Description

For those who like smaller capitalization tech.  After I wrote up Micron, i got inspired to write again. 

Logmein (LOGM) is a deep value investment with significant upside (60% - 100%) but with the appeal of a recurring SAAS (software as a service) based business model.  LOGM provides cloud-based collaboration, IT management, and customer service offerings aimed at addressing the requirements of the evolving mobile workspace, primarily for small and medium sized businesses. LOGM is composed of two distinct businesses: 1) Remote Monitoring and Customer Care (RMCC), a subscription-based, high margin and stable free cash flow business growing steadily and 2) Access and Collaboration (A&C), a high growth business selling newer products but generating operating losses.   Valuing the A&C business at only 1x sales (well below a reasonable valuation level, as we will describe later), implies the core business, which is growing revenues in the high single digits, is currently being valued at 5x EBITDA, with a greater than 10% FCF yield.  In addition, the current enterprise value is equal to a reported bid from Citrix pre-IPO in 2008 (at least $200mm, per CFO Kelliher’s testimony).  Logmein has close to $8.50 a share in cash, or slightly less than 50% of its market capitalization. 

LOGM products are well regarded.  Follow the below links to see some reviews of their key product offerings:

Cubby: http://www.pcmag.com/article2/0,2817,2412716,00.asp

LogMeIn Pro: http://www.pcadvisor.co.uk/reviews/software/3355239/logmein-pro-review/

Join.me: http://www.pcadvisor.co.uk/reviews/internet/3237142/joinme-review/ ; http://reviews.cnet.com/8301-19512_7-20032134-233.html#ixzz1LwUsfDRe ; http://www.pcmag.com/article2/0,2817,2385148,00.asp

Logmein Central: http://www.pcmag.com/article2/0,2817,2360730,00.asp

Logmein Rescue: http://community.spiceworks.com/product/11813-logmein-rescue

Recent Events –

LOGM provided 2013 guidance in February implying consolidated revenue growth of 12% (vs. 24% in 2012, excluding a one-time change in go to market strategy for a product called Ignition, which became a free product in 2012). LOGM attributed the decelerating revenue growth to its core remote monitoring and customer care business to slower adoption of its mobile support products in its Rescue line, which provides remote support functionality. In addition, LOGM guided non-GAAP operating margins of ~15% vs. 20% in 2012, and attributed the compression to increased selling and marketing spend on its fast-growing A&C business (primarily its online collaboration product, join.me, and its cloud storage product, Cubby, launched at the beginning of 2013). These investments generate attractive lifetime unit economics (with 80% renewal rates) but negative margins in year 1, due to COCA recognized up front and revenues recognized over the life of the contract (and subsequent renewals), with gross margins >90% over time.

 A patent dispute between LOGM and 01 Communique has been a long term overhang on LOGM but ws finally resolved through a jury trial inVirginia, earlier this year.  The jury found LOGM to not infringe on the 01 patent.  Despite a move higher after the trial verdict was announced, LOGM’s stock now trades close to its historic lows.

SOTP Analysis

Management does not do a good job laying out a sum-of-the-parts analysis as they still view themselves as a growth company.  However, it is clear that the  RMCC division generates more than 100% of LOGM’s EBITDA and FCF, while the A&C business is growing at a much faster rate (>20% in 2013 management guidance) but generating losses.  Our best guess is that current year guidance implies close to 40mm of ebitda for RMCC and -10mm for A&C.   For anyone interested in a detailed description of how we do our calculation, we will provide it as a message to this posting.  The RMCC business is projected to grow revenues at 10%, with 32% EBITDA margins, limited cap ex ($3-4mm), and $24mm of FCF. We believe this business should be valued at 10x – 12x EBITDA. Valuing the A&C business at only 1x sales (well below what we view as an appropriate valuation) implies the core business is currently valued at 5x EBITDA, or a greater than 10% FCF yield. Valuing  RMCC at 12x EBITDA and A&C at 3x sales implies upside of >75% at management’s guidance, which we view as conservative.   At a typical SAAS based multiple on the A&C business (5x revenues), the stock would be worth $35 or greater than 100% upside.

