Seeking Alpha

Care.Com Is A Take-Over Target At An Attractive Valuation

|
About: Care.com, Inc. (CRCM), Includes: ANGI, IAC
by: Brecht Hanssens
Summary

The stock is trading at a compelling value because of a scandal reported by the WSJ earlier this year. It has lost more than 60% of its value since then.

The operational business seems to be intact, even with more spending on R&D and other expenses to make sure the platform is safe to use. The company is not profitable.

The CFO and CEO have resigned from their positions after the scandal, with no permanent replacement being found.

This and other facts signals a sale could be imminent. If this comes to fruition, activist shareholders say there is at least 40% upside in the stock.

The calculation of the activist, Engine Capital, is very well though out and seems even prudent to me. When an acquirer shops around, it will likely pay a premium to the sales multiple because of the type of transaction: it's about land grabbing, not profits.

Introduction of Care.com

Care.com (CRCM) is an online caregiver platform valued at 325 million dollars. I say healthcare, but it's actually more than that. It's a classic platform business model. Care.com matches suppliers of care services (nanny, nurse, dog sitter) with people looking for one.

The company claims to have 19.8 million families and 14.3 million caregivers on the platform.

The marketplace for family care is going through a rough patch. After a WSJ article claimed there were not enough security checks on the providers on the platform, Care.com take a major hit to its reputation. This is bad in and of itself, but it's particularly bad when your business depends on very high levels of trust and a lot of word-of-mouth.

Reaching people which might be interested in using the platform becomes more expensive, while it's also harder to convert this group into actually paying customers. It's a double-whammy.

A typical land grab situation

Care.com has focused, as any platform business, on volume and revenue. Profitability is not to be expected any time soon, but this doesn't mean there has been no value created.

Revenues have been rising every year, with the growth rate from 2017 versus 2018 was a decent 10%.

Source: Care.com

If we take a look at the latest earnings report, we see that revenue is still growing at a 10% clip, even with the disastrous WSJ article (more on this later).

However, the company hasn't been able to translate this revenue growth into profits. Cost of revenue grew nearly 40%. Cost of revenue in 2018 was 21% of total revenue, while in 2019 it's 26%. Not very encouraging.

Source: Care.com Q2 results

Moreover, the company has invested heavily into R&D with the budget nearly doubling from 8.5 million USD to 16.9 million USD. This is explained by two factors:

1. More investments into automated background checks

2. More investments into new products and services, i.e. on the B2B side (Care@home)

All-in-all, a platform internet business like this is rarely valued on profits, but more often on a sales multiple.

This is likely a major reason why investors don't care (that much) about the profitability today. The company itself says it is able to get a x4.9 return on investment when acquiring new customers.

The lifetime value (on a gross profit basis) amounts to $498, while the company spends $102 on average to acquire a new customer.

Source: Care.com Q2 results

The company is reinvesting all the cash into building out a strong and loyal user base: a typical land grab.

Risks to the business

There are some major risks to owning Care.com.

1. The metrics are a bit 'fishy'

The first and foremost risk is that a bunch of investors don't trust the numbers. For example, one contributor on Seeking Alpha noted in a comment on an earlier article that the 30+ million 'members' are simply anyone who has provided an email address since inception of the business.

It would definitely pay off to see the company report on 'monthly active users' or 'paid subscribers'. It is indeed striking that the company does not report these typical metrics, including user retention, churn, etc.

2. The CEO and CFO have left

This is closely tied to the above of course, but the company needs new leadership. The CFO resigned in August after the WSJ scandal, and the CEO stepped down as well but is the executive chairwoman.

3. Reputational risk

As a Belgian proverb says: 'Trust arrives walking and leaves on a horseback'. This is particularly true in the healthcare space, where you are looking for someone to take care of your loved ones such as your kids, elderly or pets.

The Wall Street Journal had discovered that some caregivers were not officially registered some even had a criminal record. Since then, the stock has plummeted. Not only has it scared of investors, it also has a real effect on the operational business: increasing costs and lower revenues.

