Carbon Black: Short Sellers Send The Stock Price To Undervalued Levels

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About: Carbon Black (CBLK), Includes: CSCO, FEYE, PANW, SYMC
by: Bilbao Asset Management

Summary

Carbon Black is a provider of endpoint security solutions. The company’s systems offer a predictive security cloud platform for preventing cyber attacks even before a data breach occurs.

Keep in mind that the short interest went from zero to over 2.81 million in less than eight months.

The company trades at 4.6x forward sales, which seems too low. Comparison with other peers shows that Carbon Black could easily trade at 5x or 6x forward sales.

The amount of global revenues from the endpoint security market is increasing at a high pace. This figure was equal to $4.1 billion in 2014, and it is expected to be equal to $8.02 billion in 2021.

The quarterly report noted that the number of customers who acquired cloud-based solutions increased from 1,170 to 2,450.

After delivering better-than-expected revenues and EPS, Carbon Black (NASDAQ:CBLK) continues to be punished by the market. The company seems to be undervalued at 4.6x forward sales with gross profit margin of 78.20% and revenue growth of 28% y/y in the last quarter .

The current undervaluation may be explained by the activity of short sellers. Keep in mind that short interest has increased quite a bit in the last eight months. If they close their positions, the share price should creep up in the near future.

Source: Prospectus

A Market Leader In A Growing Industry

Founded in 2002 and headquartered in Waltham, Massachusetts, Carbon Black is a provider of endpoint security solutions. The company’s systems offer a predictive security cloud platform for preventing cyber attacks even before a data breach occurs. In order to achieve this goal, Carbon Black continuously assesses unfiltered endpoint data in real-time using big data.

The image below provides some of the features of its systems:

Source: Company’s Website

The company seems to be capitalizing on very relevant needs of global organizations. The increasing amount of mobile workforce and the increase in the amount of enterprise data in the cloud have enlarged the amount of vulnerabilities. As of today, cyber criminals are becoming experts on targeting endpoints, which are networks that are remotely bridged to client devices.

Many clients, large and small, are becoming aware of these new threats. The prospectus reads that 33 companies of the Fortune 100 are clients of Carbon Black. In addition, as it will be noted later, the number of clients is increasing at 39% y/y. That’s not all. Large corporations like VMware, Inc. (VMW), Splunk Inc. (SPLK) and IBM (IBM) have solutions that integrate the company’s systems. The company is also very well diversified, which should be appreciated by investors. Carbon Black operates in very different industries, including oil and gas, healthcare, IT, and manufacturing companies.

Source: Company’s Website

Many analysts note that the company is the clear leader in the endpoint security. Gartner said recently in a report that Carbon Black was a visionary. EMA and IDC noted that Carbon Black is a clear market leader in its space. The image below provides more details on this matter:

Source: Company’s Website

The market opportunity seems quite large. According to IDC, the market opportunity could be between $6.5 billion and $19.1 billion. Keep in mind that companies operating in the IT asset management market, those selling cloud security software and vulnerability management, add up to $19.1 billion. The lines below provide further details on this matter:

Source: Prospectus

The amount of global revenues from the endpoint security market is also increasing at a high pace. This figure was equal to $4.1 billion in 2014, and it is expected to be equal to $8.02 billion in 2021. That’s approximately 92% increase in only seven years. The image below provides further details on this matter:

Source: Statista

Recent Quarterly Report: The Amount Of Assets Is Increasing

The most recent quarterly report continued to show that the business is improving. The customer count including direct sale customers and customers with subscriptions to the company’s solutions increased from 3,335 to 4,625. This means that the amount of customers is increasing at 39% y/y. Additionally, the quarterly report also noted that the number of customers who acquired cloud-based solutions increased from 1,170 to 2,450.

The financial statements reported in the last 10-Q show that the company is in good shape. The amount of assets increased from $271.56 million to $397.184 million as of September 30, 2018, showing 46.26% increase. The amount of cash in hand also increased to $69.09 million, 91% increase as compared to cash in hand on December 31, 2017. The amount of goodwill, equal to $119.6 million, did not change, which seems beneficial. Accountants did not impair the assets acquired from Confer, Objective Logistics Inc., and VisiTrend, Inc. The image below provides further details on this matter:

Source: 10-Q

Savvy individuals will say that the increase in the amount of assets was due to the recent IPO. This is true, but it seems very relevant mentioning that the number of liabilities did not increase much. The liabilities only increased by 4% from December 31, 2017 to September 30, 2018. The financial risk seems very similar to that when the company executed its IPO. The image below provides the list of liabilities:

Source: 10-Q

Revenue Grew In The Last Quarter

With that about the good financial shape of Carbon Black, the revenues reported in the 10-Q were also beneficial. Revenue increased to $53.415 million for the three months ended September 30, 2018. This represents 28% increase as compared to that of September 30, 2017. Gross profit also increased to $41.51 million, exhibiting 30% increase as compared to that of September 30, 2017.

