2023-09-19 08:58:54 ET
Summary
- N-able's tailored solutions empower MSPs to assist SMEs in their digital transformation journey, addressing the complexity SMEs face in adopting digital solutions.
- While N-able's strong growth and cybersecurity focus are promising, its high valuation, compared to peers, may limit upside potential, especially in a risk-averse market or if quarterly results disappoint.
- As such, I recommend a hold rating until the valuation turns cheaper.
Investment action
Based on my current outlook and analysis on N-able ( NABL ), I recommend a hold rating. This recommendation comes despite my recognition of the company's impressive historical and current financial performance, bolstered by robust competitive advantages and strategic endeavors. However, it's important to note that NABL's valuation appears elevated when compared to industry peers in terms of the forward PE multiple. This suggests that bullish sentiments and NABL's positive outlook may have already been factored into its current stock price.
Basic Information
On a worldwide scale, NABL serves as a leading provider of cloud-based software solutions tailored for Managed Service Providers [MSPs]. These solutions empower MSPs to assist Small and Medium Enterprises [SMEs] in their journey towards digital transformation and growth. NABL's offerings enable MSPs to efficiently monitor their clients' infrastructure, oversee data management, and bolster network security. To ensure the success of MSPs on a larger scale and maintain their commitment to delivering exceptional value, NABL extends comprehensive and proactive support to them.
Over the past three years, NABL has exhibited a healthy CAGR of approximately 7% in its revenue. In 2022, the reported revenue reached 371.8 million, marking a significant 23% increase compared to the 2020 reported revenue of 302.3 million. Furthermore, it consistently achieved an impressive year-over-year revenue growth of approximately 14.5% from 2020 to 2021. It's worth noting that in 2022, while the growth rate moderated to 7%, this actual figure is 13% when considering it on a constant currency basis.
During the fiscal year 2022, NABL maintained a robust EBITDA margin, hovering consistently around 31%. However, I acknowledge that this margin has contracted from 39% in 2020 to 31% in 2022. This margin contraction is a result of NABL's deliberate strategic shift towards expanding and enhancing its business operations. Nevertheless, the positive aspect of this trade-off is evident in its growing revenue and EPS. Notably, in 2021, NABL successfully reversed its diluted EPS from negative territory, experiencing rapid growth to achieve a diluted EPS of 0.34 in 2022. Looking ahead, I anticipate that NABL will continue to capitalize on this strong momentum in revenue growth and margin improvement in the foreseeable future.
Industry review
Many SMEs are adopting digitalization but encounter complexities. Regardless of their size, businesses across diverse industries and countries are aggressively investing in cutting-edge cloud and digital technologies to modernize their operations and keep a competitive edge. Small and medium-sized businesses [SMEs], who are increasingly using digital solutions to increase efficiency in duties like monitoring, productivity management, and customer engagement, are particularly receptive to this trend. However, putting digital solutions into practice is more complicated than it might first seem. Many SMEs are used to utilizing outdated legacy systems, so when they look online for new solutions, the variety of options can easily overwhelm them. The need for accessible and reliable IT infrastructure for the SME sector is growing as it invests in and depends more on information technology [IT].
That said, every major problem has a workable solution, and the emergence of MSPs offers SMEs a chance to accelerate their digital transformation. SMEs are looking to IT service providers for help as they invest in technology on a greater basis and raise their standards for performance, availability, and security.
MSPs, in my opinion, contribute significantly to the value chain by giving SMEs crucial assistance with technology adoption, administration, and security. Furthermore, co-managed models, in which MSPs work with internal IT departments within SMEs, allow for the division of duties and the delivery of specialized services. In conclusion, I think MSPs improve the value chain by encouraging SMEs to adopt more digital solutions, which in turn increases sales for them.
NABL business review
NABL's solution is tailored to meet the requirements of MSPs. An MSP is required by definition to work closely with its clientele, especially SMEs. MSPs must have the ability to effectively connect with a wide range of clients remotely if they want to succeed in this position. In this regard, NABL sets itself apart. MSPs may control the availability and performance of numerous systems, network infrastructure, and devices from a single place by using their remote monitoring and management system. Thanks to NABL's role-based access restriction, this streamlined approach enables MSP professionals to save time by quickly pinpointing the reasons of particular IT issues. Online interactions with clients from many businesses can make compliance a major problem. The NABL solutions enable MSPs to help their SME clients strengthen their IT security architecture.