4. Too old, too slow?

When I read about what happened, I was a bit shocked. Nowadays, there are so many tools at our disposal to do automated screening and background checks. Some banks even allow you to sign up by taking a selfie and providing some ID.

It seems easy to hook-up an API to different databases, encourage users to vet each other, or to ask for official documents when signing up.

This signals to me that the technology is probably not the best, or the most scalable. The company launched in 2006, so it remains to be seen whether everything in the back is running very smoothly.

Similarly, the website itself does not have the most modern look and feel.

5 reasons why Care.com is still a buy

Investing is inherently risky. You always take a degree of risk. It's about getting the best risk-adjusted returns. Maybe Care.com is still a good buy, just because of its potential?

Here are 5 reasons why Care.com is still a buy.

The strong balance sheet

Care.com has a decent balance sheet.

Source: Care.com Q2 results

The company has 89.5 million USD in cash and an additional $53.5 million USD in current assets. It only has $78 million USD in liabilities, with a big part being deferred revenue ($24 million USD).

This means the company has the means to put some cash to work on long-term improvements such as technology, background checks, and even deploy it in new business areas.

The turnaround potential

The company had some rough months, which means if it's able to turn around the company, the comps will be a lot better. Year-over-year the revenue growth can really stand out if they manage to get over the reputational damage.

New leadership can approach the company with a fresh mind and it might be easier to take some difficult decisions in this new context. Also, it makes the company really think about the strategy moving forward.

A newer part of the business Care@Work is seeing strong revenue growth. It was only launched in 2016. Over the first two quarters of 2019, it brought in 25.2 million USD in revenue. Extrapolating, we get to $50+ million USD for the full year. This would be a 15% increase from last year.

The huge (and growing) market potential

The market for caregivers is big and growing. The company estimates the total caregiver market to be worth $336 billion for the United States alone.

More and more baby-boomers are nearing an age where they might need some help. At the same time, there's a growing demand for daycare and babysitters from young families.

Having a seat on the supply side of caregivers (meaning, delighting the caregivers to use your platform) and being able to take payments over their platform, can be a huge opportunity over time.

The beaten-down valuation

The company has a total market cap of $336 million. If it manages to grow revenue by 12%, as is expected, full year revenue will be $215 million. Finding a platform trading only x1.56 sales is quite difficult.

In fact, a similar platform ANGI Homeservices (which I have written about) trades at x3 sales. This platform matches service professionals with people in need of home services.

Uber's full year revenue is expected to be around $13 billion and it's trading at $49 billion (that's around x3.7 revenue).

I know, this is not a perfect comparison, but anything below x2 sales in this kind of business looks pretty cheap to me. If we subtract the nearly $90 million in cash sitting on the balance sheet, you can purchase the company for only x1.14 revenue.

I would think the business should trade around x2 forward revenue in this situation meaning the business is worth $430 million and add the $90 million in cash to come up with a $520 million buy-out price.

The acquisition opportunity

This brings us to the final point: the company is a perfect take-over target for bigger companies. It's cheap, it has operations in place. Experienced companies such as IAC InteractiveCorp (IAC) seem to be a natural suitor. I have written about IAC before: the owner of ANGI Homeservices, Match.com, and many other private businesses.

The technology, experience and financial power a bigger company like this brings to the table, can be a game changer.

Moreover, the lack of permanent CEO and CFO can be an indication that the company is indeed in talks with companies to make a sale. To finish it off, an activist shareholder Engine Capital wrote an open letter to the board proposing the idea of a sale. Back in August, it wrote the company could be worth $14 to $19,4 per share. Today the company trades at $10 per share. This means the lower-bound upside is 40% and the midpoint is 67% upside.

Conclusion

While there are big risks associated with Care.com, on different levels, I believe the market is pricing in these risks by too much. If the issues are temporary, the company should trade at x2 revenue at least, which means the share price should increase by 140% to $24 (when including the cash on balance). Far more intelligent investors like Engine Capital claim the company could be sold, today, incorporating all these risks, for an average of $16.7 dollar per share. This represents a 67% upside, taking back the company near numbers seen before the Wall Street Journal scandal.

Disclosure: I am/we are long CRCM, ANGI, IAC. 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.