Constant Contact's (CTCT) share price has risen over 34% since I recommended buying the stock in September last year. The stock was doing even better before the recent correction in SaaS names and confusion around the company's first quarter guidance led to a correction. Investors as well as sell side analysts are missing the transition of the company from an online marketing tools provider to a marketing analytics firm. This gives long to medium term investors a good opportunity to get in the stock at low valuation.
Transition to Marketing Analytics Firm
In my last article, I focused on how the company is improving its key metrics by optimizing processes using big data analytics. The company was pretty successful in its efforts in 2013. After optimizing its internal processes, the company is now taking the next big step by using predictive analytics to help solve its client's problems.
Let me elaborate with an example. Last year, while using data analytics to optimize its sales process, Constant Contact found out that there were two peak time periods when a prospective customer is most likely to buy Constant Contact's products. The first peak occurs immediately after the marketing campaign while the second peak occurs four weeks after it. So, the company can increase its sales force efficiency significantly if it asks its sales people to do a follow up call with its clients four week after the first call (which happens immediately after the marketing campaign). It worked for the company and helped Constant Contact improve its sales process efficiency.
Now, the same type of information and analysis can prove very useful for Constant Contact's clients, many of whom are small business owners who don't have resources to conduct similar kind of analysis on their own. While last year Constant Contact was busy improving and optimizing its own process using predictive data analytics, the company plans to increasingly use these techniques to help solve its client's problems going forward.
The first thing Constant Contact is doing is rolling out further changes in its products and packaging. What works for a restaurant client doesn't necessarily works for a non-profit client of Constant Contact. Also, these clients have different level of marketing and technical sophistication. By analyzing varied customer needs in different industries and providing them what works the best for them, Constant Contact is likely to improve effectiveness of its clients' marketing campaigns.
The company is also rolling out a common offering environment in 2014 where it is likely to continue developing and evolving its capabilities for each type of marketing campaign. The company currently provides a suite of marketing tools to its clients and it already has the information on multiple marketing campaigns by clients across email, social media and mobile as well as complete profiles of their clients' customers. However, the company can do significantly more in terms of using insights and data from past marketing campaigns to help their clients design future marketing campaigns which are more effective. This is somewhat like Google's (GOOG) search engine and AdWords product, where the company can use past data to make future marketing campaigns more relevant. Usually, predictive analytics works better when the company has more data (from more clients). Constant Contact has a big advantage over its smaller peers because of its huge user base of ~600,000 customers (which makes it the market leader).
Figure 1: Constant Contact Evolution
Why is the market missing this opportunity and why is it such a big deal?
Constant Contact has suffered in the past from high expectations while rolling out new products like its social media offering in 2012. So management, while excited, is more cautious this time in managing expectations and is waiting for these initiatives to play out. As discussed above, the company has just began testing products and packaging to better suit their client needs later last quarter and their new common offering environment is set to release in 2014. As these products gain traction, the market will understand the fundamental transformation which the company is seeing and its stock price will benefit.
One thing which gives us a glimpse on the company's internal plans and projections is how aggressively it is hiring new employees in order to scale up its offering. Last year, the company hired 400 new employees across sale and engineering department, and increased its work force by 35%. This indicates upcoming significant ramp up in product offering and sales effort through 2014.
Constant Contact's bears have always complained about the commoditization and increased competition in the space. The company's transformation is a fatal blow to that argument. This transition helps the company differentiate itself from other companies in the sector and gives it a competitive advantage in the industry which is becoming overcrowded.
Although there are a lot of competitors in the email-marketing space targeting SMBs, most of them do not have resources to invest significantly in providing detailed analytics solutions in addition to basic email/social media marketing tools. Even if they have the financial resources, it will be difficult for them to produce similar results, given the depth of information Constant Contact has from its user base of 600,000 users to analyze what works best for consumers. This is likely to put Constant Contact's smaller competitors at a disadvantage.
These initiatives will also help the company in going after larger clients who require a higher level of sophistication in terms of marketing tools and tracking their campaign. Further, a client is more likely to go for Constant Contact's service over competitors if he knows that he can start small only using the company's email marketing product initially - but the option to size up in terms of marketing and analytics tools is available with Constant Contact as his business grows.
Thus, I expect investors to give a higher multiple to the company once they realize the way things are changing during the course of 2014.
What spooked investors on the last call?
So far, so good. But what happened during the last quarter which spooked investors and the stock corrected?
