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.

Business description

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

Source: Digimarc

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.

ESG Edge Scores

ESG  Edge score

0

Environmental

0

Social

0

Governance

0

Socio-political

0
ESG Edge score – DMRC versus peers
Source: Rebalance, Edison Investment Research
DMRC’s ESG Edge score – 2021 versus 2020
Source: Rebalance, Edison Investment Research

Subscribe to receive Digimarc related content

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.

Exhibit 2: Historical financials and Refinitiv consensus

Year end

Revenue

Gross profit margin (%)

EBIT

EPS

DPS

P/Sales

Yield

12/18 21.2 60 -33.5 -2.86 N/A 31.8 N/A
12/19 23 65 -33.7 -2.79 N/A 29.4 N/A
12/20 24 67 -32.8 -3.41 N/A 28.1 N/A
12/21e 26 66 -40.1 -2.12 N/A 25.9 N/A
12/22e 31 66 -34.1 -2.03 N/A 21.7 N/A
Source: Digimarc, Refinitiv consensus at 10 January 2022.

Sustainability at DMRC at a glance

Strengths

  • 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.

Weaknesses

  • 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.

Opportunities

  • 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.

Threats

  • 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 peers

Source: Rebalance, Edison Investment Research

Exhibit 4: DMRC’s ESG Edge score – 2021 versus 2020

Source: Rebalance, Edison Investment Research

Peer benchmarking

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).

Exhibit 5: DMRC’s ESG peers

Company

Market cap local ccy (m)

Sector

Business profile

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
Source: Rebalance, Refinitiv, Edison Investment Research.

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. 

Exhibit 6: Peer group comparison

Company ESG Edge score Environmental score (35%)* Social score (35%)* Governance score (20%)* Socio-political score (10%)*
Adobe 2.1 2.5 1.9 1.8 1.8
Impinj 0.9 0 0.9 2.3 0.8
Mitek Systems 0.7 0 0.8 1.4 1.4
Zix 1.1 0.4 1.4 1.6 1.6
Ocado Group 2.1 2.3 1.9 2.3 2.3
Tomra 1.8 1.9 1.7 2.2 1.2
Peer group average 1.5 1.2 1.4 1.9 1.5
Digimarc 2.1 3 1.3 2.3 1.4


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

Source: AIM

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.

General disclaimer and copyright

This report has been commissioned by Digimarc and prepared and issued by Edison, in consideration of a fee payable by Digimarc. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison’s policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

AustraliaEdison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for ‘wholesale clients’ within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are ‘wholesale clients’ for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a ‘personalised service’ and, to the extent that it contains any financial advice, is intended only as a ‘class service’ provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the ‘FPO’) (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the ‘publishers’ exclusion’ from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.