Description

Double-Take Software (DBTK) offers compelling value with relatively little downside at current prices. When reporting fourth quarter numbers, the company released lower than expected margin guidance due to high product development spending. The market punished the stock brutally. The stock is down to $12.90 from $21.72 at year-end. The selling is far overdone, partly driven by fast-money growth investors hitting the door at any price, and perhaps exacerbated by the overhang from ABS, a private equity investor that has been selling its stake over time. The company develops, sells, and supports software that reduces downtime and protects data for business-critical systems. The company's software continuously replicates application data on a separate server. This facilitates recovery in the event of a disaster or other service interruption. DBTK's solution appears to be the leader within the host-based replication market, particularly with Microsoft Servers.

Double-Take's software is useful for both small enterprises (20 people) and Fortune 500 companies. While the customer breakout is not exceptional, their 2006 10-K indicates "Our customers include over half of the Fortune 500 companies, 20 of the 25 largest U.S. law firms in the 2006 The American Lawyer AmLaw 100, over 1,000 financial institutions, over 1,100 hospitals and healthcare service providers and over 1,000 school districts and educational institutions." DBTK sells primarily through resellers [75%] (Dell with 17% of total sales), distributors [11%] (Sun Bell (12% of sales), Bell Microproducts, and Tech Data), OEMs [9%] (Hewlett Packard), as well as through an in-house direct sales force [5%]. The company has roughly 10,000 customers and half the Fortune 500 (in some capacity). 40% of their sales are maintenance and professional services contracts, whereas 60% are perpetual licenses. Roughly 1/3rd of its new sales are to existing customers (e.g. BofA Atlanta tells BofA Boston about their replication software). Given the small deal size ($10k avg), the business has more consistency than software companies built on fewer and larger sales on a quarterly basis. Finally, 35% of sales last year were international and this percentage will likely rise with the recent decline in the dollar (which will contribute further to dollar-denominated growth).

The company's current EV is $220mm ($65mm in cash and short-term securities), 2007 sales were $83mm, and 2007 EBITDA was $19mm (22.9% margin). 2006 Sales were $61mm and 2006 EBITDA was $8.6mm (14.1% margin). The Windows server portion of the replication solution market's growth has been and will continue to be 20% - 25% per year for the foreseeable future according to IDC. DBTK is 6th in the $2.7B (2006) replication market, behind integrated solutions (EMC, Net App, HP, IBM, Sun). Other public companies with similar profiles (CVLT, FALC) trade at much higher valuations. CVLT has lower operating margin growth prospects than DBTK yet trades at a 100% EV/EBITDA premium, while FALC has slightly better growth prospects and trades at a 300% EV/EBITDA premium.



Management has guided to $103mm in sales in 2008. We think this is conservative for two reasons: the company has a new product, TimeSpring, to push starting late in the 2Q and the company is also implementing a 10% price increase through increasing the price of renewal maintenance agreements. They are likely to beat their 25% sales growth guidance. In addition, the company has guided to compressing margins. With incremental EBITDA margin of at least 40%, one would expect guidance to yield EBITDA of $27mm (26.2% margin) in 2008, but mgmt guided to $23.5mm (22.8% margin). As mentioned above, the margin decrease in spite of strong revenue growth led to the sell off. However, a bit of history of DBTK's earnings guidance is instructive here. Last year mgmt guided to 18% EBITDA margins but generated 23%. Management also guided sales to be $78mm - $80mm, but generates sales of $83mm (beating growth guidance by 7%), so they've established a track record as being overly conservative. The main reason that margins beat in 2007 was completely within management's control -- they did not hire all the people they said they were going to. We believe that may be the case in a more limited way this year, although it's possible that they will finally go forward with an aggressive and seemingly unnecessary hiring spree.

Looking forward a few years, DBTK's net income, NI, (adjusted for goodwill amortization) relative to mkt cap net of cash, EV, will probably look like:

Current EV $220mm (using EV/TTM NI rather than mkt cap/TTM NI because of the high cash balance - EV just means market capitalization less cash in this case)
2007 NI $13mm EV/TTM NI = 16.9x
2008 NI $18mm EV/TTM NI = 11.5x
2009 NI $25mm EV/TTM NI = 7.6x

Given the growth rate, niche, and expected future profitability, DBTK deserves to trade closer to a 25x forward EV/NI currently, or $22/share (which would be 16.4x 2009 expected EV/TTM NI).

