At The Right Price, McAfee Is A 'Buy'

Summary

• I've taken some time to look at the company McAfee, a well-known global computer security software business out of San Jose, CA.
• The company has been through multiple iterations over the past 30 years but now trades as a JV with a 49% stake maintained by Intel.
• I believe that at the right price, this business is a must-own.
• While a "HOLD" today, I'm waiting for a good entry - and I'll show you at what price.

Michael Vi/iStock Editorial via Getty Images

In this article, it's time to look at a software company - namely McAfee (NASDAQ:MCFE). The company hasn't been listed on the stock market as its own company for very long. This complicates the thesis somewhat. However, in this article, I will show you why I consider this to be a good business worth investing in.

At least, it's worth investing in at the right price - which I will try to establish here.

McAfee Corp. - What does the company do?

The McAfee Corp. was known as McAfee Associates until 2014 and Intel Security Group until 2017. Following a strategic deal between Intel (INTC) and TPG Capital, the two companies converted it into a JV, with Intel, as mentioned, maintained a near-majority stake in MCFE.

The company raised $740M in an IPO around a year ago, and the company was valued at circa $8.6B based on SO. This marked the return to the public market after 9 years of being part of Intel (among other things).

The company, as most readers probably know, is most known for developing security tools for computers, servers as well as mobile devices. The company's products include things like McAfee Total Protection, LiveDSafe, Safe Connect VPN, Gamer Security, Safe Family, VirusScan Enterprise, Small business security, and many more.

The company has been in the business for more than 30 years and is one of the most well-known and leading global companies in cybersecurity. The company targets a TAM of $30.4B as of 2020, and this market is expected to grow at a CAGR of 7.9%, reaching $41.2B in 2024.

According to Frost & Sullivan, the global consumer endpoint security market (comprised of endpoint protection and prevention and consumer privacy and identity protection) addressed by our solutions is expected to reach nearly $13.1 billion in 2020, growing to $18.7 billion in 2024. According to IDC, the addressable enterprise security market addressed by our solutions is expected to reach nearly $17.3 billion in 2020, growing at a CAGR of 6.9% through 2024. The "addressable enterprise security market" represents revenue from five markets (Web Security, SIEM, Network Security, Corporate Endpoint, and Data Loss Protection).

(Source: McAfee)

The company's brand recognition in the consumer segment makes for an automatic appeal here, and the company has an experienced management team. MCFE already has complete/holistic solutions for both customer segment needs, and the company has already established its services and products across IoT and mobile devices.

MCFE targets a combined organic growth model together with appealing inorganic M/A targets to expand its business.

The company's sales are omnichannel-based. For consumers, most sales are through digitally-led approaches to reach consumers, as well as preinstalling software on OEM devices, trying to retain the consumers when trials expire. The company also works with mobile providers, ISP's, electronic retailers, e-commerce sites, and search providers. The omnichannel marketing approach is the company's bread and butter for the consumer segment.

Enterprise sales, meanwhile, are usually made and serviced through dedicated field sales teams, and sales use a mix of modern digital marketing and traditional personal marketing approaches.

COVID-19 has seen positive net effects for the company's sales and demand for products, in particular in the consumer business - though the company currently cannot determine what part of growth or revenue expansion comes from these impacts.

The company has employees across the entire world.

(Source: MCFE, 10-k)

The company's organizational/reporting structure consists of two simple segments- consumer and enterprise - or at least it did up until the middle or so of 2021, when MCFE announced the sale of the enterprise segment. Because of the way the company and services are structured, a significant portion of company OpEx is allocated from shared resources based on utilization from either segment. The two segments are of very similar size in terms of revenues, but the Enterprise segment operates at a loss.

(Source: MCFE)

The sale of the enterprise segment, announced in early/mid-2021 is a benefit to the company long-term, as I see it.

The company has achieved positive operating income, as well as Adjusted EBITDA. The company measures part of its success through subscriber numbers - and MCFE ended FY20 with 18 million Core DTC subscribers, adding around 2.8M subs on a YoY, and over 650,000 on a sequential basis from 3Q20. 4Q20 marked the 13th consecutive quarter of sequential Core DTC subscriber growth. To put it simply, people want the company's solutions.