The loss from operations was not that beneficial. The company reported losses of -$18.06 million, which was below the losses reported for the three months ended September 30, 2017. The losses are not ideal. However, investors should get to know that Carbon Black is a growth company. Revenue growth and gross profit margin matter more than the net income losses. The stock price of Carbon Black should increase in the future if revenue growth continues at the same level. The image below shows the income statement reported in the last quarter:

Source: 10-Q

The Detrimental Market Reaction

On October 25, 2018, the company released its last 10-Q, which seemed to be better than expected. Both the earnings per share and the revenues were better than what analyst were expecting. Jignesh Mehta provided information in this regard, check the image below for further details:

Source: Seeking Alpha Assessment

Earnings call transcript also included very beneficial information. The company said that it has five products available: Cb Defense, Cb ThreatSight, CB LiveOps, Cb ThreatHunter, and Cb Defense for VMware. Investors should understand that more products could mean more revenues and more contracts signed with new clients. The following lines show the optimism of Patrick Morley, President and CEO:

Source: Earnings Call

That’s not all. Among other beneficial information, the company released that it had signed agreements with two Fortune 100 Companies and a large Spanish auto parts manufacturer had increased its demand for Cb Defense. The following lines provide further details:

“We signed one of the largest Cb Defense transactions to date, a multimillion dollar ACV win for a total of 350,000 endpoints with the Fortune 100 Company.” Source: Earnings Call

“We also signed an important Cb Defense deal with the Fortune 100 healthcare company, who is looking to consolidate its endpoint security following a recent acquisition.” Source: Earnings Call

As it was obviously noted in the earnings call, the 10-Q was very solid. The market should have reacted positively, but it did not. In only one day after the report, the share price declined from $19 to approximately $17, losing 10% as can be seen in the image below.

Source: Seeking Alpha

The company continues to destroy its valuation even after delivering beneficial figures. Since May 2018 when the company executed its IPO, the price has gone from $24-$30 to $16.48 as of November 2, 2018. It does not really make much sense since nothing has changed in the last eight months.

Valuation

With revenues of $53 million in the last quarter, assuming 2018 revenue of $212 million seems reasonable. Using this figure and 28% revenue growth, forward revenues of $271 million seems also achievable. The company has an enterprise value of $1.27 billion, thus the EV/Forward Revenues equals 4.6x.

  • Cisco Systems (CSCO) trades at 3.6x sales with an enterprise value of $180 billion.

  • Symantec (SYMC), with an enterprise value of $15 billion, trades at 3.23x sales with revenue growth of 11% and gross profit margin of 74.35%.

  • Palo Alto Networks (PANW), with an enterprise value of $16 billion, trades at 7.45x sales with revenue growth of 29% and gross profit margin of 71%.

  • FireEye, Inc. (FEYE) trades at 3.41x sales with an enterprise value of $2.78 billion, revenue growth of 11.20% and gross profit margin of 75%.

Among these competitors, the only company that should be compared with Carbon Black is FEYE. CSCO, SYMC and PANW are tool large. FEYE is trading at 3.41x sales with much less revenue growth and gross profit margin than that of Carbon Black. Keep in mind that the revenue growth of Carbon Black is more than two times that of FEYE. Carbon Black should not trade at two times the EV/Revenues ratio of FEYE. However, the company could trade at 5x or 6x forward sales.

Short Interest

The amount of short interest reveals that short sellers are operating on the stock. Keep in mind that the short interest went from zero to over 2.81 million in less than eight months. Perhaps, the company was a bit overvalued at $24. However, as of today, Carbon Black seems slightly overvalued. The upside potential on the stock seems more significant than the downside. With this in mind, short sellers may close their positions soon. The image below provides further details on the amount of short interest.

Source: Ycharts

Conclusion

With the company delivering a solid quarterly report, selling new products and beating the expectation of market analysis, the current valuation of Carbon Black does not seem logical. The company trades at 4.6x forward sales, which seems too low. Comparison with other peers shows that Carbon Black could easily trade at 5x or 6x forward sales. With that, short sellers seem to be operating on the stock, which may be pushing the share price down. As they close their positions, the price may creep up in the future.

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.