While Constant Contact delivered solid results showing gains in all key metrics and its FY2014 guidance was above expectation, its Q1 guidance at 13% revenue growth and 10-12 cents EPS was slightly lower than estimates. Over the last few years, the company's year over year growth rate had been strongest in Q1 and then had slowly decreased sequentially as the year progressed from Q1 to Q4 (see below).
For example, in 2012, Q1 saw 20% YoY growth, Q2 saw 18%, Q3 was 17% and Q4 was 15%. Since it is a short lead time business, visibility is limited to next quarter (Q1) and even the company itself has limited visibility for rest of the year (Q2-Q4). So, when investors looked at the company's Q1 guidance of 13% and looked at the past few years trend where the company's YoY growth has sequentially slowed throughout the rest of the year, they doubted that the company can deliver over 13% growth for the full year. This was a risk factor in their mind and since, the stock had already seen a 50% run up since September, they decided to play it safe.
However, I believe their skepticism around the full-year guidance is misplaced and one needs to understand that the dynamics this year are different from the last few years. While in 2012 tapering off of excitement around the social media product slowed growth and in 2013 difficult comps in the back half of the year from SinglePlatform acquisition played spoilsport, 2014 is likely to be different. The company is set to roll out the improvements in product and packaging throughout the year as well as a common offering platform in the middle of the year which will help its revenue growth accelerate from the first quarter as year progresses.
Further, the company is also increasing pricing of its products. The biggest one among them is increase in pricing for SinglePlatform customers. The company has increased its pricing from $49 to $79 and all its new clients are coming at that price. As the year progresses, I believe the company will slowly roll-out this pricing increase to its existing customers. This alone has a potential of increasing ARPU by $1 by this year end (assuming 16,000-17,000 paying customers for SinglePlatform).
While the improvement from increase in price of existing product like SinglePlatform is not tough to estimate, the impact from new product and packaging is difficult. The least we can say is that it would be positive. So, that will mean more than the 13% growth the company saw last year. Historically, the company has been very successful in terms of cross-selling. Currently, it sells 1.78 products per customers (up from 1.47 in 2008). So, this goes in favor of the company.
Earlier (until the Sept. 2013 quarter), management had $50 as a long-term ARPU target while on the most recent call it indicated that this target is achievable in the intermediate time frame (3 years) as they are becoming increasingly confident in new products and packaging from what it is seeing in its test launches. The company saw a ~$2 increase in its ARPU last year without any major launches. Now with these new launches and increase in pricing of SinglePlatform (from $49 to $79) contributing, I believe it can perform much better than 2013.
Here are my assumptions and calculations for revenues.
Net customer addition in line with last year (~10,000 per quarter, conservative as better product and packaging, and increased sales efficiency will likely accelerate its topline growth.)
SinglePlatform's price increase to add $1 to ARPU by 2014 year end but since the price increases for existing customers will be rolled throughout the year average sequential increase will be ~$0.25 per quarter.
In 2012, when the company rolled out social media products its ARPU increased by $0.55 per quarter despite the product being only a moderate success. Last quarter, the company saw a sequential improvement of $0.93 in ARPU. If we assume the company can get $0.50 sequential increases in ARPU from its roll out of new products and packaging, common offering platform and better analytics, we get the following estimates for 2014 revenues:
Average User Count
Average User Count
Base ARPU (Q4 2013)
Benefits from Products, packaging, analytics, common offering platform
There is further upside possible if the net customer additions accelerate from 2013 levels due to better offerings. I believe investor skepticism around the company's full-year guidance is not justified. As investors realize over the course of next couple of quarters that its growth is accelerating, they are likely to be positively surprised.
Constant Contact is currently trading at EV/Sales (2014) of 2.2x while its high growth SaaS peers like Responsys (MKTG) are trading at 5-6x EV/Sales. Most of this discount is due to the company's slowing growth. As this reverses and the growth re-accelerates in 2014, I expect the stock to get higher multiple. I am not expecting the topline growth to re-accelerate over 20% in the near term or stock to get 5-6x EV/Sales multiple like its peers. However, even if the company's growth stabilizes around current levels and it posts more than 13% revenue growth this year in line with the guidance it has provided, some of the skepticism around the company's prospects will wane and the stock can trade at 3x EV/Sales ( ~33% upside from current levels).
- Roll out of new offerings
- Results and guidance which indicates accelerating growth (13% or higher)
- Transformations are inherently risky and difficult with many unknowns and moving pieces. So far, things are going in the right direction for Constant Contact and management is executing very well. However, if something goes wrong in term of their product and analytics strategy, the company's stock price may be adversely affected.