Should You Buy LogMeIn as It Plunges on Weak Guidance?

The last time I wrote about LogMeIn Inc. (LOGM, Financial), it was flying high at $117. The Massachusetts-based unified communication company has lost 33% of its market capitalization since then.

The bear thesis was based on the argument that LogMeIn can’t keep up with lofty growth expectations set by Wall Street as the growth in unified communication, collaboration and identity management industry are not that rosy. Due to high growth expectations, the market was paying a premium on the stock price. Consequently, the stock plunged more than 25% on Thursday as the company gave a hint of slowdown in growth in revenue and earnings. Now that the company has lost a good chunk of its market value, it’s time to revisit the bear thesis.

How were the quarterly results?

LogMeIn reported the results of its second quarter on Thursday, beating the top line and bottom line consensus. Revenue grew 15% year-over-year to reach $307.1 million during the quarter. Earnings per share came ahead of analysts’ consensus to reach $1.32, up an astonishing 30%. Regardless, the market is punishing LogMeIn for weak guidance for fiscal 2018 as the company expects midpoint revenue of $1.19 billion for the year, slightly below the analysts’ consensus of $1.22 billion. Earnings per share are also expected to fall behind the Street’s consensus of $5.27.

What’s the outlook?

“While we expect isolated headwinds in the second half of the year, we continue to be pleased with the trajectory of our long-term growth drivers—Unified Communications, Digital Engagement and Identity—all of which accelerated in the quarter,” noted Bill Wagner, president and CEO of LogMeIn, in the earnings press release.

The company is expecting a slowdown in growth during the second half of 2018. LogMeIn now expects its top line to register a 16.6% growth rate during 2018 as opposed to 18% growth expected earlier. Increasing competition from the likes of Microsoft (MSFT, Financial) and Cisco (CSCO, Financial) might be the reason of the potential slowdown in growth.

According to Gartner magic quadrant, Cisco and Microsoft are among the leaders of unified communication players; LogMeIn isn’t on the list.

It can be seen that LogMeIn is also not on the leading quadrant for meeting solutions. Although Gartner puts LogMeIn in the challenger position, the company lags behind four major providers of meeting solutions. Further, LogMeIn couldn’t make it to the Gartner’s 2018 magic quadrant of identity and access. As the company generated 29% of its revenue from identity and access during the first half of 2018, rising competition in this area can pressure LogMeIn’s top line going forward.

All in all, LogMeIn is facing competition from seasoned technology companies in both collaboration and communication, and identity and access segment, which doesn’t bode well for revenue growth in upcoming quarters.

What’s the thesis?

LogMeIn should be avoided for a couple of reasons including rising competition and amortization concerns. The situation of competition is evident from Gartner’s magic quadrant and management’s own comments about “isolated headwinds” during the next few quarters.

Apart from competition, amortization is a big issue as far as value of LogMeIn is concerned. The company reported amortization expense of $66 million during the second quarter of 2018, making up more than 90% of the non-GAAP net income. The inclusion of amortization expenses would have reduced the earnings per share to as low as about 15 cents during the second quarter of 2018.

Classification of amortization expeses, LogMeIn, Q2 2018

As Wall Street is fixated on non-GAAP numbers, their valuation models are driving an inflated stock price for LogMeIn. LogMeIn is a software company, so recognition of intangible-amortization is one of the key factors in determining the true value of such a company. When Wall Street says that LogMeIn is expected to report more than $5 per share in earnings during 2018, amortization expense is excluded. In other words, adjusted GAAP earnings are more appropriate for calculating LogMeIn’s fair value.

After accounting for amortization and assuming 15% growth in earnings during the next five years, the stock seems to be priced for perfection. See the valuation sheet below.

Bottom line

Although LogMeIn posted healthy growth during the quarter, increasing competition and very high amortization costs make the stock an unattractive investment proposition despite the recent plunge in share price.

Disclosure: I have no position in any stocks mentioned and no plans to initiate any positions in the next 72 hours.