Carbon Black: Not A Buyer Of This Cloud Security Offering

Summary

• Carbon Black has seen a successful IPO, which does not come as a surprise.
• Strong growth and growth prospects make it a potential lucrative investment as sales and billing multiples are very reasonable at the offer price.
• After shares have seen a big jump on their opening day, relative appeal has diminished, as I am not jumping on board at these levels.

Carbon Black (NASDAQ:CBLK) has seen a successful public offering, which does not come as a surprise as the company focuses on cloud security solutions, which it sells on a subscription basis. The company has seen very strong growth in recent years as rosy prospects make that investors are naturally attracted to such a growing business.

Relative appeal could be found at the offer price as the strong pricing action following the offering has removed this relative appeal in my eyes, as I will keep a close eye on the developments going forward.

Next Generation Security

Carbon Black provides so-called next generation security solutions. The company works with a predictive cloud solution, which continuously captures and analyses unfiltered data in order to provide a robust security solution. The ¨real-time¨ solution is critical as cyber attacks occur more frequently and quick responses are needed to remedy the impact of such attacks.

The challenge is that networks become more diverse at the same time, which increases the challenge to secure the corporate network. To provide security, Carbon Black focuses on the endpoint, which is the new perimeter, as these endpoints can be cell phones, laptops, desktop computers, but also printers, screens, cameras and other systems.

By the end of 2017, Carbon Black counts 3,739 companies as its clients, which resulted in revenues of little over $162 million, for average revenues of $43k per customer.

The Offering And Valuation

Carbon Black sold 8.0 million shares at $19 per share, being the high end of the preliminary offering range of $17-$19 per share, after the company already hiked this preliminary range from a previous range of $15-$17 per share.

The 65.8 million shares value the company at $1.25 billion at the offer price. If we include pre-IPO cash holdings of $36 million, as well as gross proceeds of $152 million from the IPO, operating assets are valued at levels close to $1.08 billion. After shares have risen to $24 on their opening day, the valuation of operating assets has risen towards $1.40 billion.

The company has rapidly grown and is generating quite a substantial sum of revenues to justify this valuation. The company reported revenues of $70.6 million in 2015, yet it lost $36.6 million on an operating basis.

Ever since, Carbon has delivered on continued growth. Revenues were up by 65% in 2016 and came in at $116.2 million, with operating losses expanding to $45.6 million. Growth slowed down last year but remained quite impressive as revenues rose by another 39% to $162 million, while losses rose to $55.2 million. Growth rates slowed down during the year as fourth quarter revenues were up ¨just¨ 31% on an annual basis to $44.8 million.

With operating assets valued at $1.08 billion at the offer price, the company is valued at 6.7 times revenues reported for 2017, as that multiple has risen to 8.6 times sales at current levels of $24 per share. Actual billings grew by 48% last year to nearly $213 million, indicating that operating assets are valued at 6.6 times billings.

The first quarter results for 2018 are not finalised yet, although the company has issued a preliminary outlook. Revenues are seen at $47.5-$48.0 million, which at the midpoint suggests that sales growth comes in at 33%, marking a slight acceleration from the growth number reported in Q4. Disappointing is that operating losses continue to increase to more than $18 million for the quarter.

Relative Appeal?

The good thing is that Carbon operates in a rapidly growing industry, yet this segment is getting more crowded as well. Carbon names legacy players such as McAfee and Symantec (SYMC) in its S1 Filing as competitors, but the real competition are emerging giants like Palo Alto Networks (PANW), FireEye (FEYE) and Cisco (CSCO) although the latter is of course a much more diversified business, and not a pure player.

Palo Alto is awarded a near $17 billion valuation on an enterprise basis, equivalent to 8-9 times sales while its growth comes in at 25-30% on an annual basis. This is fairly similar to Carbon with exception of the fact that Palo Alto posts operating losses being equal to just 6-7% of sales.

FireEye is valued at close to $3 billion, which works out to just a 3.8 times sales multiple, although FireEye grows sales by less than 10% on an annual basis and the company is posting fat losses, equivalent to 30% of sales.

It goes without saying that at the offer price and based on the indicative first quarter revenue results, multiples look reasonable at 7.3 times annualised current sales, especially if top line growth can be maintained at >30%. While the company is losing close to $75 million a year (on a GAAP basis), the IPO proceeds and current cash holdings make that the business can finance this burn rate for another year or two, not taking into account the non-cash nature of stock-based compensation charges and operating leverage showing up at some point in time.

Key risks include of course competition, a potential data breach or inefficient solutions being provided, slower pace of growth and lack of operating leverage over time. On the other hand, the sales multiples remains very reasonable, certainly if growth can be maintained and operating losses come down. Note that if shares would be awarded a similar sales multiple as Palo Alto Networks, shares could be awarded a $27 valuation. While growth rates of both firms are roughly equal, or Carson Black is actually growing sales at a slightly quicker pace, it still is lagging a great deal compared to Palo Alto in terms of margins and market leadership.

I could see relative appeal if shares were to trade around the $20 mark or high-teens, but for now see no appeal at these levels in the mid-twenties.

Analyst’s 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.