Insider Insights

Betting On Backup

A busted IPO, an attractive business model, and broad-based insider buying are the pillars in place for Carbonite (CARB: Nasdaq). Shares are attractive by a variety of metrics, possibly due to understandable competitive concerns. But we spot value, and have followed insiders into these beaten-down shares.

Founded in 2005, Carbonite provides encrypted online backup solutions for consumers and small and medium sized businesses. Users access files in the “Carbonite Personal Cloud” where they can browse and share their photos, videos, and documents using a Web browser or the company’s  free iPad, iPhone, and Android apps. The company already has more than one million active users.

Carbonite came public last August, opening at $10.80 before zooming up above $20 on an intra-day basis a few days later. Shares are now back down below $10, even lower than where most insiders have recently been buying.

Many would argue that cloud-based storage has minimal barriers to entry and is a largely commoditized business. We can’t disagree. But Carbonite is one of the early movers in this space, and now has an IPO-generated cash cushion that gives it a competitive advantage. Most importantly, Carbonite has also developed a sufficiently robust platform that offers many desired features and unlimited backup offering at a fixed, low price. It appears to be a formula that is attracting users at a rapid clip.

The potential size and growth of Carbonite’s industry would make the firm a top-line growth story even if market share just remained steady. Analysts expect the $1 billion cloud storage market to reach $2.5 billion by 2014. The company’s growth is also likely to come from international expansion as more than 90% of sales are still derived in the U.S.

Add it up, and Carbonite appears capable of 30% sustained annual growth into the middle of the decade. In the fourth quarter of 2011, the total number of subscribers grew 29% from a year earlier to 1.22 million, and analysts are anticipating 38% sales growth for the year ahead.

Carbonite’s a fairly straightforward business model. The firm charges individual consumers a flat fee for unlimited data backup with one, two or three-year contracts. Carbonite entered the small to medium-sized business market in 2010, with an offering that allows for backup of unlimited number of PCs for a flat fee, but caps the data storage at 250GB and 500GB. Further storage has to be purchased on a per GB basis.

Carbonite is among the few companies that have an unlimited data backup offering for consumers. When combined with high ease-of-use ratings in consumer surveys, you can see why Carbonite has seen a high try-to-buy conversion ratio at 69-70%, with a third of its customers buying without even trying the product. Still, we don’t discount the relative merits of competitive offerings such as Dropbox, Crashplan, Norton Online backup and Mozy.

A quick review of the competitive offerings implies that Carbonite offers the best combo of features and price at this time, though that is subject to change as the industry evolves. Right now, Carbonite has been able to modestly boost pricing without a noticeable drop-off in the subscriber base. The Average Revenue Per User (ARPU) has risen from $10.59 in the first quarter of 2009, to a recent $13.

On its IPO roadshow, Carbonite discussed a range of proprietary patented technologies, mostly focused on efficient utilization of storage servers. Here again, we think it’s wise not to assume that any technology lead can be sustained. But on the flip side, we also feel it is logical to assume that Carbonite’s management hasn’t come this far with the business not to try to stay ahead of the evolving technology curve. And they would seem to have the cash war chest to stay competitive as well.

We think that CARB has understandably sold off due to the early-stage nature of the company’s income statement. Carbonite has yet to attain full-scale margins and profits. The company prorates revenue over the life of the contract, so sales and cash flow figures are under-stated. Customer acquisition costs are expensed over the first year of service, so margins for returning customers are quite high. To be sure, results are also still being constrained by heavy spending on marketing, though that should shrink as a percentage of sales as the revenue base builds. Indeed it was the recent announcement that marketing spending will remain high in 2012 that has pushed the stock down to fresh lows.

In the absence of tangible valuation metrics, shares lacked support, especially as the broader market swooned last summer. CARB is still clearly in a technical downtrend as well, which wil no-doubt turn off some investors. Insiders, however, have already signaled value in their beaten-down shares.

Insider buying began last November and has been steady ever since. Much of that buying took place in the $11-12 range, with more recent insider buying earlier this year done as CARB fell below $10. Only one executive has so far taken advantage of Carbonite’s lockup period expiring, and sold shares.

We concur with insiders that shares are oversold, and expect continued strong growth over the course of 2012 will help this recent IPO regain an uptrend. But coming up with an appropriate upside figure for CARB is more art than science. The best we can do is compare Carbonite to other cloud-based plays on an Enterprise Value (EV)-to-Revenue basis. As a point of reference, Salesforce.com (CRM: Nyse) trades at 7.5 projected 2012 sales. For Cornerstone OnDemand (CSOD: Nasdaq), that figure is 8, and for Concur (CNQR: Nasdaq), the figure is 7. Meanwhile, after falling more than 50% from an early peak, Carbonite trades for two times 2012 EV/sales. For further perspective, Carbonite is expected to boost revenues nearly 40% in 2012, while that figure is 36%, 50% and 26%, for Salesforce, Cornerstone, and Concur, respectively.

To be sure, this is all about the customer base. Carbonite is scrambling to build as big a base as possible as quickly as possible. Frankly, we’d be surprised if this company was still independent three to four years from now. Instead, it could well be integrated into a valuable division of a larger tech firm. As an example, Google (GOOG: Nasdaq) is gearing up to make a fresh push with its “Chromebooks,” which have minimal local storage capabilities. An offering such as Carbonite dovetails quite well with that model. A similar case can be made with companies like Microsoft (MSFT: Nasdaq) and Dell (DELL: Nasdaq).

To view CARB’s Bullish Insider History, Click Here.

To view the Screening Tool we used to find CARB, Click Here.

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Jonathan Moreland

Mr. Moreland began working with insider data in the early 1990s while an analyst for the old Individual Investor magazine. A fundamental analyst with an MBA in finance and studying for Level III of...
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