Why the reset numbers are attainable, and (hopefully) beatable

LOGM uses a freemium sales model where the company’s goal is to hook you on their products and then up-sell you to a fee based version.  As a result, LOGM has over 17mm current free users.  Over time, their goal is to penetrate this user base by forcing them to pay for services.   The price points for their services are typically at substantial discounts to their larger competitors. Recently, LOGM began to restrict certain features in some of its core free offerings to prevent commercial use of its products. On March 4, 2013, LOGM announced it was limiting LogMeIn Free to 10 computers per user, incenting commercial users to sign up for LogMeIn Central, at a cost of $199 /year. Assuming 10mm free users of this product, a conversion of an incremental .05 - 1% represents $10-20mm of annual revenues, at a 90% flow-through to operating income. We believe that this potential benefit was not included in management’s guidance, and have excluded it from our base case analysis. 

We believe there is potential upside in increasing customer acquisition rates, particularly in its join.me products.   With 7.5mm free users and conversion rates of only 2% (up from 1.5% a year ago), LOGM has significant headway to increase its conversion rate to its historical 5% rate.  Every 50 bps in conversion rate is 5-6mm with 90% incremental Margins.

Downside Protection

During the 01 Communique patent trial, LOGM CFO Kelliher testified that Citrix had made an offer that would “start with a 2”, clarifying he meant at least $200mm (source: court transcript):

Q. Do you know when Citrix and LogMeIn first began discussions

about a potential acquisition?

A. 2006. It would have been 2008. Sorry.

Q. Who at LogMeIn was involved in the discussions?

A. Myself, Mike Simon.

Q. Who at Citrix was involved in the discussion?

A. The only person I remember is their vice president of

business development, Mike Cristinziano.

Q. What kind of deal did the talks anticipate?

A. Their discussions were regarding an acquisition of -- of

LogMeIn by Citrix.

Q. Okay. How long did the discussions go on for?

A. Approximately two months, three months.

Q. Did you provide documents to Citrix?

A. I did.

Q. What documents did you provide?

A. We would have provided some financial reports, and we would

have provided a presentation of the company.

Q. Citrix was a direct competitor of LogMeIn, correct?

A. That is correct.

Q. At some point did LogMeIn come to have an impression of what Citrix might be willing to pay?

A. Yes.

Q. And what number did LogMeIn infer Citrix was looking for?

A. That it would start with -- to my knowledge, that it would

start with a two.

Q. Okay. 2 million, 200 million?

A. 200 million.

Q. Did LogMeIn consider that amount to be too small?

A. Yes.

Q. What number did LogMeIn feel would be appropriate?

A. To my knowledge, 400 to 500.

Thus, in 2008, Citrix made an offer of at least $200mm, vs. LOGM’s current EV of $216mm. In addition, Kelliher revealed that there were discussions with Cisco and Hewlett Packard prior to the IPO.

We believe that LOGM would still be an attractive acquisition candidate for these players (and others). LOGM’s proprietary Gravity data platform is the secret sauce that enables them to achieve gross margins of 90%, despite handling tens of millions of free users. These margins are best in class, and it does not appear as though the platform has been able to be duplicated. We believe that this platform could handle additional SaaS products from third parties (similar to Amazon Web Services hosting software services for third parties) but more safely and securely. It is difficult to place an exact value on the platform, but we believe just opening the platform to third party products could be worth tens of millions of dollars in additional revenue at 90% gross margins, significant upside not baked into our estimates.

We believe that at current valuation levels, LOGM’s operating performance has been substantially de-risked, given the valuation backstop from potential M&A and its proprietary gravity platform, implying limited downside from current share price. In addition, both the CEO and CFO have made significant share purchases at the current depressed levels following its 2013 guidance, showing their faith in and commitment to LOGM. As part of the fourth quarter earnings release, LOGM announced a $25mm share repurchase program.

Conclusion

We believe that LOGM represents a compelling risk/reward opportunity, given material upside in our SOTP analysis and limited downside given potential acquirers and its proprietary gravity platform. Following the jury’s judgment for LOGM in its patent trial with 01, we believe LOGM management can re-focus on growing the business profitably and demonstrating its underlying value to shareholders in what appears to be an attractive segment of the market. We think LOGM is a rare opportunity with 100% upside and limited downside, and therefore is a compelling opportunity for our fellow VIC members.

Catalyst