In January of this year Carbonite, Inc. (CARB) acquired privately held Double-Take Software in a sign and close transaction. Carbonite has a market cap of only $550 million and the stock price more than doubled in the past 12 months.. I just subscribed to its consumer product and decided to crunch some numbers to see if it should be an addition to my portfolio. After looking into it I've decided to keep the company on my watch list but to pass on investing now as growth seems to be slower than I would have expected for a tech company trading at 25 times forward non-GAAP earnings.
What do these two companies do?
Carbonite is a hybrid software backup company that is primarily cloud-based. Subscribers to its software-as-a-service (SaaS) solution receive automatic backup of their computers and servers with accompanying recovery capability. The company serves customers like me, a single user, as well as its primary target of small to medium business (SMB) accounts. If Murphy’s Law strikes and a business loses its data the information can be restored – real time if you have a portion of your data on the company's EVault hardware solution and in a few hours from the cloud.
Double-Take Software is a near real-time data mirroring solution. It allows a business to immediately access data from its cloud in the case of data loss. This is a big step up from the cloud based offering from Carbonite.
Known in the industry as a high availability solution, Double-Take allows Carbonite to offer a whole new set of features to its SMB customer base such as high availability replication of data and applications, emergency failover for both primary location or cloud based data, the ability to easily move system locations, and migrate servers to updated software.
Image source: Carbonite.
This deal was not cheap
In 2010, a private equity company took Double-Take Software private by buying it from the public markets for $242 million . Carbonite bought the company in January for $65.25 million. The acquisition is forecast to be accretive this year with Double-Take adding $0.10/share in non-GAAP EPS at the mid-point of the company's guidance. Carbonite has 28.25M shares outstanding so Double-Take would add $2.825 million earnings meaning it was sold to Carbonite at a multiple to earnings of 23. Regardless of what the private equity firm paid for the company the price Carbonite paid is by no means cheap.
Where does the company go from here?
Carbonite is experiencing high gross margins, due to its SaaS subscription business model, and increasing operational efficiency. A great combination.
In 2016 the company had a gross margin of just over 70%. Below is a graph showing its increasing operational efficiency.
Image source: Carbonite.
The acquisition of Double-Take should help increase operational efficiency even further as one would expect that there will be synergies in the two businesses that will help reduce costs.
Strategically the acquisition makes sense as it strengthens Carbonite’s product portfolio offering for its SMB customers.
Slow growth may be a sign of trouble
The chart below shows that Carbonite’s consumer business is in slight decline while SMB is growing. Note that the outsized SMB growth in 2016 was due to Carbonite's purchase of a product line called EVault from Seagate Technology PLC to enable hybrid real time backup for its SMB customers.
| Metric | 2015 | 2016 | Growth (YOY) | 2017 Guidance | Double-Take at Mid-point of Guidance | Growth at Mid-point (YOY) | Growth Without Double-Take Contribution |
|---|---|---|---|---|---|---|---|
| Consumer bookings | $89.6 million | $84.9 million | (5%) | $76.4 million - $84.9 million | 0 | (5%) | (5%) |
| SMB bookings | $54.5 million | $124.4 million | 128% | $158.6 million - $170.2 million | $25 million | 32% | 12% |
| Total bookings | $144.1 million | $209.3 million | 45% | $235.0 million- $255.1 million | $25 million | 17% | 5% |
Data source: Carbonite. Chart by author.
If we take out the acquisition of Double-Take it appears the company is only planning for 5% organic bookings growth. Even its strategic target of the SMB market is only showing 12% organic bookings growth.
Below is a chart that looks at Non-GAAP earning's growth, and again without Double-Take, organic growth is only 10% YOY.
| Metric | 2016 Earnings/Share | 2017 Earnings/Share Guidance | Growth at Mid-Point of Guidance (YOY) | Double-Take Earnings/Share Guidance | Organic Growth at Mid-Point of Guidance (YOY) |
|---|---|---|---|---|---|
| Non- GAAP EPS | $0.60 | $0.72 - $0.80 | 27% | $0.08 - $0.12 | 10% |
The current stock price yields a forward PE multiple of 25. Organic earning's growth is only forecast to be 10%. Using the 27% total growth would yield a more reasonable result, however, the company excludes its cost of acquisitions in its non-GAAP EPS calculation. If I am going to look at Double-Take's portion of the growth then I want to compare apples with apples and include the cost of the acquisition accounted for in the GAAP numbers.
Unfortunately the company does not give any GAAP earning's guidance for this year. Historically we know on a GAAP basis it lost $0.15/share in 2016 and it lost $0.80/share in 2015.
What is a Fool to do?
This company will remain on my watch list and I'll be interested to check in throughout the year to see if Carbonite can increase profits through greater operational efficiency and return to the type of growth in the SMB space it saw in 2016.
Without higher growth the company will never make it into my portfolio, although I do plan to continue to be a customer of its product.