MCFE also managed a consumer TTM retention rate of 100% for the 4Q20 quarter, vs 97% on a YoY basis. All in all, those are truly excellent numbers and showcase the company's competitive advantages and product trust. The company's consumer business is mostly a sub-based model, with 85% or above of TTM revenue coming from subs for the last two years.

Enterprise, meanwhile, generated 75% of revenues from a recurring revenue model with most contracts (80%+) from contracts with a value of over $100,000. These Core Direct to Consumer and retention numbers represent key operating metrics for MCFE.

So, that is McAfee. A company selling cybersecurity solutions and suites to consumers - and no longer enterprises - and doing so successfully.

Fundamentally speaking, the company has a debt level of around $5B, with around $4B of that being long-term debt, but over 99% of that debt is due in 2024, which gives the company plenty of time for refinancing and planning.

MCFE currently carries a yield of almost 2% and an earnings yield of around 5%. The company has no S&P credit rating, and little history to base things upon given its relative freshness on the market.

Let's look at recent results.

McAfee Corp. - How has the company been doing?

The company's core subscriber base growth is accelerating, with interest in cybersecurity solutions increasing. This has led to the following trends for MCFE.

• Double-digit YoY revenue growth, coming in at $467M for the quarter, annualizing nearly at $2B in revenue.
• $218M of adjusted EBITDA, coming in at a very impressive growth of 38% YoY.
• 17% core DTC subscriber growth, now closing in on the 20M subscriber mark.

Current consumer trends are a strong tailwind to MCFE.

(Source: McAfee)

This quarter marks the 15th straight quarter of Core DTC subscriber growth, and a dollar retention rate of 100%. Relatively new areas of personal protection products add to the company's revenues and interest in company products.

Underlying numbers are very convincing.

(Source: McAfee)

There is also little doubt in my mind that the company will be able to continue to grow. The company has nearly half a billion worth of cash/equivalents as of 2Q21, and a 62% YoY increase in company cash flow.

Unlevered FCF is also up 29%, and the company decided on a 0.115/ share dividend during the quarter, creating a yield of nearly 2% at today's price. It's not "bad" for the sector overall, but nor is it at the top.

The company has given us financial guidance for 3Q21, which comes to very similar numbers to 2Q21.

(Source: MCFE)

For the time being, we can see MCFE as a company that's able to generate upwards of $1.8-2B in revenues and $700-800M in adj EBITDA per year, coming to an adj EBITDA margin of 35-38% or thereabouts - which is pretty impressive. The company has also given us an FY21 outlook.

(Source: MCFE)

So, big news for the year is the divestment of enterprise during 1Q21/2Q21 - and these are in my mind, positives for the company's long-term potential.

The company offers investors several moats and advantages, even following this development. They include brand recognition, team experience, customer base quality, and breadth of product offering.

While competitors exist - everything from Microsoft (MSFT) and NortonLifeLock (NLOK), as well as newer companies such as CrowdStrike (NASDAQ:CRWD) and others - MCFE, has obvious love and respect for its products, underbuilt by extremely strong customer retention and growth. The company's products are priced very humanely, with family subscriptions up to 10 devices being no more than $3-$4/month, something I believe most customers feel they're able to spend on security.

Results being good and forecasts being positive, I very much feel that this validates the company's expectations of forward growth and customer retention. Given the current metrics and historical numbers, I believe the company's forward trajectory to be positive. The company slashing enterprise solutions really showed that MCFE is willing even to divest important segments to grow into the sort of company they want/need to be.

Overall, and despite the limited length of the current listing, my forward outlook on MCFE is one I share with the company - and it's positive.

McAfee Corp. - What's the valuation?

Now we move into valuation, and here things get somewhat trickier. The divestment of enterprise and the number of currently moving parts in the company make valuing this business somewhat tricky. Over the course of about a year, we've seen plenty of volatility and instability, the latest of which we're currently seeing. Some people may call the company undervalued or buyable at this juncture or this price, but I'm not so sure I would agree with that assessment.

The company currently trades at an average P/E of 21.64 - but even if we look at 2023E earnings, which are expected to grow significantly to an EPS of $1.52 compared to 0.94/share, the company is just below fair-value P/E 15X today. On an estimated 2021E forecast, the company currently trades above 20X. For a company with no credit rating, 2% dividend and little history to show for it, that's a bit high for my taste.

