Description

Ticker: GSB

Price: $3.40

Shares Outstanding: 21.2M

Options Outstanding: 2.0M @ $2.12 average strike

Market Cap: $72.1M

Cash: $5.1M (net of $15.2M of deferred revenue)

Debt: $0

Enterprise Value: $67.0M

Overview

In our hyperconnected world, the need for data security is integral for the protection of people and organizations.  This has been exemplified as recently as last Friday’s hacks of major websites.  We believe GlobalSCAPE offers a way to invest in the continued importance of data protection through a company that is cash generative, well capitalized, and trades at a compelling valuation.

As a standalone company, we think GSB is worth 70-100% over current prices within three years under a conservative set of assumptions.  There are also several large strategic buyers who would pay a greater premium to acquire GSB’s industry-leading product set and strip out the public company costs. Andreas posted this idea nearly three years ago, and directionally he telegraphed many of the trends in the business.  We urge readers to review his write-up and the evolution of the business since then, but we will also fill in the gaps.  Since Andreas wrote up GSB at $2.40, the following has changed:

-        LTM revenues have grown 30% to $31.8M

-        Cash balance has grown from $11.4M to $20.3M

-        GSB is on its third CEO in as many years – Craig Robinson died in September 2013 after six months on the job and his replacement, James Bindseil, was succeeded by Matt Goulet in May of this year without much explanation

-        The company instituted a small dividend and currently has a yield of 1.8%

-        There is a heightened awareness of data security from high visibility breaches (DNC, NSA, podesta, powell, Target etc)

-        They have recently re-focused on their core managed file transfer (MFT) business

At an enterprise value of $67M, coupled with significant cash generation and a growing end market, this investment offers slightly less upside that when originally posted, but with substantially less risk and greater visibility.

The Business and Industry

At the core of GlobalSCAPE’s business is Managed File Transfer (MFT), which involves moving data from point A to point B in a highly secure and largely automated fashion.  An example of this would be PayPal uploading its ACH transfer files to its partner banks, and the bank then sending back the resulting files.  We use this example because PayPal is an actual customer, along with other high profiles organizations such as JP Morgan, Getty Images and the US Army.  We like that GSB continually grows its impressive customer base while retaining its current clients at a 90%+ rate.

MFT is a $1B market, with IBM serving as the leader with a 35% market share that they have bought through acquisition.  GSB is the only pure play public company in the space and has a 3% market share.  GSB is able to compete with the likes of IBM because they (1) have the best feature set with the most functionality and (2) have the most flexible offering that allows for hybrid cloud/on premise solution.

We also like that MFT is a very small part of their customers’ budget, especially when you consider the cost of a potential breach.  With purchasing decisions made more on quality than price and high switching costs, you have a dynamic where the incumbent enjoys both pricing power and high retention rates.

We suggest you look at their corporate presentation, which provides a great overview of their products, the industry, their customers, and the product roadmap/strategy.

http://dynamic.globalscape.com/files/globalscape-CorporatePresentation-072816.pdf

Recent Developments

Matt Goulet was promoted from COO to CEO in May 2016 and has been with the company about a year and a half.  His first priority has been to implement a strategic re-focusing on their MFT products as the company had been diverting a disproportionate amount of resources to their other data security verticals.  We believe this is rational as MFT is where GSB earns 90% of its revenue and has been building its reputation for over 15 years.  With only 3% of a $1B market, there is plenty of growth to be had by improving and selling this product set.

Valuation

In 2015, GSB earned $30.8M of revenue with $6.4M of EBIT, a 21% margin.  Management has guided to 15% growth in 2016 with similar margins, numbers which they reiterated on their second quarter call despite trailing those targets YTD.  If they hit their 2016 projections that will be $35.4M of revenue and $7.4M of EBIT.  Let’s conservatively assume they are able to grow top line at 5% in 2017 - 2019, and grow EBIT margins to 25% over that time.  That gives us 2019 revenue of $41M and EBIT of $10.3M versus a current enterprise value of $67M.  Under this assumption set, the table below assigns a 2019 value at a range of EBIT multiples. We back out the deferred revenue from the cash balances.  

We believe a growing company in a high-profile market, with high margin recurring revenues, will warrant an EBIT multiple of 10-13x as a standalone business.  To a strategic buyer who could strip out public company costs, we could see this being purchased at a premium to these multiples.

Summary

GlobalSCAPE provides mission-critical software in a large and growing space.  With security breaches on the rise, we expect a growing stream of high-margin revenues/earnings that are protected by a 90%+ renewal rate.  With a renewed focus on their core products, we believe the company is poised to grow revenues, widen its moat, and cement its leadership in the space.

GSB boasts a pristine balance sheet and tremendous revenue visibility in an industry that is largely immune to economic cycles.  These factors and many others make the company an ideal target to a strategic or financial buyer.  We believe there is very little risk of permanent impairment to the franchise and the current valuation provides the prospect of an attractive investment given the risk profile.

Risks and Other Considerations

-        The biggest risk we foresee is the company making a bad acquisition, something they have done in the past under previous management.  There has been much discussion of making a purchase on earnings calls, but nothing concrete.  Management is keen in reinvesting in the business, and we hope their eagerness will not cause them to reach for an acquisition that is a poor fit in terms of product set and/or price.

-        A failure of their product could be catastrophic given the premier customers.

-        The CEO turnover is a concern.

-        Chairman Thomas Brown owns 26% of the company, which he acquired in 2002.  He has a lot of control as the Chairman and largest shareholder, but everything points to him being rational and acting in the best interest of shareholders.

-        We think the CFO is excellent.

Catalyst

the cash printing press

Data security valuations and consolidation