protection, recycling and product cloud. We understand the aim is to create a portfolio of differentiated high margin and scalable tech-solutions dedicated for large and fast-growing markets.