Description

Investment Thesis

Care.com (CRCM) is attractive due to its recent 30% decline stemming from reputational concerns that have little impact on its underlying business fundamentals. Over the next year I believe Care has 25-40% upside in a base case given its historical valuation ranges, while over the longer term, its position as a top player in an underserved marketplace could merit a premium valuation in line with other leading online marketplace companies.

The Situation

On March 8th, the WSJ published an investigative piece questioning Care.com’s background check process for caregivers, which was then followed up by a March 31st report that uncovered thousands of unverified listings for its day care centers. Over the past month, numerous media outlets jumped on the headline-grabbing opportunity and with securities class action lawsuits filed against the company, shares are off 30% from March 8th and 36% from the 52-week high.

There have been nine incidents over the past six years where caregivers with criminal records were listed on Care.com and later accused of committing a crime while caring for children or elderly people. There have also been numerous instances of unverified or unlicensed day care centers listed on the site. Although the incidents involving children are terrible and unimaginable (but nothing new), Care has clearly stated that families who want a more granular, employment-level background check will have to pay extra. Care performs a preliminary screening using multiple criminal databases, and although it is unacceptable harmful people bypassed this stage, I believe the company is in the process of adequately correcting its past mistakes.

Care’s March 11th 8-K stated that the company implemented new oversight processes for caregiver accounts and disclosed the removal of 10% of caregiver accounts over several quarters based on preliminary screening results. The 8-K filed on April 1st noted that all unverified day care center listings were removed, representing 45% of total day care centers. On the surface, losing 10% of caregiver profiles and 45% of daycare centers seems like a big deal, but the revenue associated with all daycare centers represents only .5% of total revenue, while caregiver profiles can differ in quality and revenue impact.

Investment Highlights

• Trades at 33% discount based on 2019E FCF yield with conservative revenue growth assumption.

• P/S: 17% discount based on 2019E revenues.

• Best-in-class platform with improving unit economics and favorable secular tailwinds.

• Churn remains flat but ROI, length of paid time (LOPT), and customer acquisition costs (CAC) are improving.

• Low penetration of current market represents significant growth opportunity, especially in senior care given age demographics.

• Top company in large, fragmented marketplace with no publicly-traded peers.

• Diversifying revenue mix through Care@Work’s corporate partnerships.

• Investments across senior care verticals should add to growth story.

• Executive Officers and Directors own 28% of the stock.

• CEO has 112.5K options with exercise price of $21.03.

LTM Margins Over Time:

Business Overview

Care.com is the world’s largest online marketplace for managed family care, running a network of 18.3 million families and 13.4 million caregivers, spanning more than 20 countries (~10% of revenue). The company helps families address care needs such as childcare, senior care, special needs care, and other non-medical family care needs across four service lines.

Business-to-Consumer:

• Consumer Matching: Provides subscribers (caregivers) with network of care providers (employers).

• Competitors: UrbanSitter and SitterCity

• Removed caregiver accounts fall into this service line.

• Payment Solutions: Payroll processing and tax preparation services for nannies, housekeepers, and other household employees.

Business-to-Business:

• Care@Work: Employer-sponsored program for employees seeking matching solutions, on-demand back-up care services, and consumer payment solutions.

• Fastest growing service offering and primary driver of shifting revenue mix.

• Recruiting and Marketing Solutions: Serves small-to-medium sized businesses such as day care centers, nanny agencies, and home care agencies.

• Removed daycare centers fall into this service line.

What the Market is Missing:

One can make many assumptions on what will happen to Care’s user base as well as its growth, but given disclosures from the two most recent 8-Ks, it is apparent that the sell-off was a massive overreaction.

Many profiles on the site are non-paying and add little to the bottom line beyond immaterial marketing revenue. Given the recent news and steep slide in share price, and even when using the most conservative assumptions, the market’s reaction was unwarranted. In the above impact analysis I assume that at a minimum, caregiver accounts have a 50% impact on paying families. A closer look at Care.com’s statistics shows that only 1.8% of the 18.3M families/members are paying members (Q4 2018). If one were to assume a similar dormant rate for caregiver accounts, the share price impact would be much lower.

Despite recent image problems for Care.com, its website still seems like the clear-cut leader in the space. By searching around on some well-known parenting websites, I can see that Main Street has a more optimistic view compared to the investors who sold off after March 8th. Searches on Parents.com, Babble, Alpha Mom, All For the Boys, Baby Center, Fatherly and Bundoo yielded zero negative articles about Care.com, while Mother.ly had one article about Care.com’s recent background screening issues. Additionally, it appears the post-article hype is beginning to fade.

Google Trends - “Care.com WSJ”

In addition to the caregiver and childcare issues, BestBuy suspended its Care@Work partnership and is currently weighing its options. The sell-side has picked up on this development, but the caregivers in the Care@Work segment represent Care.com employees who are internally screened by the company. While other companies could potentially sever ties with Care.com, this seems unlikely given we are almost two months away from when the negative news flow began circulating.

Customer Matching Competitors:

The consumer matching space--aligning families with caregivers--is fragmented but has some larger competitors such as Sittercity and UrbanSitter. Despite the negative headlines, Care.com has greater search activity than its competitors. Care.com’s app is ranked #78 under the Lifestyle category on the App Store and carries a 4.6 rating from 34.8K reviews. In comparison, Sittercity has the same rating as Care.com but half the reviews, while UrbanSitter carries a 4.8 rating with only 5.4K reviews.

It is also worth noting that its competitors have dealt with similar issues in the past:

• https://www.nbcchicago.com/investigations/unit-5-babysitter-background-checks-179041071.html

• https://www.sfgate.com/news/bayarea/article/Former-Teacher-Arrested-On-Suspicion-Of-Lewd-Acts-12970470.php

Google Trends

Business-Level Value Drivers:

Average revenue per user (ARPU) has been flat but improvement in LOPT and CAC is boosting ROI despite stagnant churn. While paying families as a % of total families has been in steady decline, opportunity through penetration of current addressable market remains.

Valuation

Based on a blend of FCF yield and Care’s historical EV/Sales multiple ranges, showing upside of 25-40% over the next year.

Assumptions

• 2019E: Revenue projection of $206M, conservative given management’s guidance of $217-$221.

• Management’s past revenue guidance has proven to be a solid proxy.

• Free Cash Flow Yield: trailing four-quarter average

Key Risks

• Integration challenges in senior care investments

• Additional bad press

• Termination of Care@Work partnerships

• Churn

• Ongoing securities class action lawsuits

Catalyst

• Q1 and Q2 earnings show minimal financial impact from recent news.

• Announcement of new Care@Work partnerships.

• Or alternatively, concerns fade regarding potential partnership terminations (e.g. BestBuy).

• Buybacks through strong cash position.

• Continued investment in senior care growth adds free cash flow and/or portends increased attention.