At the end of last week, SMTP (SMTP) reported Q2 earnings ending June 30th, which came in at $0.03/share and revenues of $1.5m. Top line growth was 6% year over year, which is more or less inline with recent results. Bottom line earnings were significantly reduced from a year ago, but this was due mostly to heavy M&A activity in recent months. We can expect some of these costs to subside a bit in the near term after the company has announced two big acquisitions together with its quarterly report. For the second quarter in a row the company will pay out more cash in dividends than it has taken in from operations (annual yield is still 7.5% at current prices). Obviously, this isn't sustainable longer term, but it appears to be a positive sign that the company was very confident in the accretive power of its two pending acquisitions that it didn't see the need to cut the dividend.
Since early 2013, the company has seen growth slowed to a single digit pace, and this quarter was keeping with those recent trends. A few weeks ago, I published an in-depth analysis on the company, which you can view here, where I covered the reasons for this. Although the email marketing and delivery industry continues to grow at double digit rates, SMTP has been in the process of shifting its business model to ramp up sales & marketing and better capture opportunities in the face of slowing growth. This journey to re-ignite growth has just taken one big step forward, as the company also announced last week that they are acquiring SharpSpring and GraphicMail. Interestingly, the market reaction to this was quite muted on Friday, as the stock was only up a few percentage points. However, I think the market is so far way underestimating the positive impact of this. Just consider:
GraphicMail is an established company with many years of worldwide operations in email marketing. Not only does the company bring a complementary product to SMTP's strength in email delivery services, but the company has more than 50 salesmen with local expertise in many foreign markets. SMTP has a sales & marketing team of only 6 people, so this factor in itself is a big deal. Also, the company is similar to SMTP in that it has a wide variety of diverse customers (>30k), providing for a stable re-occurring base. Once training is ramped up, there will be an overnight plethora of cross-selling opportunities to accelerate growth for both companies.
SharpSpring is a young company which focuses on marketing automation, which is another complementary service. The company has been rapidly growing revenue, much faster than SMTP, and will immediately set up the combined companies to double digit top line growth. Management will be incentivized to continue this as well, since two-thirds of the purchase price is based on earn-outs tied to continued revenue acceleration.
GraphicMail is profitable, and SharpSpring is cash flow breakeven as of the past few months. So neither company will be draining cash and the overall combined company should maintain a decent margin profile.
Backing out the approximately $7.6m upfront cash being spent on the acquisitions, SMTP's EV/Rev multiple will drop well below 2.5x. This is because revenues should double from the onset. Part of the purchase price of the two acquisitions is in SMTP stock, which will cause some near term dilution (about 8% for the GraphicMail purchase), and this could be another 10% or so for SharpSpring in early 2016, depending on how well they meet their earn-out targets. However, the combined forces of these three companies should far outweigh this drag from an investor perspective. With much higher revenues, a profitable business, accelerated growth rates, and a much larger sales force, the stock valuation is set to factor higher in the coming months, as investors start to better understand the potential.
Overall, I'm really excited about these acquisitions and will be adding to my position at these levels before the market really begins to catch on.
Disclosure: The author is long SMTP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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