Special Bulletin July 27, 2016
Shares of LogMeIn (LOGM) are surging 20% this morning after the company announced a merger agreement with Citrix’s (CTXS) GoTo business last night. There are a lot of details to cover here, and the deal is actually quite fascinating for those interested in M&A deals. If that doesn’t describe you, don’t sweat it. The bottom line is that LogMeIn will continue to exist, it will just be a much bigger company.
From my original recommendation price, the stock is now up 45%. And I’m recommending selling a portion of your stock to lock in the gain (25% to 50% seems appropriate, but you need to decide for yourself). Let the rest of the position ride. SELL HALF, HOLD THE OTHER HALF.
Here are (a lot of) the details:
LogMeIn and Citrix’s GoTo business will join forces through a Reverse Morris Trust (RMS) transaction. Prior to the announcement, LogMeIn had a market cap of around $1.7 billion. Citrix had a market cap of $13.4 billion, which is, obviously, a lot more. Citrix has been looking to shed the GoTo business for a while, and it’s an almost perfect fit with LogMeIn since many of the products overlap. Without a doubt, the two companies were fierce competitors.
It’s important to know that a deal like this can only happen when the stars align. That’s because the RMS is a tax-free transaction. In order for it to work, several hurdles have to be cleared. First, the company spinning out a business unit (in this case, that’s Citrix) has to own over 50% of the resulting company. Citrix shareholders will own 50.1%; LogMeIn shareholders will own 49.9%.
For a deal like this to work, the two businesses must be about the same size. If they are not, there has to be room for logical transactions to “right size” the respective companies to bring them close. I’m not 100% sure (I’m typing all of this up quickly), but at first blush, I think this right sizing is being accomplished by having Citrix contribute $25 million to the combined company, and having LogMeIn distribute three special dividends of $0.50 each at three points leading up to the proposed Q1 2017 combination (for a total of $1.50). Those special dividends represent a yield of 2.6% based on the Cabot Small-Cap Confidential reference price of 58.13 (the math is 1.5/58.13 = .0258). That works out to almost $38 million in total dividends to be paid by LogMeIn.
I don’t think any debt is being issued to make the deal work. But LogMeIn does need to issue 27.6 million new shares to distribute to Citrix shareholders. That’s a considerable number, given that LogMeIn currently has around 25.3 million shares outstanding (diluted). But it makes sense when you realize that Citrix needs over 50% ownership. As you would expect, LogMeIn needs shareholder approval to get this deal done.
The two companies bring very complementary businesses to the table. LogMeIn is on track for $330 million in revenue in 2016. GoTo is on track for $680 million (more than twice as much). Together, they will have combined revenue of over $1 billion. And management’s early analysis suggests over $100 million in cost synergies (that’s 10% of combined revenue, which is significant), $250 million in annual free cash flow (that’s nice) and over 35% adjusted EBITDA margins (LogMeIn says this represents an 80% improvement in its adjusted EBITDA).
As far as product lineup goes, the graphic below shows the combined products as they fit into LogMeIn’s current three business areas. I added the red lines to show the new GoTo products.
The new company, which will still be called LogMeIn (for now), will be led by LogMeIn’s current President and CEO, Bill Wagner, CFO Ed Herdiech and some combination of talent from both companies. The Board will have five directors from LogMeIn and four from Citrix. It’s a little unusual for an RMS transaction to have the smaller company in “control,” but that’s the way the chips fell in this one. And, it’s good—we like LogMeIn a lot more than Citrix!
So should we buy more, hold or sell?
Let’s talk about valuation. Yesterday, LOGM traded with an enterprise-value-current year sales ratio (EV/Sales) of around 4.5. That’s about average for a Software-as-a-Service company growing in the 20% to 30% range (Q2 revenue was 28%). If we assume $1 billion in revenue in 2017, and give a similar valuation, that implies an enterprise value for the combined entity of $4.5 billion. BUT Citrix GoTo isn’t growing as fast, and remember, it has twice the revenue of LogMeIn. According to Citrix’s 2015 10K, its software and services business segment, which includes all the products in this proposed deal, plus a few that aren’t, grew by 12.2%. Taking the estimated 2016 respective revenues of each entity, I calculate an approximate weighed average annual revenue growth rate of 16%. A company growing at that pace, with estimated 2017 revenue of $1 billion, could trade with a forward EV/sales ratio of 4, right now. Which implies a target enterprise value of $4 billion.
