Symantec (NASDAQ:SYMC) announced another sizable deal with the purchase of LifeLock, just months after it announced the multi-billion purchase of Blue Coat.
The strong price action and operational improvements, following the Blue Coat deal, mark a reversal from gradual declines in operating and share price performance. This might have given management the confidence to pursue this latest deal. While the strategic rationale behind both deals is solid, Symantec is incurring some debt with these transactions.
While I remain very cautious on the prospects going forward, given the steep multiples paid, aggressive assumption of cost savings and synergies, and assumption of debt, it has to be recognized that Symantec is making some operational improvements. Even as I remain cautious amidst the run-up in the share price, I see no specific trigger or event to initiate a short position at these levels.
A Review Of Events
With the $4.65 billion purchase of Blue Coat, Symantec's management was able to please investors in a big way. This was in large part driven by the guidance, which called for non-GAAP earnings of $1.80 per share by 2018. I called this guidance quite optimistic in June, when management laid out the trajectory for future earnings growth.
The purchase price for Blue Coat represented a steep multiple given that the business posted non-GAAP revenues of $755 million on a trailing basis, although revenues were growing by 17% per year. The six times non-GAAP revenue multiple seemed steep despite the growth, as part of the growth was the result of acquisitions. While non-GAAP operating profits surpassed $150 million, the GAAP reality was a lot less impressive as Blue Coat posted a net loss of $250 million.
The Market Is Upbeat
Despite the steep multiples paid for Blue Coat, amidst relative modest growth reported by the company alongside large GAAP losses, investors were upbeat on the deal. Alongside the deal, Silver Lake doubled its investment into Symantec towards a billion, as Blue Coat's previous owner, Bain Capital, would invest $750 million into the business as well.
Besides this vote of confidence, investors liked the strategic rationale, as Blue Coat is strong in networks and cloud security, areas underserved by Symantec. With the deal, the company aims to provide coverage across all areas of the security market after having long relied on the consumer security market. Other potential drivers behind the deal include shared selling efforts, shared R&D investments and expectation of $150 million in cost synergies.
While these items all favor the deal, note that the multiples of the deal have been high. Shares of Symantec rose another $3 towards $20 per share in the time frame of a few days on the back of the news, adding another $2 billion in shareholder value in the process.
Current Trends Look Encouraging
Symantec released its second-quarter results for the fiscal year of 2017 in early November. The company had quite some good news as the business seems to have re-found operational momentum with revenues being up 8% to $979 million, or up 6% in constant currency terms.
Revenues came in far ahead of the guidance, in part driven by a $124 million revenue contribution by Blue Coat in a two-month period after the deal closed. This was much higher than the $100 million being anticipated by management. Management was furthermore very pleased with the progress on the Blue Coat deal and indicated that it achieved a run rate of $100 million in terms of cost savings and synergies. Note that the business outlined plans earlier this year to cut costs by $400 million as synergies relating to the Blue Coat deal should amount to another $150 million by 2018.
Quarterly non-GAAP earnings came in at $0.30 per share, a penny ahead of last year. While this growth seems modest, the results comfortably came in ahead of the company's own guidance at just $0.18 to $0.21 per share. The GAAP results were less impressive, as the company reported a $0.23 per share loss, largely relating to expenses incurred following this M&A activity as well as restructuring charges.
The company actually guides for non-GAAP earnings of $1.12-1.18 per share in the upcoming year, yet it is expected to post a modest GAAP loss this year. Most of this results from restructuring and acquisition related costs, as stock-based compensation is seen at $0.36 per share. If we exclude the latter, realistic GAAP earnings are seen around $0.81 per share.
Given that current costs savings and synergies already total $100 million per year versus the expected $550 million by 2018, there is room for earnings growth. The additional cost savings of $450 million is equivalent to $0.72 per share given the 620 million shares outstanding. After applying a 30% tax rate, after-tax earnings could see a boost of $0.50 per share for a pro-forma GAAP earnings number around $1.30 per share by 2018.
If the company can deliver on these incremental cost savings, which looks ambitious, shares trade at 18 times realistic earnings projected by 2018.
Adding To Leverage
On the back of the solid execution in Q2 and progress with cost savings, Symantec decided to use its large cash balance and modest existing net debt load of $1.6 billion in order to pursue more dealmaking.
Therefore, it announced the $2.3 billion deal to acquire LifeLock. This company has 4.4 million members, who are offered consumer security solutions such as identity protection and recovery services. LifeLock generates roughly $650 million in revenues for a 3.5 times revenue multiple. Its sales are growing in the low-double digits while GAAP profit metrics come in around flat.
The deal will more than double net debt towards nearly $4 billion, but that is not withholding management from upping the share repurchase authority by half a billion. This means that leverage is going up significantly, yet it seems manageable if the company continues to grow and realizes cost savings and synergies.
Final Thoughts, A Word Of Caution
Symantec has gotten more aggressive rather than relying on simple financial engineering, as management previously aimed to offset ailing core performance with share buybacks. The company has made two deals to fortify its growth profile in emerging areas, yet the question is whether SYMC is paying a bit of a steep price for these assets.
The market has taken these deals relatively well, aided by the fact that some operational momentum is showing up, including the core areas of Symantec. Combined with upbeat comments on the prospects for cost savings, and an 18 times pro-forma earnings multiple for 2018, there is reason for optimism. While the company has taken on some leverage, it does not really pose a threat as leverage ratios remain moderate, combined with strong cash flow generation.
Despite the better operational momentum, likelihood of realization of synergies, and the strategic sense behind recent dealmaking, I remain cautious. Continued focus on non-GAAP accounting, a "troubled" past with regards to broken promises, and recent CFO transition of Thomas Seifert in his early fifties, are potential red flags.
Recognizing the improved operational performance, I do not automatically believe that shares are a short candidate at these levels given the importance of cybersecurity and strategic dealmaking, as I was positively surprised how well the market took the deals. For now, I continue to watch the story with great interest, being somewhat cautious as I believe that there might be room for negative disappointments in terms of growth and synergy targets.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.