Datto Holding (NYSE:MSP) went public on Oct. 20 at $27 per share and trades around $32.72, as of Nov. 13. That represents a 21% gain for the IPO owners, but there is still a question of whether MSP stock represents a bargain for new investors.
So far, I don’t think so, although the company has not yet released its Q3 earnings. They are due to come out on Nov. 23 and that could potentially change my mind.
But for the time being, I believe MSP stock could be overvalued based on its historical financials and my projections going forward.
First, here is a little on Datt’s business model. MSP stands for Managed Service Providers. That is who Datto Holdings clients are, which it calls “partners.” Datto Holdings provides cloud-based software and technology solutions to more than 17,000 MSPs.
Essentially MSPs provide cybersecurity and data backup software from Datto for their clients, mostly medium and small businesses. Datta has more than 1,000 MSP partners which contribute over $100,000 in annual recurring revenue to Datto.
MSP Stock’s Enterprise Value
Here is how I went about assessing MSP stock’s value using its public data. The problem with the state of disclosure in the U.S. in public documents is the SEC does not allow forecasting in a company’s IPO documents.
However, by contrast, SPAC (special purpose acquisition companies) mergers with private companies consistently provided not only multi-year forecasts but also peer valuation forecasts. This differential makes no sense to me, but, of course, as usual, the SEC has no clue about how to make investing easier for investors.
Nevertheless, here is what we can glean from the IPO documents. Data Holding sold 25.3 million shares at $27, raising $683 million before expenses. However, there were 135.91 million shares outstanding before the IPO, according to the company’s latest prospectus, page 70. Therefore, there are now 161.21 million shares outstanding, giving it a market capitalization of $5.274 billion at $32.72, as of Nov. 13.
The best information we can get from the IPO prospectus is that on page 16 some basic summary financial information is provided. Normally the dearth of financial information like this would never pass muster in a private merger. But for some reason, the SEC thinks it is sufficient for public investors.
The company has $576.69 million in debt and $59.55 million in cash. Therefore, after the IPO, it now has $742.55 million in cash (minus IPO expenses, which I estimate will be about $10 million to $15 million), and debt of $579.69 million. So the net cash position is about $147 million.
Therefore, the enterprise value (EV) for MSP stock is $5.128 billion (i.e., $5.274 billion market value less $147 million net cash). We can use this to estimate the company’s valuation metrics.
MSP Stock’s Valuation
To estimate the company’s EV-to-EBITDA ratio (earnings before interest, taxes, depreciation, and amortization), we need to find and estimate its EBITDA number.
The company does not provide an estimate for the 2020 EBITDA. The best we can find is its half-year results of adjusted EBITDA of $63.851 million. This was 53% higher than last year.
Therefore, let’s estimate that the 2020 number will be 53% higher than last year. The 2019 adjusted EBITDA number was $84.6 million. Using a 53% increase factor, that puts the forecast 2020 adjusted EBITDA at $129.4 million. Another way to do this would be to simply double the half-year number of $63.85 million. That results in $127.7 million. To be optimistic, let’s use the higher number, $129.4 million.
Now we can measure the EV-to-EBITDA ratio. We divide $5.274 billion by $129.4 million, to derive a ratio of 40.78 times EV/EBITDA.
That is extremely high. It leads me to the conclusion that this IPO is fully valued. Unless, of course, I see the Q3 results, which might show an even higher than 53% growth rate in adjusted EBITDA.
What to Do With MSP Shares
It’s hard to say right now that this is not a growth stock. For example, it appears that the underlying rate of growth in MSPs is significant. The MSP market is expected to grow from $152.45 billion in 2017 to $257.84 billion by 2022, representing an 11% compound annual growth rate.
Therefore, I would expect to see a similar increase in Datto’s adjusted EBITDA. Let’s estimate that in five years its adjusted EBITDA has grown by 11% annually. That represents an increase of 68.5% over that period. Therefore, adjusted EBITDA would be at $218 million.
The problem is that this still means the EV/EBITDA ratio is high in five years. That would put it at 24 times (i.e., $5.274 billion divided by $218 million).
However, assuming a 40% growth rate over that period would lower the multiple to just 7.6 times (i.e., $5.274 divided by $696 million).
Therefore, we can conclude that the market expects that MSP will grow its bottom line by at least 40% annually over the next five years. This is fine, but it also means that there is no room for any kind of slowdown. In other words, MSP stock is at full value, with no margin of safety. Let the buyer beware.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.