Mimecast: Volatility Remains A Concern

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Source: knowyourmeme

Mimecast’s (MIME) evolution outside of email security is promising. There is a strong demand for its security offerings. Financially, it isn’t as unprofitable and leveraged as most peers. Lastly, the company doesn’t have the most attractive balance sheet. As a result, Mimecast provides a balanced risk/reward at the current price. I will be initiating a Hold rating with a PT of $50.

Consumers/Demand (Rating: Bullish)

Source: Mimecast

Mimecast provides security solutions primarily targeted at the email market. Emails remain the largest SaaS product, according to Nikesh Aurora of Palo Alto Networks (PANW). Mimecast’s growth has been driven by the global success of Microsoft’s (MSFT) Office 365 business.

As early as April 2019, Microsoft reported 180 million monthly active users of Office 365. As a result, Mimecast has a significant leeway ahead of it.

Business/Financials (Rating: Neutral)

Mimecast has evolved from an email security company to a company that offers products that address other cybersecurity segments. This includes web security, DLP, eDiscovery, threat intelligence, and security training. This has been driven by acquisitions funded by its IPO proceeds and debt issuance. Like other SaaS plays, Mimecast is stress testing its growth by investing a lot in sales and acquisitions to capture market share. Unlike most competitors, Mimecast has been able to record better gross and operating margins. Though Mimecast is still unprofitable, its profitability margins aren’t too offputting.

Source: Author (Using data from Seeking Alpha, data in millions of USD)

The slightly conservative growth strategy might have cost it some market share as competitors like Proofpoint (PFPT) are gaining market share at a faster rate. Mimecast’s balanced strategy of growth and profitability is a good one. As you can learn from the chart above, gross and operating margins haven’t improved meaningfully over the years. This means either Mimecast is in the investment mode, or there isn’t competitive leverage in the segments it plays in.

In terms of its value proposition, Mimecast has improved over the years. Its +90% retention rate is a testament to this. Also, its triple-digit annual recurring revenue rate underlines the fact that customers see the real value in its products. Though its email security business remains the bread and butter of its revenue growth, adding capabilities in threat intelligence, security awareness, and web security is a good strategy. This will help reduce churn rate while driving up the average deal size of its products. This means gross and operating margins will improve.

Another interesting development for Mimecast is its API initiatives. Management seems to be more interested in developing APIs that can communicate with products owned by other vendors. The point of this strategy is to make it easy for customers to include Mimecast’s security products when they are shopping or upgrading their security appliances. It also makes it easy for Mimecast to partner with network security vendors without coming off as a threat. This is a good initiative, and I believe it will help Mimecast in its competitive positioning going forward. Though this means we should expect less focus on expansion into adjacent security segments as Mimecast would rather be seen as a friend than an enemy.

Source: Author (Using data from Seeking Alpha, data in millions of USD)

Moving on to its statement of cash flow, FCF has increased over the years. This is a blend of stock-based compensation, and better cash collection driving its working capital. As a % of operating cash flow, net income isn’t significant. Though it is improving.

Source: Author (Using data from Seeking Alpha, data in millions of USD)

Recently, cash flow from investing activities has been driven by new acquisitions. In the past, management has preferred to invest the cash on its balance sheet in marketable securities.

Source: Author (Using data from Seeking Alpha, data in millions of USD)

In terms of its financing activities, cash flow has been a function of its recent debt issuance. This leads us to the balance sheet, which isn’t the most attractive. This is due to recent acquisitions. Cash and cash equivalents now stand at $199m while total debt is $243m. This puts debt to equity ratio at 120%, giving a current ratio of 1.2.

This means Mimecast has a thin leverage margin. Overall, Mimecast doesn’t have the best financials; given its minimal competitive leverage, investors should begin to lower their expectations for massive multiples expansion.

Investors/Valuation (Rating: Neutral)

Source: Author (Using data from Seeking Alpha, data in millions of USD)

Mimecast has an average analyst’s price target of $55. This means Mimecast is trading at a discount to the Street’s estimate. Analysts have revenue growth expectations of 23% and 21% in 2020 and 2021, respectively. Likewise, they have an EPS estimate of $0.44 and $0.66 in 2020 and 2021, up from $0.26 in 2019. Compared to the sector median, Mimecast appears expensive; however, this is because it is projected to grow at ~3x the sector median.

Mimecast has a quant rating of neutral and near negative quant factor grades for value, profitability, momentum, and EPS revision. The only clear positive quant factor grade is growth. For short-term investors, buying into Mimecast is a bet on the continuation of its growth momentum. Given that the company’s recent growth narrative has been driven more by acquisitions, I will be wary of buying too much into the growth narrative. Mimecast trades at a P/S of 6.8x. This is right under the conservative number of 7x, which I prefer for fast growth unprofitable SaaS plays. It has a positive but lofty EV/EBITDA of 87x. Compared to most competitors, this is in line with minimal downside or upside bias. As a result, the current price provides a balanced risk/reward with a strong possibility of another rally if Mimecast continues to meet its near-term growth target.

Source: Author (Using data from Seeking Alpha)

The table above highlights the assumptions driving my valuation narrative. The revenue projection results in a P/S of 9x and a P/S (FWD) of 7x. This gives a share price target of $50. Beyond that point, Mimecast begins to appear overvalued, and I will be wary of more multiples expansion.

Macro/Competitors (Rating: Neutral)

Mimecast’s biggest competition is Proofpoint. Though, given the size of the market, I think there will be enough to go round in the near term. The email security market is one of those rare cybersecurity segments with a clear value proposition. Management is also positive about winning deals from the aftermath of the Symantec acquisition by Broadcom (AVGO).

I see Mimecast maintaining its steady growth momentum. However, I don’t see a paradigm lift in return on invested capital happening anytime soon. Currency fluctuation remains a big macro headwind for Mimecast. This mainly stems from the United Kingdom, which is now 28% of Mimecast’s revenue – down from 32% last year. Other geographies outside the US aren’t performing as expected.

We would like to have seen, particularly the U.K. growing a bit faster. Really what we’re seeing is, and it’s showing up in a bunch of the economic reports and whatnot, but that there’s this natural tendency for deals to perhaps extend a little bit and move slower. And I think it’s really things like that that are trickling through the business. It’s still got good growth, but not as quite. It’s certainly not keeping up with their North American counterparts.

As a result, I am not bullish on Mimecast’s macro and competitive positioning in the near term as the United States seems to be doing the bulk of the heavy lifting.

Conclusion (Overall Rating: Hold, PT: $50)

Source: Author (Daily Return Volatility)

Overall, Mimecast is well-positioned in its niche. Growth will continue to be driven by its expanding TAM and average deal size, coupled with the global demand for Office 365. Its near-term strategies are promising, and its valuation isn’t too frothy. I am bullish on its long-term plans. Finally, I’m unwilling to put a Buy recommendation on Mimecast due to its huge volatility. Therefore, I will be initiating a Hold rating with a price target of $50.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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