Time for a Backup Plan

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

 On November 6, J2 Communications (NASDAQ: JCOM) reported a 9.9% ownership stake in Carbonite (NASDAQ: CARB), as well as a continuing interest in acquiring its competitor.  J2 also disclosed that it submitted a buyout offer of $10.50 per share in cash, or roughly $269 million, to Carbonite’s board on August 31, but the offer was rejected without a counter response.  The offer valued the company at 4.4 times FY2011 sales and 9.7 times FY2011 book value, a rich premium given that Carbonite has yet to reach profitability in its business.

What’s the Value?

Carbonite is a leading provider of online backup solutions for consumers and small businesses.  Founded in 2005, it was one of the first companies to provide unlimited backup of customers’ files, photos, and documents for a fixed monthly fee.  Carbonite has grown very fast over the past four fiscal years, with revenues and total customers rising 2709.3% and 1187.4%, respectively, between 2007 and 2011.  While the company has been successful in its direct marketing efforts, with roughly 1.4 million customers as of September, the marketing and infrastructure costs have resulted in operating losses in each year since its founding.

Meanwhile, J2 has been diversifying into the data storage market, with its purchases of Data Haven in July 2011 and C Infinity in October 2011.  After beginning as an online fax services provider in 1995, it has grown consistently through acquisitions, including 37 purchases since 2000.  J2 sees significant value in combining Carbonite with its own backup services businesses in order to gain critical mass in this growth sector.  Individuals and businesses are increasingly accessing their information remotely, through internet connections on computer laptops and mobile device applications.  Providers of online backup solutions provide customers with the desirable benefits of encrypted security, unlimited storage, and remote accessibility.  The use of mobile devices is a trend that will continue in future years and the market for storage solutions will grow proportionately.

J2 has a strong track record of integrating its acquisitions efficiently, with revenues and operating income growing 49.6% and 57.3%, respectively, over the past four fiscal years.  Despite lackluster global growth this year, the company has continued to deliver for investors.  During the first nine months of 2012, J2 reported revenues and operating income of $269.3 million and $119.9 million, increases of 9.9% and 23.1%, respectively, over the prior year period.  Both gross and operating margins remained near their highest levels of the past five years and J2 reported solid operating cash flows that added to their strong financial position.  However, top line growth has slowed versus the prior year and the company sees an opportunity to put its cash to work at favorable long term returns.

Stick with the Leader

Given Carbonite’s unwillingness to negotiate, investors should watch this corporate drama from the sidelines.  Instead, investors wanting to participate in the future growth of the sector should stick with EMC (NYSE: EMC), the industry leader.  The storage business requires large scale and capital to compete effectively, and EMC has significant amounts of both.  The company is a leader in most of its business segments, including enterprise storage systems, backup and recovery solutions, and IT security solutions.  Over the past four fiscal years, EMC’s revenues and operating income grew 51.2% and 97.9%, respectively, as it continued to gain market share and pursued selective acquisitions.  In addition, the storage giant has a majority stake in VMware, the fast growing leader in virtualization and IT infrastructure solutions.  There is always the possibility that EMC may spin the shares off to investors at some point in the future.  With EMC’s current stock price valuing the company at roughly a 14 P/E multiple, it a long term holding for any portfolio.

rghanley owns shares of Carbonite and EMC. The Motley Fool owns shares of EMC. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus