ETWO - E2open Parent Holdings: Too Much Uncertainty Risk For Me To Stomach

2023-10-17 16:47:57 ET

Summary

• ETWO's 2Q24 revenue slightly below expectations, with weak professional services revenue due to lower utilization of services.
• Management reduced revenue guidance for FY24 by 5%, indicating a decrease in revenue and a diminished likelihood of positive outcomes.
• ETWO's potential for inorganic growth through M&As is unlikely due to increased costs of capital and limited leverage capacity.

Investment action

I recommended a hold rating for E2open Parent Holdings ( ETWO ) when I wrote about it the last time, as I wanted to get more clarity on the sales and marketing strategy and the magnitude of S&M investments. Based on my current outlook and analysis, I recommend a hold rating. I believe the uncertainties are elevated, making it extremely difficult to model the near-term performance. The downgrade in FY24 growth, the potential decline in EBITDA margins to drive organic growth via cross- and up-selling, and the departure of the CEO are just too much risk for my stomach at the moment.

Review

ETWO's 2Q24 recorded a total revenue of $158.5 million, slightly below the anticipated consensus of $159.9 million. The revenue performance of the company was primarily influenced by the subscription revenue, which amounted to $134.7 million and experienced a year-on-year growth of 2.4%. Additionally, the professional services revenue amounted to $23.8 million. However, professional services revenue was relatively weak due to lower-than-anticipated utilization of services among significant clients, a trend that persisted throughout the second quarter. At $56.1 million, Adjusted EBITDA surpassed expectations of $52.3 million. The increase in EBITDA resulted in a non-GAAP net income of $16.9 million.

Although ETWO has made strides in enhancing its profitability, I contend that the drawbacks experienced during the quarter significantly overshadow this positive aspect. Additionally, these factors have contributed to my growing pessimism regarding the business's prospects in the short term. To begin, management reduced their revenue guidance for FY24 by 5%, which is approximately $32.5 million at the midpoint. The FY24 guide suggests a decrease in revenue of 3.4% at the midpoint when compared to the previous year. This development represents a significant shift in circumstances, as I had anticipated a certain degree of economic recuperation during the gradual recovery process. Significantly, the remarks made by management convey to the market a diminished likelihood of any potential positive outcomes. The occurrence of delayed transactions persists, as customers are increasingly scrutinizing their expenditures and exhibiting reluctance towards undertaking lengthy transformation processes with uncertain outcomes in the current macroeconomic climate. Notably, these trends exhibited a further decline towards the conclusion of the quarter, which means 3Q24 is likely to face a similar dynamic. If that is not conclusive enough, management anticipates that the lackluster performance observed in the completion of deals, implementation of cross-selling strategies, and attachment rates of professional services during the quarter will continue to persist for the duration of the year.

For investors who believe that ETWO has the potential for inorganic growth through M&As, considering the company's recent activity in this area with four acquisitions in the past few years, it is regrettably improbable. It is important to note that the current cost of capital has significantly increased, and the leverage profile of ETWO is approaching a level of approximately 5 times the estimated EBITDA for fiscal year 2024. This greatly diminishes the leverage capacity that ETWO can utilize to carry out additional mergers and acquisitions. Moreover, as previously mentioned, I appreciate the strategic decision of ETWO to allocate resources towards sales and marketing activities prior to the anticipated economic upturn. However, it is important to note that this approach necessitates the presence of a robust financial position in order to effectively execute such investments. Once again, this constraint hinders the ability of ETWO to carry out substantial mergers and acquisitions.

Therefore, I believe the sole means by which ETWO can achieve further growth is through the implementation of up-selling and cross-selling strategies to promote its products and solutions among its existing customer base. This task is more challenging in practice than it may appear in theory. The sales force and go-to-market strategies of ETWO are expected to necessitate several quarters of investment, realignment, and training to effectively facilitate significant cross-selling initiatives, as indicated by management during the earnings call. In addition to addressing these changes, ETWO is currently grappling with a customer base that is subject to budgetary scrutiny in an uncertain macroeconomic climate. This situation has resulted in prolonged sales cycles, increased customer turnover, and reduced utilization rates for professional services. Hence, the potential traction for up- and cross-selling has low visibility as well.

The recent announcement of the departure of former CEO, Michael Farlekas, from the company represents a significant development that introduces additional uncertainty to the stock. In my opinion, ETWO's new management team has the necessary industry experience to pinpoint problem areas and set priorities for fixing them. Nevertheless, the absence of a proven track record in executing strategies while leading ETWO introduces an element of uncertainty, which is evidently disfavored by the market as indicated by the significant decline in the stock price subsequent to the earnings report.

All in all, I believe the growth outlook is very weak in the near term, and there is little visibility as to when the business will recover. To drive growth, I expect ETWO to give up some of the EBITDA margin improvement it has gained recently, as management will need to reaccelerate operating investments to drive growth as demand returns. Moreover, these uncertainties make it hard to model the business in the near term (which is why I am skipping my valuation section for this quarter update).

Final thoughts

My assessment of ETWO points to a high level of uncertainty. The recent performance, characterized by a decline in revenue, lowered guidance, delayed transactions, and challenges in up- and cross-selling, does not inspire confidence in the short-term prospects of the company. Additionally, the departure of the CEO introduces further uncertainty. While ETWO has shown profitability improvement, the current economic climate and increased costs of capital make inorganic growth through mergers and acquisitions unlikely. The need for substantial investments in sales and marketing, coupled with a cautious customer base, further dampens the outlook for growth. As such, I recommend a hold rating, given the elevated uncertainties.

Overall, the path to recovery for ETWO appears uncertain and challenging, making it a less-than-ideal investment option at this juncture.

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