Constant Contact Pre-Earnings: Revenue And Margin Prospects Look Challenged Post Digital Industry Consolidation

Digital marketing solutions provider Constant Contact (NASDAQ:CTCT) is expected to report fiscal 2013 results on January 30. The company provides engagement marketing tools via email, social media and mobile platforms to help small businesses achieve revenue growth through targeted, time-bound marketing campaigns and promoting business offers, thereby increasing the business’ visibility. Constant Contact has been a strong performer in 2013, gaining close to 127% in stock value, partly supported by speculations of its acquisition following the recent consolidation within the industry. ExactTarget was acquired by Salesforce.com (NYSE:CRM) while Neolane and Responsys were acquired by Adobe(NASDAQ:ADBE) and Oracle (NYSE:ORCL) respectively.

We believe this industry consolidation could have severe negative impacts on the company’s long term growth prospects. While revenue has grown at a compounded annualized rate of 38% between 2007 and 2012, the company is witnessing a steep deceleration in top line growth. For fiscal 2013, we have a revenue estimate of $285 million for fiscal 2013, which is within the $284 million – $289 million revenue guidance provided by the company, and a non-GAAP net income estimate of 66 cents per share, which is the midpoint of the 62 – 69 cents per share guidance provided. However, we have a compounded top line growth rate of 10% between 2013 and 2020 which is one of the reasons for our price estimate standing 32% below its current market price of $31. In this pre-earnings note, we present our take on Constant Contact’s business post the consolidation within the digital marketing industry.

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Industry Consolidation Could Lead To Expense Expansion And Revenue Growth Contraction For Constant Contact

The recent consolidation of the digital marketing industry means Constant Contact will effectively be competing against deep pocketed players. Although Constant Contact’s primary target customers are small and medium businesses (as opposed to larger corporate enterprise businesses), it faces the risk of the acquired companies launching new marketing products catering to small business’ needs in an attempt to expand their addressable market. Much of the growth in the digital marketing SaaS industry is expected to come from the small and medium enterprise (SME) businesses, due to the scope of expansion in these areas. This potential risk could lead to an expansion in R&D and SG&A expense as Constant Contact invests to retain its existing market share within the small business marketing sector.

Additionally, its top line growth has seen consistent deceleration, falling from 73% in 2008 to 18% in 2012. Constant Contact offers social media engagement and email marketing solutions for small businesses and has very low presence on the enterprise digital marketing front. Constant Contact’s customer growth rate, albeit on a double digit level, is much lower than the 65% growth seen in fiscal 2008. While one of the reasons for this steep decline could be attributable to the economic crash in the U.S. in 2008 – 09, when SME businesses were severely impacted, another reason for the slowdown in customer base expansion could be a saturation in the small business market. Slowing growth in Constant Contact’s customer base constrains the company’s future revenue prospects, adding to margin pressures for the company in the future.

Another factor that is crucial to the company’s business is the average revenue per user (ARPU). Constant Contact’s ARPU was approximately $42 in Q3FY13 compared to $40 in fiscal 2012. With slowing growth in its customer base, ARPU is a key driver for the company’s top line growth. Management expects to drive ARPU growth through an increase in list pricing, bundling packages together, and cross-selling existing products. However, the extent of ARPU expansion capable from these initiatives remains to be seen. We will look for insights regarding these challenges as we review the company’s commentary with earnings.

We will be updating our $21 price estimate for Constant Contact after the company files its results with the SEC.

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