We can assume the share count of the combined entity will be around 53 million (25.3 for LOGM right now, plus 27.6 to be issued to Citrix shareholders). LogMeIn just ended the quarter with $225.4 million, but will pay out $38 million in dividends, and Citrix will add $25 million back to the pot. So that implies cash equivalents of the combined entity will be $238 million, assuming LogMeIn adds zero cash before the transaction closes (unlikely, but…), which is estimated to be in Q1 2017.
Add that cash to the enterprise value to get the theoretical market cap and you get a market cap of $4.24 million. Divide that by 53 million shares and you get a price per share of roughly 80.
Shares of LogMeIn are trading at 84 right now. So given my admittedly rough math (but by no means illogical), shares are trading at a slight premium based on this news. I think the implied market cap is closer to $4.5 billion.
So back to answer my question above, is the stock a Buy, Hold or Sell?
What do you do when you stumble into the bank to get change for $100, and the teller says they’re running a special and gives you $120 back? You smile and say, “thank you very much,” and head for the door.
Today, I recommend selling part of your position in LogMeIn to lock in the 45% gain. We’ve made it in just over seven months, and over that time, the stock has outperformed the small-cap benchmark by more than 26%. You can’t go wrong by taking a little off the table. Especially since there is integration risk as this deal moves forward.
Sell what you feel comfortable with. You can always sell more later. If you hold on, and this deal is done, the combined company should have a market cap north of $4 billion and be growing at around 15%, give or take a little.
For purposes of the Cabot Small-Cap Confidential portfolio, I’ll note my advice as Sell a Half. That means that, just like Mitek, we’re holding on to the rest for now. If it keeps going up, we’re psyched. We can just keep holding. If it goes down, we’ve still made money.
This is already a long update. But for those of you who are interested, I’ve copied parts of the internal memo that LogMeIn management shared with its employees below. It gives few more details about the proposed deal, but more importantly, it shows how big a deal this is to all those who work for the respective companies.
From LogMeIn’s internal memo:Why is LogMeIn merging with GoTo?
This transaction marks the beginning of what we see as an amazing new chapter for our company. Together we’ll become one of the world’s top 10 SaaS companies – a market leader with over $1 billion in revenue, nearly 3,000 employees and more than 2 million customers in virtually every country across the globe.
First and foremost, this deal accelerates our strategy. Over the past year, we’ve talked a lot about our growth strategy and aspirations, namely our desire to define the future of our three core markets while doubling the size of our business. We see this deal as a rare opportunity to accelerate this plan, and in the process fundamentally redefine and lead our industry.
We believe that when you combine GoTo’s broad customer base, business-tested products, and brand recognition with LogMeIn’s renowned focus on user experience, proven ability to win millions of users, and our deep experience running a growth business, you have a recipe for disruption. Specifically, we believe we will have the combined strengths required.
What name/brand will the new combined entity carry? Will the company be LogMeIn? GoTo? Something else?
We expect there will be a single parent brand for the new entity, but that brand and the timing of its rollout is still to be determined.
There is inherent product and business overlap. Do you expect to consolidate the product lines?
- This merger gives us the opportunity to completely rethink the way we go to market in transformative ways. While we don’t have all the answers, specific product decisions will be made by the combined management team after closing. In these cases, it’s typical to look at products in three ways:
- Some products may be rebranded and kept as-is
- For some, taking the best of features and functions, and roll them up into a new product
- In some cases, discontinue products
- An integration team will be formed that includes representatives from both LogMeIn and GoTo to help us start a planning process for things like products, that will guide how we bring the two businesses together. No decisions have been made regarding products.
- As we embark on this journey, customers should expect that their products will be supported for the foreseeable future
- It seems like this merger is focused on our collaboration, identify and access management, and customer engagement and support markets, what happens with products like Xively?
- We currently have no plans to change our course with Xively
- In fact, Xively is coming off its best quarter ever and has had a very good first half of the year
- We have and continue to believe that the IoT will have a meaningful impact on virtually every market in which we play today
- We’ve also been talking about the “Support of Things” and our long term strategy to redefine how company’s engage with their customers and their products
Should we expect that LogMeIn’s culture will change?
- The combination brings together two innovative cultures and both companies will play a role in contributing to the building of a new and distinct culture. We expect to bring together the best of both companies’ cultures, while creating new aspects to our culture to support our new business.
- At our cores, LogMeIn and GoTo both have a focus on the possibilities and outcomes our technology delivers for people: LogMeIn seeks to simplify the way people connect to each other and the world around us and GoTo believes that human connections are at the core of everything they do.
- Having a fantastic culture absolutely remains a goal of ours