Listed at #22 in Forbes Best Small Companies for 2013, today’s specimen to examine is CommVault Systems.
CommVault made it to the list based on the following criteria defined by Forbes.
- annual revenue between $5 million and $1 billion
- stock price no lower than $5 a share
- excluded financial institutions, REITs, utilities and limited partnerships
- rankings are based on earnings growth, sales growth and return on equity in the past 12 months and over five years
- dropped thinly traded names and those with fuzzy accounting or major legal troubles
- factored in stock performance versus each company’s peer group during the last year as of Oct. 1
CommVault Systems (CVLT)
According to CommVault’s website, the company is a information management software company.
I have no idea what that means.
The problem with a lot of public companies is that they don’t know how to explain who they are and what they do.
The company has a software called Simpana, but again, the description is simply “A Single Platform to Protect, Manage, and Access all Your Company’s Information”.
Again, that is just gibberish.
10 minutes later, I find a video that explains what it’s about.
Normally, if I have to work this hard just to figure out what the company does, it’s a pass.
But I want to go through how I’m thinking about this company from beginning to end.
- Market Cap of 3.15B
- Sales Growth: 20%
- EPS Growth: 19%
- TTM ROE of 13.9%
- Cash Adjusted PE: 42
- EV/EBITDA: 27.3
Right away, you can tell that these are not cheap stats.
Although sales growth of 20% the past 5 years is impressive, a low ROE makes me think how long it can keep up the expected growth.
Download the CVLT Stock Report and Follow Along
Before getting too far into this analysis, here’s a stock report for CVLT so that you can follow along with all the numbers.
This report contains all the data from the fundamental stock valuation models.
Pros with CommVault Systems
CommVault has no debt and capex is also very low for software companies.
That’s the benefit of having no inventory. It also positively affects the cash conversion cycle because the inventory factor is disregarded.
Another benefit with B2B software companies is that prices can be passed along to customers.
These types of solutions can easily cost in the hundreds of thousands of dollars. Include yearly maintenance and support packages and a few thousand bucks is nothing.
One characteristic to look for in stocks, as mentioned by Warren Buffett, is that you want to find the ones that can increase prices.
Although there are competitors who offer similar products like CommVault’s Simpana, once a client has invested time, money and training into a particular software, it is very difficult to change.
Example: there are free word processors and office programs on the market but people still pay to use Microsoft Office.
Software that is deeply integrated into the IT infrastructure of a company and at the very core of controlling important processes is difficult to switch.
That image at the very top of this post is a diagram of how Rackspace uses CommVault. Imagine Rackspace having to uproot and replace CommVault.
Huge pain barrier to overcome.
Possibly why FCF has been growing and gross margins is very consistent as recurring revenues kick in.
On a quality scale, CommVault scores well.
Cons with CommVault Systems
Fundamentally, there isn’t anything wrong with the company.
Strong growth, pricing power, fat and profitable margins and strong quality scores.
The only negative aspect of CommVault is the stock price.
At the current price of $66.52, it’s trading at an EV/EBITDA of 27.3, P/FCF of 28.6 and P/E of 50.
In the IT infrastructure and security software space, competition is intense and these multiples are pretty much industry averages.
Thinking About Growth Rates
Here are some multi year averages.
The way I calculate growth and performance numbers is by taking the CAGR of multiple periods and then calculating the median to smooth out irregular data.
It’s a technique I got from F Wall Street.
Let me go through it quickly.
The idea is that instead of calculating a straight line CAGR from year 1 to year 5, you calculate year 1 to 3, year 2 to 4, year 3 to 5 etc and continue mixing up the years.
An example of why I do it like this is the 2008+ recession. Of course during the recession, you think that it will never get better. But looking back, the economy and stock market has rebounded back stronger than ever.
So how much do you have to factor in 2008 into the long term performance of the company?
Obviously, it wasn’t a normal year.
As a comparison if you were to calculate the CAGR from 2008 to 2013, it comes out to 28.36%.
From the table above, by smoothing the years out, the growth comes out to 32.2%.
I don’t use the 32% in this case because the ROE is much lower. In the stock valuation models, I’ve capped the default growth rate to be the ROE because a company can’t grow faster than its rate of return. (This is a topic I’ll have to go over another time for sure.)
But capping the growth at 11% is too harsh in CommVault’s case. Fundamentals are strong and with the rapid growth of data, more companies relying on securing data and controlling their infrastructure, growth should exceed 11%.
Reverse DCF on CommVault
I admit that I’m no expert on CommVault, and in this case, the best way to value a stock is to use the reverse DCF.
If you are unsure of what a company is worth, then don’t do blind discounted cash flows because the chance that you are wrong will be high.
It is much easier to do a reverse valuation first and then decide whether it makes sense before plowing ahead and changing assumptions.
For CommVault, it’s a toss up between using a 9% and 12% discount rate.
Although profitable, CommVault is in a competitive landscape and new technologies can uproot its position anytime.
So I’m going with a 12% discount rate.
Starting TTM FCF is $116 and with this, the implied growth rate in the stock is 19%.
If you have your own DCF model, apply the same concept. Start off with the TTM FCF and then adjust the growth rate until the fair value matches the current price.
The All Important Question
Is continued 19% growth achievable?
My max is 20% when I look at companies. But to buy a company with high growth expectations, it must have a super strong moat and CommVault doesn’t have that.
It’s difficult to quantity the strength of a moat, but one way to help you is