Synopsis / Situation Update
The downward spiral of Care.com (NYSE:CRCM) continues unabated. Its shares have declined another 11% since my last article on the company. Perhaps more alarmingly, the absolute disconnect between management's perception of this venture's merits and economic reality continues to widen at a dramatic pace.
Let us briefly recap the vast swath of destruction that has occurred since CRCM plunged into the public equity market in January:
1. The shares are down 53% (through December 4) from the IPO price of $17, and are down 73% from the post-IPO high of $29.25.
2. In the same time span, the S&P 500 and NASDAQ are each up 16%.
3. In the last four quarters alone, CRCM burned $20.9 million of additional shareholder cash, and an additional $26.5 million has been shoveled into the furnace for acquisitions and miscellaneous "investments."
4. Despite management's claims of leveraging its cost structure and gaining scale, overhead as a percentage of revenues remains as high as it was nearly five years ago (see below).
The facts speak for themselves. Despite the company's ongoing frenetic public relations push to promote this gambit and keep the music playing, the market is speaking loudly and clearly about its perceptions of this entity. And, by the way, the "feel good" public relations strategy is funded entirely with shareholders' money since the company has never generated a cent of cash flow of its own (to my knowledge).
The chart speaks for itself:
Before we embark on an examination of the latest quarterly "results," could we please refrain from using the term "earnings"? There are no earnings. There have never been any earnings. More importantly, there is no cash flow, which is even more critical than earnings, and (based on publicly available information) there has never been any operational cash generated by this company after roughly eight years in existence. The point being, this is not some brand new venture - CRCM has burned cash at an alarming rate from day one, and continues to do so consistently each day it opens its doors.
The third quarter results showed continued top-line growth, with a 24% increase over the prior quarter and a 48% increase over the third quarter of 2013. However, after you strip out the impact of the Citrus Lane acquisition, organic sequential growth was 14.6% and year-over-year organic growth was 36.5%. To be sure, these are still impressive growth rates.
The problem, however, is that none of this growth generates a single penny of cash flow or earnings. As a result, I believe the company remains on track to either insolvency or a massively dilutive equity raise, most likely in the form of a convertible security with a strike price that will be well below the $17 IPO price. As of September 27, the company had cash of $83.6 million, which is well in line with my projection for a year-end cash balance of $77.3 million. By way of reference, CRCM is still due to make earn-out payments this year of $5 million to Breedlove and $0.7 million to Parents in a Pinch. This would bring the cash remaining to $77.9 million, which is very close to my forecast.
In its third quarter results announcement, management argued that marketing expense was being more efficiently leveraged as the business grows. The actual trend (according to their own financial statements) seems to be essentially flat (if not increasing), albeit with some quarterly fluctuations:
Perhaps more disturbing, however, is the fact that G&A and R&D expenses as a whole have increased significantly as a percentage of revenues. This is not the telltale sign of a tightly run ship. Rather, it is emblematic of a company that still operates as though shareholders' cash is its own personal piggy bank. While direct marketing spend to acquire new customers may be declining on a relative basis (which is obviously a good thing), these savings are more than eaten up by what appears to be bloated overhead spending, which has increased meaningfully.
Part of this should, of course, relate to the incremental expense of being a public company, but that certainly cannot explain the full increase, given that the 400 basis point increase in G&A presumably related to preparing to go public was first seen in Q3 2013 (when G&A spiked from 21.7% of revenues to 25.1%). In the most recent quarter, it now stands at 29.6% - not an encouraging trend to say the least (noticing a trend here?).
As one example, in July the company terminated the lease on its existing office space of 53,950 square feet, to move to a new space that initially will be 36,174 square feet, under the company's stated premise that its current space was inadequate for its expanding business. This makes no sense. If 53,950 square feet wasn't adequate, how is a space that is 33% smaller adequate? Yes, it also acquired the right to lease two additional floors in the new building, but this doesn't occur until 2019. Something doesn't add up. More tellingly, in terminating its existing lease, it left behind substantially all of the office furniture. Once again, this does not smack of a disciplined or efficiently run operation that has any meaningful concern for its shareholders.
CRCM's continued opaque disclosure about its customer trends is a further disturbing aspect of this enterprise. Management boldly trumpets its growing number of "members," yet the company's methodology for calculating "members" would seem to be rather flawed and disingenuous, to say the least. Management apparently counts as a "member" anyone who registered on their website since it was launched years ago, whether or not that person actually paid anything to CRCM and whether or not they still use the site:
The latest data I could find was through 2013, and showed that only 10.4% of "members" actually paid anything, which was significantly lower than in 2010, when the figure was still just a meager 14.8%.
To its credit, management finally did relent and produce some quantitative data purportedly showing customer retention rates increasing, as well as average revenue per user (ARPU), although the latter metric appeared to be essentially flat. We shall stay tuned on these metrics to monitor the trends. That said, the bottom line metric is free cash flow, and there appear to be few prospects for this in the near future unless CRCM trims its bloated cost structure and operates like a public company, not a hobby.
Of further note is the recent departure of the CFO, after a mere 20 months on the job. Although there is nothing unusual about an executive leaving to pursue a new opportunity, Mr. Leahy was presumably closest to the numbers and had a very good grasp of the prospects of CRCM. Directionally speaking, this is simply another red flag as it relates to CRCM and its outlook (i.e., if it were such a great opportunity for value creation, why leave, and why so quickly?).
As a side note, I did observe that the CEO in August did make a modest purchase of shares (unclear whether it was simply the exercise of options). To put this in proper context, the total transaction value was less than $25,000 - although directionally it is obviously encouraging to see management investing in the business, this was a bit of a token gesture to say the least, especially given that she was paid $1.8 million in compensation in 2013 by a company that burns $66,000 of cash per day on an average.
Finally, revisiting the broader topic of the viability of CRCM, management repeatedly said on its Q3 earnings call that it hope to achieve EBITDA breakeven "in 2-3 years." Given the expense trends in this business, there is nothing to suggest that this is remotely achievable, save a massive downsizing of the bloated cost structure. Moreover, EBITDA is a metric that can be manipulated; cash flow cannot. As the saying goes, earnings are an opinion, cash is a fact.
Despite its presumably noble intentions of helping care providers match with care consumers, whether CRCM can ever generate a cent of cash flow remains a very dicey proposition. The shares continue to trade essentially as a long-dated, out of the money call option and are essentially a bet as to whether this plane will ever get off the ground before it reaches the end of the runway. I remain quite skeptical, especially in light of the trends in overhead spending and the emerging trend of acquiring growth (a la Yahoo (YHOO)) as opposed to generating ongoing, meaningful and profitable organic growth.
As each day passes, CRCM moves closer and closer to requiring a massively dilutive equity raise (which it acknowledges in its 10-Q), and I believe the market is factoring this into its resoundingly negative view of this stock.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.