Gigamon (NYSE:GIMO) is an incredible growth story. Its shares have seen a big reset in early 2017 as management had to correct its own too optimistic projections for Q4.
Despite a 10% revenue miss versus its own forecasts, growth is still impressive, and investors should be aware that the revenue numbers have always been volatile in the short run. The miss makes the situation look worse than it really is certainly if delayed sales will be made up for in the first quarter of 2017.
A Growth Story In Network Traffic Visibility
Gigamon provides traffic visibility solutions for networks which ever grow more complex in size, accessibility and location. Following the foundation of the firm in 2004, it went public in 2013 by offering its shares to the public at $19 per share.
Gigamon's product and software allow for dynamic and intelligent visibility of traffic across the network. Besides watching traffic, organizations can also use it to control access, making the software notably suitable for security and compliance goals. Commercial applications can be thought of as well, including analysis of traffic of course.
With networks growing more complex through developments such as virtualization, mobile applications and the cloud, managing these networks becomes a challenging task. This is certainly the case as the Internet of Things development makes that so many devices are connected, making it more important to manage traffic after it has access to the network, rather than preventing each device from penetrating the network.
Growth has been nothing short but speculator. For the year 2013, when the company went public, revenues came in at $140 million, which were nearly five times as much in 2009. Unlike most start-ups, or rapidly growing technology offerings, Gigamon was actually profitable on a GAAP basis, attracting my interest.
2014: An Important Lesson Applicable To Today
After the IPO in 2013, shares actually rose to a high of $40 per share as they doubled from the offering price. Yet investors were in for a shock in early 2014. The company issued a profit warning for Q1 of 2014, forecasting revenues to come in roughly 10% below the previous forecast.
A second profit warning followed for the second quarter of that year, causing a massive correction in the share price, which fell to just $10 per share. Note that the company held roughly $4 per share in net cash as well, indicating how severe the price reaction in the stock has been.
On the other hand, it was understandable why investors had some doubts as the company was posting modest losses at the time while top-line sales growth slowed down to single digits at the time.
These lessons are important as Gigamon issued a warning for the fourth quarter of 2016 as we will discuss below.
Let The Good Times Roll, Great Operational Leverage
Following difficult times in 2014, Gigamon has regained operational momentum in 2015 as overall sales growth improved to +40%. This was driven by roll-outs of new product versions, additional partnerships in terms of distribution, and integration with other software platforms.
The good thing is that momentum has continued in 2016. First-quarter sales were up 43% to $67 million, and second-quarter sales were up by 46% to $75 million. In both these quarters, GAAP profits came in at $3-4 million.
Third-quarter sales growth accelerated towards 47%, with revenues of $83 million translating into GAAP earnings of $6 million. Note that the actual customer account was up just 17%, indicating how much growth in the current customer base really is. The company guided for fourth-quarter revenues of $92 million, or 37% year-on-year growth, and earnings of roughly $7 million.
Note how much leverage there is in terms of earnings as third- and fourth-quarter earnings are roughly twice the earnings reported in the first half of the year on the back of relatively modest sales growth.
Too Much Momentum, Setback Provides Opportunity?
In the aftermath of the strong Q3 results and the strong outlook for the fourth quarter, shares jumped to $55 per share. That values the company at $2.1 billion, or $1.85 billion net of cash holdings, equivalent to 5.5 times annualized sales.
As it now turns out, the fourth-quarter guidance was not achievable. The company cut the guidance to $84.5-85 million which implies that annual growth still comes in at 26% per annum. The company cites that customers have been postponing purchase decisions, the same reason which caused turmoil in 2014 which proved to be a great buying opportunity.
Shares have now plunged to just $30, shedding 30% of its value overnight as growth slows down to 26%. While it seems that management has been a bit too upbeat, I wonder if shares would have fallen so much if the company issued this outlook in the third quarter.
While shares still trade with very decent gains compared to January of 2016, we have to appreciate that cash holdings are very substantial at $245 million, equivalent to $6.50 per share. Based on the projected earnings rate of $7 million in Q4, earnings might come in at $0.70-0.80 per share, still translating in high GAAP earnings multiples, although adjusted earnings are much higher.
There are reasons to be upbeat however in 2017 as growth continues and the company announced its first Fortune 1000 client for its AWS service which has been launched in November. With solutions being promised for Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Azure (NASDAQ:MSFT) being developed as well, there is no reason to not assume quarterly revenues surpassing the $100 million mark in the upcoming year.
Final Thoughts, Worth Picking Up
Recent results reveal the operating leverage in the business model as third- and fourth-quarter profits of 2016 being roughly double those reported in the first half of the year.
If we assume that revenue growth comes in at 20% from the Q4 numbers, we can end up with a $100 million quarterly revenue run rate. Based on the operating leverage in the model, earnings of $10 million should be within reach, equivalent to +$1 per share. At the same time, cash balances have likely grown to $7 per share, implying that operating assets trade at just 23 times forward earnings at this moment.
This looks like a compelling multiple given the past growth, strong leadership, growth opportunities with existing customers, and the operating leverage in the business model. Recent corporate hackings and concerns about cybersecurity even penetrating the political environment make the outlook look solid.
These long-term favorable trends, solid earnings projected for 2017 and strong net cash position make me a gradual buyer in the $25-30 range.
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.