NABL's market strategy is also based on a unique "land and expand" approach. This business strategy, which is closely aligned with MSP partners, puts NABL in a position to successfully serve the SME market and achieve the targeted sales volume. This strategy's ability to let NABL develop alongside MSPs, in my opinion, is what makes it so noteworthy. This expansion takes place as MSPs increase the number of clients they serve, roll out new services made possible by NABL's technologies, and as their clients buy more devices and subscriptions. Additionally, NABL's partner success initiatives enable MSP partners to increase revenue, expand their customer base, and access and use technologies through NABL's platform. However, NABL's strategy for growing its network of MSP partners focuses on a low-touch, high-velocity approach.
Latest earnings review
NABL has once again outperformed my expectations in terms of both revenue and profitability in 2Q23, showcasing improved execution while maintaining a robust demand in the MSP sector. Notably, the revenue surged by 15.8% year-over-year, reaching $106.1 million, surpassing management's projected growth rate of 12%. Subscription revenue also exhibited impressive growth, increasing by 15.6% year-over-year, totalling $103.4 million. Additionally, the company achieved an adjusted EBITDA of $34.9 million, with an adjusted EBITDA margin of 32.9%, exceeding my expectations.
When compared to 1Q23, it's evident that revenue growth is gaining strength. In the first quarter, year over year revenue growth was at 9.9%, while the second quarter saw a substantial increase to 15.8%. This suggests a positive trend in revenue growth, and I anticipate this momentum to continue into the next quarter. Furthermore, NABL's consistent and robust adjusted EBITDA margin, which stood at 32.8% in the first quarter and remained in line with the current quarter's margin, is an encouraging sign. It indicates that NABL's EBITDA margin is likely to persist at this healthy level moving forward.
Historically, NABL has implemented price increases in the latter part of the June quarter. This year, they raised prices in April, resulting in a double benefit to NABL's revenue in April and May before the anniversary of the 2022 price increase in June. Despite the earlier price adjustment, the guidance for 3Q anticipates a year over year revenue growth of 13.9%-14.4%. This indicates continued robust revenue growth in the second half of the year, reinforcing my expectation of continued growth in the upcoming quarter.
Moreover, NABL's sustained sales execution has consistently driven revenue growth while keeping operating expenses in check. In this quarter, revenue growth at 15.8% year over year outpaced the growth in operating expenses, which was at 11.3% year-over-year. This was largely attributed to better leverage in Sales and Marketing and General & Administrative functions over the past year. I anticipate further incremental leverage from SG&A in the coming fiscal year, supporting continued revenue growth and an expanding EBITDA margin.
Valuation
I believe NABL can grow at 13% because of the following key factors. Firstly, the company's robust historical financial performance, combined with a strong second-quarter result and improved performance compared to the previous quarter, sets a solid foundation for growth. This performance is primarily driven by the widespread adoption of digital technology, with NABL playing a pivotal role in empowering SMEs on their digital journeys. Additionally, the growing emphasis on cybersecurity fortification has emerged as a significant driver of sales for the company.
In terms of margins, I anticipate NABL's margin to remain stable at 16%, which aligns with consensus expectations. The company has consistently demonstrated its ability to drive revenue growth while effectively managing operating expenses through better leverage of its SG&A expenses, resulting in improved incremental leverage. Based on my model, I have set a target price of $13.78.
However, when compared to peers such as Progress Software ( PRGS ) and SolarWinds ( SWI ), NABL appears to be overvalued. Peers have a median forward earnings multiple of 12.54x, whereas NABL trades at 37x. This is despite NABL's earnings margin stands at 5.59%, in line with the peers' median, and having a modestly higher NABL's debt-to-equity ratio of 3.52x, higher than the peers' median of 3.4x. While NABL's higher expected growth rate justifies the premium, there may not be sufficient margin of safety and upside potential for new investors at the current share price.
Even if I give NABL the benefit of doubt and assumes it trades down to its average of 33x, which is still at a very high premium, the stock upside is limited to only 4%, which is not attractive at all.
Author's work
Risk and final thoughts
In the stock market, corrections tend to have a more pronounced impact on stocks with higher valuations compared to the broader market. It is a potential concern given its high valuation. A shift towards risk-averse sentiment could lead to a decline in the stock prices of higher-valuation companies, even in the absence of a broader market correction. Furthermore, if NABL were to report quarterly results or guidance below market expectations, it could result in a contraction of its valuation multiple.
Overall, I recommend a Hold rating for NABL due to valuation considerations despite its strong performance. NABL has shown impressive financial growth and is well-positioned in the MSP sector, which is vital for SMEs' digital transformation. Recent earnings have exceeded expectations, with strong revenue growth and healthy margins, indicating continued momentum. However, NABL's high valuation compared to industry peers raises concerns. While its growth prospects are promising, the stock's current premium may limit upside potential for new investors. Market corrections could impact NABL's stock price more significantly due to its high valuation.
For further details see:
N-able: Hold Rating Due To Valuation Considerations Despite Strong Performance