Gigamon (NYSE:GIMO) is a network visibility, monitoring and security vendor that went public in 2013, and is still fairly undiscovered and unfamiliar to investors. It is not your typical IPO company as it has developed market leading technologies, has been profitable for several years, and is growing its top line at 25%-35% YoY.
The company has grown top line in excess of 30% over the past several years, and this growth is expected to continue at 25%-35% given the company's nascent 7% penetration rate of its TAM. This future growth will come from underpenetrated enterprise markets including Fortune 1000 companies, international expansion, further penetration into the service provider market, and expansion into security offerings. The company's TAM (total addressable market) is estimated between $2 and $3 billion growing at double digits annually driven by cloud and big data, as well as the rapid transition from 1G Ethernet connections to 10G, 40G and 100G connections.
Gigamon is a likely strategic M&A candidate given its technology and reasonable valuation. Among potential suitors are traditional switch and routing companies (Cisco, Brocade, and Juniper) as well as Oracle, IBM, Hewlett Packard, Dell, Riverbed, F5 Networks with Oracle, and Cisco making the most strategic sense.
Oracle has made acquisitions of complementary technologies by buying session-border controller specialist Acme Packet and network optimization specialist Tekelec at premiums of 8 and 10 times their revenues, respectively. Gigamon's leading technology and products would bolster Oracle's fledgling network tools solutions and its hardware business (formerly Sun) in its effort to further diversify into enterprise network and service provider markets. Oracle needs Gigamon to solidify its data center, cloud and big data offerings as the industry transitions from 1G to 10G, 40G and 100G Ethernet connections. For Cisco, Gigamon's technology will be value adding to its switching and data center offerings. And Cisco has to cherish Gigamon's 75%-77% gross margins and targeted operating margins of 23%-28%. For both Riverbed and F5 Networks, acquisition of Gigamon would make strategic sense in terms of technology and addressable markets. For example, Riverbed acquired network performance specialist Opnet for 6 times revenues and already closely partners with Gigamon. It may also consider acquiring Gigamon to fend off the acquisition proposal by an activist investor Elliott Management.
We are a little perplexed as to the reason(s) Gigamon has not yet been acquired, but our best guess is that it is a matter of price. Mind you, Gigamon's largest shareholder (18%), Highland Capital Partners, is a venture capital firm and is not in the business of long-term investing in public companies. It was a seller at $38.50 in the October 2013 secondary offering. Highland's managing partner Corey Mulloy is the Chairman of Gigamon's Board. Gigamon also has five early 5%-plus investors who would become willing sellers if the price is right. Then the question becomes: What is the right price? Highland Capital Partners sold at the prices of $19.00 in the IPO and at $38.50 in the secondary offering.
We would speculate that it will be willing to entertain offers in the high $20s to low $30s range, which would value Gigamon at the reasonable acquisition valuation of between 5 and 6 times revenues (Acme Packet and Opnet were acquired at 8 and 6 times revenues, respectively). If Highland becomes an interested seller, bidding war is not out of the question. The acquisition premium can easily approach 60% to 80%, and we do not believe it is currently reflected in the stock price -- especially given the relatively high probability of Gigamon being acquired.
Gigamon's gross margins currently range between 75% and 81% and operating margins are targeted between 23% and 28%. Q1 FY 2014 and Q2 operating margins are depressed as a result of the investments in R&D and international sales force expansion. The company has $140 million in net cash, or $4.40 per share, and $0 in debt. YoY growth in deferred revenue is an indication of sustainability in future revenue growth.
The current stock price is $16.84 with $14.75 (52-week low) and $41.81 (52-week high). Total market value is $534 million, or about 3 times projected FY 2014 sales, with about 31.7 million shares outstanding. The stock's FY 2014 P/E of 40 (refer to Pt. 3) will decrease to FY2015 P/E of 20 net of cash. Mean analyst target on the stock is $25.08. Early investors and insiders own 63% of outstanding shares, with five early investors and insiders owning around 5% each for a total of 27.9% of outstanding shares and Highland Capital owning 18.6%.
Our investment thesis is as follows: Not all high-growth stocks are "priced" the same and after more than 50% collapse in its stock price, Gigamon could and should be considered a high-growth value stock. If the company can execute, and deliver on its financial guidance in coming quarters, we believe the stock could rise to the mid-$20s in the next six months. If Gigamon is acquired, we see the acquisition price of $28 to $32 based on comparable transactions analysis (refer to Pt. 2).
Disclosure: I am long GIMO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.