Based on current estimates, investing today and basing it on a 15X P/E, 2023E total returns would be around 6.6%, or 2.89% per year.

(Source: F.A.S.T. Graphs)

You will note that these estimates are actually including some fairly positive growth estimates, and even with those estimates, we get these sorts of numbers. The company is currently estimated to drop revenues 36% in 2021, followed by 11% revenue growth in 2022, coming to a 4-year CAGR of around negative 7.8%. In short, it will take time for MCFE to right itself following the revenue and EPS drop this year. Dividend growth is expected to be moderate/high, at around $0.46/share for 2022E, coming to 2.1% dividend on the current share price - again, not something I consider an argument that would entice me to buy the stock at this price.

The company has some truly impressive fundamentals, margins, income numbers, subscriber numbers, and future potential - but the very simple fact is that at today's price, you're paying a premium to any income level prior to the 2022-2023E. That's quite a long time to have your money invested at expensive levels, not to mention the risk that something may occur in the interim that could push valuation levels below to where your returns would be negative.

Those of you who follow my work know that I'm hesitant to invest in uncertainty, even if the prospects are good because to me investing in the market is very much a comparative/relational thing. By that, I mean that any investment that's considered must be considered compared or in relation to other investments available on the market. If company A offers 15-20% annual growth with a very well-covered dividend, you'd need some very good reasons to invest in a company that offers an uncertain 6-10% annual return with a lower yield and no history.

Too many investors are poorly served by advice or considerations where they invest in things with rather sub-par return potential, while rarely even considering what they could have gotten if they'd simply looked at the broader market for safer alternatives.

In that sense, MCFE certainly is not a "BUY" here.

I would consider it a "BUY" at around $15-16/share, though it's questionable whether the company will trade so low simply because this year and possibly the next year are only going to be somewhat negative or flat years. It might not - and in that case, you wouldn't be able to pick the company up cheaper than you're seeing it today. However, that's really a risk you have to take sometimes.

You have to be able to say and to miss out, on a company that's too expensive even though it might really not get much cheaper, because the potential total RoR is simply too low.

In the same way, you have to have the conviction to really put capital to work when that price is low enough, and usually go against the grain of the broader market.

This is not something most investors are comfortable doing - but it's the core of my strategy.

So while I wish I could tell you that MCFE is buyable today, I don't see it that way. I wouldn't pay more than $16/share at most for the company today, despite the upside and quality that I see. That represents a price level that is significantly below the target stock price low currently maintained by 8 S&P Global analysts for MCFE, where the average comes in at around $29.88/share. (Source: S&P Global).

However, even if that price level became realized by 2023, the resulting total RoR of 37.63% and total annual RoR of 15.29% under such estimates, are significantly less than I'm currently forecasting to get from several other investments I'm making. I'm not saying these are bad returns - I'm saying that I can get better at:

• Cheaper prices
• Better valuations
• Higher yields
• Safer histories/credit ratings

That, to me, is key.

So, as of right now, I consider MCFE a "HOLD" with a $16 fair value price target.

Thesis

My thesis for MCFE is:

• It's a qualitative, excellent company in the cybersecurity space. It has an excellent business model, moat and will likely see significant forward subscriber and business growth, making for a very appealing potential prospect.
• However, returns are hampered by poor valuation and 2021-2022E return levels, which are negative YoY or flat.
• For what we're seeing for these years, the risk and the price that the market is asking us to pay for this is too high.
• Because of this, MCFE is a "HOLD" here.

Remember, I'm all about:

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

This process has allowed me to triple my net worth in less than 7 years - and that is all I intend to continue doing (even if I don't expect the same rates of return for the next few years).

If you're interested in significantly higher returns, then I'm probably not for you. If you're interested in 10% yields, I'm not for you either.

If you however want to grow your money conservatively, safely and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.

MCFE is currently a "HOLD" due to overvaluation.

Thank you for reading.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of INTC either through stock ownership, options, or other derivatives. 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.

While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment, and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding of the necessary risk tolerance involved. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles. I own the Canadian tickers of all Canadian stocks I write about.