LogMeIn Inc. (LOGM, Financial) generates most of its revenue from identity and access management services followed by collaboration services. Collaboration revenue grew at 36% p.a. while access management witnessed 27% p.a. growth in revenue during 2014-2016.
The company monetizes its products primarily through annual subscription. Customers of the company include SMBs, IT service providers and consumers. It is worth mentioning that the annual renewal rate stood at 75% in 2016. LogMeIn’s revenue is expected to reach $1 billion during 2017, thanks to the merger with Citrix’s GoTo business. The market seems quite excited about the company’s prospects as the share price more than doubled during the trailing 12 months.
However, in point of fact, prospects aren’t as good as reflected in the stock price. The company isn’t a leader in its space; details follow. The addressable market to which the company refers in its investor presentations is flooded with competitors, and LogMeIn isn’t among the key players. The actual addressable market for the company is web conferencing, identity and access management, which are not growing at the optimistic rates cited in the media. Following are some of the red flags that support a bear thesis.
Merger benefits might be overhyped
LogMeIn acquired Citrix’s GoTo solutions recently. This can help the company increase its reach and benefit from synergy effects. Cost savings of $100 million are expected over the next two years. The company now has more than 2 million customers and millions of free users worldwide.
There are costs associated with the merger. The company expects to incur $45 million of merger-related fees and expenses in 2017. Furthermore, Citrix’s solutions aren’t exactly market-leading solutions. This is among the reasons Citrix divested its business.
Competition is intense
LogMeIn faces stiff competition from blue chips including Adobe (ADBE, Financial), Amazon (AMZN, Financial) and Cisco (CSCO, Financial). There are a lot of question marks for LogMeIn regarding potential market share gains in unified communications. The company is, at best, a niche player. It doesn’t have deep pockets to compete on price in the long run.
Another problem is that the company lags behind its competition. LogMeIn isn’t mentioned in Gartner’s Magic Quadrant for unified communication. The company isn’t leading its own niche market. Its GoTo solutions aren’t as mature as solutions from Cisco, Microsoft (MSFT, Financial) and Adobe.
LogMeIn’s own services are in the niche players’ category, which has the lowest ability to execute and lack of complete vision, according to Gartner. Overall, it seems difficult to justify the rosy earnings growth forecast of 35% p.a.
Gartner's cautions for Citrix include the company’s inability to deploy on premise, hybrid and dedicated solutions. This certainly raises security and privacy concerns. That’s the reason gaining traction with large corporations might be a problem for LogMeIn.
Earnings aren’t in line with revenue growth
In 2016, a $27 million increase was witnessed in general and administration expenses; sales and marketing expenses increased by $24 million, and R&D increased by $15 million. Revenue increased $65 million. As operating expenses of the company mimic variable nature, it’s difficult to ascertain when the company will achieve economies of scale that can translate into meaningful earnings. According to the company filings:
“We believe that as we continue to grow revenue at expected rates, our cost of revenue and operating expenses, including sales and marketing, research and development and general and administrative expenses, will increase in absolute dollar amounts.”
Amortization shouldn’t be ignored
Note that despite impressive revenue growth during the last couple of years, GAAP earnings remained under pressure. Furthermore, there’s a broad difference between the GAAP and non-GAAP earnings of the company amid stock-based compensation and acquisition-related costs and amortization. The problem is that earnings consensus ignore the acquisition related costs and amortization, which can lead to a distorted valuation.
Acquisition-related costs and amortization for the company increased from $11.2 million to $35 million in 2016, which made up around 66% of the earnings. Ignoring acquisition-related costs, as a one-off transaction, amortization of intangibles amounted to around $11.8 million. This translates to 22% of the company’s earnings. Exclusion of amortization can lead to a risk of impairment-related losses going forward, which can affect the stock price.
It’s not prudent to value the company based on non-GAAP earnings amid increasing amortization. High amortization means that the company’s intangibles might not be worth what was originally proposed. This can be dangerous in terms of EPS forecast and valuation. Note that despite acquisition of intangibles, assets related to technology decreased in value in 2016.
Valuation reveals significant downside
| Projections | Â | Â | 2017 | 2018 | 2019 | 2020 | 2021 | Perpetuity |
| Â | Â | Notes | Â | Â | Â | Â | Â | Amounts in million |
| Net Income | Â | Â | 197.5 | 249.1 | 286.5 | 329.54 | 378.9 | 435.81 |
| Â | Cost of capital | r*capital invested | 241.1 | 259.8 | 281.3 | 306.0 | 334.4 | 367.1 |
| Â | Â | Â | Â | Â | Â | Â | Â | Â |
| Adjusted Net Income | Â | Â | -43.54 | -10.60 | 5.28 | 23.55 | 44.56 | 68.72 |
| Discount factor | Â | Â | 1.00 | 0.93 | 0.87 | 0.80 | 0.75 | 16.64 |
| Economic Value Added | Â | Â | -43.54 | -9.86 | 4.57 | 18.96 | 33.36 | 1143.45 |
| Period | Â | Â | 0 | 1 | 2 | 3 | 4 | 5 |
| Â | Â | Â | Â | Â | Â | Â | Â | Â |
| Â | Â | Â | Â | Â | Market value added | 1147 | Â | |
| Â | Â | Â | Â | Â | Invested Capital | 3017 | Â | |
| Â | Â | Â | Â | Â | Value of the equity | 4164 | Â | |
| Perpetual Growth in Residual Earnings | 8% | Â | Price Target | 79.0 | Â | |||
The valuation sheet indicates that the fair price for LogMeIn is around $79, translating into a downside of more than 25%. Consensus earnings from 2017 and 2018 are used for valuation despite the fact that these earning figures are highly optimistic. The company faces strong competition, and synergy benefits might not pan out amid acquisition-related expenses.
Amortization is ignored, which is also a red flag. Anyhow, for the valuation, earnings are expected to grow at 15% p.a. during 2018-2022. Analysts are predicting a 30% growth rate during 2017-2022, but industry forecasts tend to differ. Global Industry analysts predict that the web conferencing market will reach $3.9 billion by 2020 with a CAGR of 11.5% in Asia Pacific during 2015-2020. Markets&Markets is forecasting a 12.9% CAGR in the identity and access market during 2016-2021.
It isn’t prudent to forecast a 30% growth rate for a company that generates most of its revenue from web conferencing, identity and access services; a 15% growth rate seems plausible. Looking at the P/E ratio, it is evident that LogMeIn offers no value whatsoever. The company trades at a P/E of 29 based on 2017 earnings, which is quite high given the fact that market forecasts point toward 12% to 15% top-line growth in the industry. All in all, LogMeIn seems grossly overpriced.
Final thoughts
LogMeIn is trading around its 52-week high amid merger excitement. The market is ignoring the fact that the company isn’t a leader in unified communication or in its niche market for that matter. Ignoring amortization is just like turning a blind eye. Further, EVA valuation also reveals significant downside.
LogMeIn is a sell amid gross overvaluation, unrealistic growth targets and overoptimistic merger expectations.
Disclosure: I have no position in any stocks mentioned and no plans to initiate any positions in the next 72 hours.
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