This year the guidance takes into account an additional $4mm they are spending expanding and integrating a recent acquisition, TimeSpring (bought for $8mm late in 2007 - almost zero revenues currently). They are hiring developers for an office in Montreal intended to integrate the TimeSpring software (which will be sold as a separate piece of software with its own price tag) into the Double-Take software suite. TimeSpring allows for a relatively painless process of rolling back in time on a given application. For instance, imagine accidentally deleting a table in a SQL Server database. TimeSpring customers can roll back in time to the last 10, 100 or 1000 transactions to reinstate the database prior to the accident. While DBTK's customer base should value TimeSpring's products, it's hard to projection what additional gross margin dollars will be generated by TimeSpring sales. However, by incorporating aggressive TimeSpring spending but no additional TimesSpring revenues, DBTK appears to again be acting with extreme conservatism.

Moving on to the main software package, the essential point on Double-Take's software is that it is as good as or better than competitor solutions at a lower price point. Double-take offers bit-by-bit background replication (every time something changes on the host computer the backup computer is updated) and instantaneous failover (if the hard-drive fails on the host computer, the backup computer replaces the host in a matter of minutes). This is a solution that is a significant step up from more traditional processes of bringing the system back online (tech guys scrambling to reboot and adjust for the error). Given that the per workstation cost is approximately $1,000, the Double-take solution comes in at a price significantly below solutions with comparable functionality offered by EMC, Symantec, Microsoft, and Neverfail [prices would be helpful here]. It is a much easier solution for small and mid-sized businesses data needs than larger more expensive non-modular solutions. A list of competitors for those looking to dig further on this point:

Tape Backup: Symantec Netbackup, IBM Tivoli Storage Manager, CA Brightstor Enterprise Backup, Legato Networker, CommVault Galaxy
Snapshots: Microsoft Volume Shadow Copy Service, EMC TimeFinder, Snapview
Clustering: Microsoft Cluster Service, Symantec Cluster Service, Steeleye lifeKeeper, Legato AutoStart
Remote Disk Mirroring: EMC SRDF and Mirrorview, Symantec Volume Replicator, FalconStorIPStor, DataCore SANmelody, Hitachi TrueCopy
Continuous Data Protection: Revivio CPS, Mendocino Software RecoveryONE, TimeSpring TimeData, Kashya KBX5000 Data Protection Platform, Microsoft Data Protection Mgr
Host-based asynchronous Replication: Symantec Replication Exec, Legato Replistor, Neverfail, XOsoft WANSync

Weak hands in stock as of year-end 2007:
The Top 3 Holders as of 12/31 were:
ABS Capital Partners -- pre-IPO private equity investor who just registered their shares
Copper Rock management -- a private client investor whose website states: "Copper Rock Capital's investment strategy is constructed to outperform in up markets due to our pure fundamental growth approach and also to protect our clients' capital with our portfolio construction and strong sell discipline. We believe we are good buyers of stocks and great sellers of stocks."
Oberweis Capital Management -- "On a style continuum, OAM’s focus falls between Growth and Momentum. AGARP or Aggressive Growth at a Reasonable Price is an accurate description of our investing style, a process that allows for the detailed evaluation of rapidly growing companies selling at a price no greater than half their internally generated growth rates."

These seem like potentially weak hands to us in the current environment, as do many of the other investment firms holdings shares as of the 12/31 round of 13-Fs. The technicals in broken momentum stocks have likely increased the overreaction of DBTK shares to guidance.

Acquistion target?:
At these levels, Microsoft is a potential acquirer of Double-take. Their solutions have not caught on and tend to be lower quality. MSFT's competition has come in the form of free (included) tools, but they offer a program-by-program solution, rather than a server-wide suite. Their replication software doesn't support non-Microsoft programs, for instance. Double-take continues to wait for a big push in their core market out of MSFT, but has not seen one yet. At the current DBTK valuation (7x next year's EBITDA), MSFT has to see DBTK as a potential solution to their replication software problem.

Catalyst

Next few quarters show continued outperformance relative to mgmt guidance. Valuation-focused investors replace growth investors.