Kiwi school internet filtering startup sells to Aussie outfit in $20m deal

A big score for a startup's founders, and major investor Punakaiki Fund.
Punakaiki Fund director Lance Wiggs: $1m fund in Linewize last year parlayed into Family Zone shares with a face value of $3.7m (photo: Chris Keall)

Linewize, a three-year-old Christchurch company that helps schools filter internet content, has sold to the ASX-listed Family Zone Cyber Security in a deal worth up to $20 million.

In an almost all-share deal (bar a $A200,000 deposit), Family Zone will fork over 21 million shares for 100% control of Linewize (Family Zone shares closed at 85c on Friday).

The deal consists of 9.5 million ordinary shares and 9.5 million performance shares that will vest when certain targets are met. Additionally, Linewize founders Scott Noakes and Michael Lawson will get one million Family Zone shares each as part of their personal performance plans.

Messrs Noakes and Lawson own 32% of Linewize each. They will stay onF and have placed their stakes in a voluntary 24-month escrow.

Punakaiki Fund — which stands to nearly quadruple its $1 million investment — owns 20%.

Family Zone staff hold the remaining 16% through an employee share ownership scheme.

Robust earnout targets
According to an ASX filing by Family Zone, the performance shares will be paid in five tranches over the next five years, and are dependent on Linewize hitting some robust targets. The first target is $A1.25 million in recurring revenue; the fifth is $A9.95 million (Linewize hasn't pubicised its revenue, other than to say it's grown 100% in the past year. based on its pricebook, it's revenue with its current 130,000 students would be somewhere between $234,000 and $780,000; a chart with a Family Zone presentation shows it heading for $900,000 by the end of this year).

Punakaiki Fund principal Lance Wiggs, who took part in deal negotiations, says it is structured so that his fund will get extra shares to compensate if the Australian buyers’ share price falls below 70c – a safeguard he wanted built into the deal because Family Zone is just over a year out from its IPO and heavily traded for a small company (its market cap is near the $A70 million mark). In midday trading today, shares were at 77c.

The deal is still subject to Family Zone shareholder approval but Mr Wiggs says he’s confident it will get the green light. A vote is expected in late November.

Family Zone performance since its IPO (Source: ASX)

What happened to Warren Buffett-like patience?
The Punakaiki director often talks about his fund’s 10-year investment horizon.

Why did it back the sale of Linewize, barely a year after buying in?

"The founders wanted to sell and we backed them," Mr Wiggs says.

Noakes and Lawson made a compelling case, Mr Wiggs says. He hates to say the dreaded word 'synergies' this really is a case of two companies that will be stronger together.

Although Family Zone and Linewize are in the same business – making sure school kids can’t access bad stuff on the internet – the Kiwi company has a superior technology stack, according to Mr Wiggs.

For example, by using machine learning, Linewize’s system is able to spot the new breed of dynamic VPNs – or virtual private network software that can be used to thwart internet filters.

And Linewize can also be used to manage and monitor students’ internet use, giving teachers an easy way to see who is accessing it, and when – and whether they’re on sites likely to help with their studies or goofing off (and don’t smirk about school kids being spied on; we all have the government looking over our shoulders via Coretex).

Mr Wiggs says that’s why Linewize, founded in 2013, has been able to sell its product into 260 schools – representing around 130,000 students or about 15% of pupils in the country – despite Crown agency Network For Learning offering its own service for free. Linewize charges schools between $1.80 and $6 a student a year, depending on the level of service.

For its part, Family Zone is much better at sales and marketing, Mr Wiggs says. While products in this area have usually been sold to schools, who then provide free access to students, Family Zone’s model sees a school mandate the use of its product – then any parent who wants their child to take a digital device to school has to subscribe to Family Zone ($5.95 a month covers a family with up to three kids).

It has yet to be decided if Punakaiki will hold or sell the parcel of Family Zone shares it will receive when the deal is finalised – or the performance shares if targets are hit and those materialise.

Punakaiki's return
At face value, the deal is worth $3.7 million to Punakaiki (which will also get $A40,000 of the deposit to cover its deal expenses).

The fund paid $NZ1 million for its stake, built up between June and December last year.

Fund rising across the board
Mr Wiggs says valuations for the nineteen companies Punakaiki is invested in are still being finalised for the fund's latest quarterly report.

However, rises nearly across the board (ThisData was a rare miss) mean the fund's total assets could be $30 million he says, which would see the fund's shares top $20.

The fund launched three and a half years ago with shares at $10. It's targetting an IPO in mid-2019, by which point the fund wants to have $100 million in assets.

Punakaiki currently has 625 investors, with an average holding of just under $44,850 at $20 per share.

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