CommVault Systems, Inc. (CVLT) is a high growth stock trading at elevated prices. I want to focus upon CommVault’s successful growth story, but highlight why the shares are currently overpriced. This is an excellent time to short the stock at the $72 range.
CommVault was formed as a development group within AT&T Bell Labs in 1988 and spun-off as an independent company in 1996. Today, the company is a publicly-traded entity that focuses on data management software and services, with headquarters in Oceanport, New Jersey.
CommVault’s flagship Simpana software integrates multiple modules into a single, easy-to-manage platform for high performance data solutions (data protection, migration and archiving, replication, recovery, search and compliance) while minimizing complexity and data management costs for globally distributed network storage systems. The company complements its software suite with a full set of professional services. CommVault’s primary markets include North America, Europe, Australia and Asia.
Over the past few years, the company has benefited, and should continue to benefit, from the explosion of data through fixed, mobile, virtualization and cloud-computing applications and enterprise efforts to manage this proliferation. However, the software industry is one of rapid evolution and obsolescence, so the company’s challenge is to make sure it evolves with industry standards and continues to update its solutions in step with customer demands without being blindsided by new technologies or platforms that render its products obsolete.
Dividends – None
CommVault has not paid any dividends to-date nor announced any intention of doing so in the future even though the company has sizable cash reserves, strong operating cash flow, zero debt and minimal capital expenditure requirements. While shareholders have been rewarded well through share price appreciation, a significant dip in shares could result in pressure to initiate dividends.
Shares have risen significantly over the past four years – up from about $12 around December 20, 2008 to about $72 around December 20, 2012. Over the past 12 months, shares have risen 77% and trade at a fairly high price-to-earnings ratio of 83x with a market capitalization of $3.25 billion (11.6 times Book Value).
Share price valuation metrics (P/E ratio, Price/Book-Value) appear to be well ahead of fundamentals such as projected five-year earnings growth of 25% or even reported quarterly earnings per share growth of 70% – suggesting that shares are considerably overpriced at current levels and could fall victim to broad market drops.
On October 25, 2012, CommVault’s Board of directors authorized a $50 million increase to its existing stock buyback program, which now has a balance of $102.8 million. However, the company did not buy back shares in 2Q12, likely signaling management’s belief that shares are overpriced.
CommVault gets its revenue from two sources – software licenses and services, typically sold as a bundle. Its unified platform approach is designed to give enterprises complete data lifecycle management at lower cost with fewer resources and in less time than alternative solutions.
The company derives half of its revenue from software and half from services, but margins on software are far higher than on services. Historically, CommVault has generated about 2/3rds of its software revenue from existing customers and about a third from new customer additions.
Indirect sales through resellers, original equipment manufacturers (OEMs) and distribution channels account for approximately 88% of total software revenue, with the balance of about 12% generated from direct sales.
Over the past six months, channel sales have increased 31% with added revenue contribution of $23.6 million while direct sales declined 12%. Internationally, almost all of the company’s sales come through its channel partners while direct sales do well within the U.S. As a result, channel relationships and direct sales are key to its long-term growth strategy.
Arrow Enterprise Computing Solutions and Avnet Technology Solutions are key distributors within the U.S., with Arrow bringing in 28% of total revenue for the six months ended September 30, 2012. Its largest OEM vendors include Dell, Hitachi Data Systems and NetApp, which accounted for approximately 14% of total revenue.
For its second quarter ended September 30, 2012, the company reported total revenues of $118.2 million, up 21% from the year ago quarter. At quarter end, the company had 17,100 licensed customers for its Simpana software platform.
Software revenues increased 24% to $59.2 million, from $47.8 million in the year-ago quarter, and accounted for 50.1% of total revenues. This substantial increase in software revenue was from 30% higher sales in the U.S. and a 14% gain internationally, relative to the year ago quarter. International increases primarily came from Australia, Canada, Latin America and Europe as the company continued its international expansion.
Enterprise sales (greater than $100,000) accounted for 56% of all software revenue up from 55% in the year ago quarter, with the increase driven by a 6% increase in sales transactions and a 19% increase in the average dollar amount of each enterprise sale to $247,000 from $208,000 in the year ago quarter. The company’s smaller (under $100,000) transactions were up 21% in the quarter.
Channel sales, through resellers and OEMs, were up 25% (up $10.4 million) while direct sales were up 17% (up $1 million).
Services revenue totaled $58.9 million, up 18.8% from $49.6 million in the year-ago quarter. This increase in services revenue was directly attributable to higher software sales and service contract renewals with existing customers.
The cost of software was up less than 1% to $644,000 while the cost of services was up 18% to $14.7 million primarily due to higher compensation, expansion of global customer support operations and third-party outsourcing to facilitate services revenue expansion.
Total operating expenses (OpEx) were up to 13% to $80.5 million, from $71.3 million in the year-ago quarter, primarily due to higher employee compensation, expansion of the company’s sales force, higher marketing expenses to build brand awareness, higher research and development (R&D) expenses tied to salary increases and an expansion in engineering staff as a strategic priority, and increases in general and administrative (G&A) expenses due to higher compensation, headcount and legal expenses.
Management successfully held OpEx increases well below the pace of revenue growth. As a result, net income increased an impressive 76% to $13.9 million from $7.9 million a year ago, with diluted EPS (earnings per share) growth to $0.29 from $0.17.
For the six months ended September 30, 2012, the company generated $42.3 million from operating activities, used $$2.2 million to purchase property and equipment (investing activities) and generated $14.5 million from the exercise of stock options and related tax benefits (financing activities).
At quarter end, the company had total assets of $488 million, up 12.8% primarily due to increases in cash and cash equivalents and net property and equipment. Total liabilities, $207.1 million, were primarily tied to deferred revenue and were up 2.2%. (Deferred revenue mostly consists of services revenue where customers have been invoiced for annual customer support agreements but where services are yet to be performed.)
Stockholders’ equity grew to $281 million from $230 million, up 22.1% since the beginning of its fiscal year.
In October 2012, CommVault announced that its Simpana 9 platform was fully integrated with Microsoft Windows Server 2012 and its cloud operating systems.
As cloud computing grows, CommVault is well positioned to serve as a centralized, hardware-agnostic data management platform that can protect applications in physical, virtual and cloud-computing environments.
Stringent cost controls kept increases in OpEx (up 12.9%) well below revenue growth (up 21%) and helped deliver strong earnings growth and solid cash from operations.
Looking ahead, the company expects future earnings growth of 25% over the next five years, well above the software industry average of 18%. Company management expects positive momentum in the first half of the fiscal year to continue in the second half, driven by strong demand from enterprise and federal customers, despite macro economic uncertainty.
Fundamentally, the company is very well positioned for growth with a solid software platform that will continue to generate strong cash flow, and a solid multi-billion market opportunity.
However, shares appear to have gotten well ahead of fundamentals, with a P/E ratio of 83x that well exceeds projected 5-year earnings growth of 25%, and a market capitalization of $3.25 billion that is over 11x Book Value of $281 million. Current valuations cannot be justified by fundamentals but appear driven by market dynamics such as excessive cash in a low interest rate environment that has driven shares up.
New investors would be well served if they avoid the stock at current levels despite strong buy recommendations from Wall Street. Existing investors should likely use a Short Call/Long Put strategy to lock in gains at current levels and forego further stock upside, or at the very least, sell part of their CVLT holdings. Aggressive, deep-pocketed investors might want to buy long-term puts to play the almost inevitable downside. That said, with market dynamics and trillions of dollars in play, there’s no saying how much higher investors will push shares or when shares will revert to saner levels.