Summary
- Alarm.com has seen its stock price plunge ~10% following its Q3 earnings release driven by weak Q4 guidance.
- Financial performance to date has been exceptional and decline in hardware sales in Q4 is likely a one time event.
- The company still has multiple growth vectors available.
- We present an updated forecast and highlight the significant valuation gap between Alarm.com and other SaaS peers.
Investment Thesis
In our recent coverage of Alarm.com (ALRM), we had theorized after stock price pullbacks that the company was mispriced by the market creating a compelling buying opportunity. Each time the stock price bounced back following the company's continued growth and margin expansion. We believe that ALRM's business is misunderstood by investors as it is a B2B play which has a moat that the market is unable to acknowledge despite stellar financial performance. In an environment where SaaS companies are trading at lofty valuations, ALRM is looking like a value play and we recommend investors establish a long position.
Price action since our last article (Source: Yahoo Finance)
Company Overview
ALRM provides a cloud-based platform and associated hardware for homes and businesses that deliver interactive security and other home automation services such as access and energy management. The company employs a B2B2C distribution model whereby it provides its platform and hardware as a white label product through ~7,000 service providers including ADT which has >25% market share in this otherwise highly fragmented market. These service providers take care of subscriber acquisition, installation and ongoing support while ALRM focuses on IP/product development and maintenance. Many end customers using a home automation/security app may not even know that they are on the ALRM platform. ALRM has a leadership position in the residential smart home security market with 65% - 75% market share (estimates vary).
Why the Recent Pullback?
Weak Q4-2019 Guidance
In ALRM's Q3-2019 earnings release, the company continued its strong top-line growth along with solid margins. This was accompanied with growing recurring SaaS revenue along with strong hardware sales. The problem however was the weaker guidance for Q4-2019. On a headline basis, the guidance pointed to a bleak future which is the key reason for the stock price plunging ~10% however circumstances are a bit more nuanced and we believe the market has over-reacted (the stock price has already recovered a bit since the earnings release on November 5, 2019 however we believe there is additional upside). The Q4 guidance in fact shows growing recurring revenue with a substantial decline in hardware sales. We view this as a temporary blip and it is not uncommon for hardware sales in SaaS businesses to be volatile as they are impacted on expenditure timing and client budgets. A review of ALRM's hardware revenue trends over the past 3 years shows that the volatility in hardware sales is not out of the ordinary.
The chart below shows quarterly performance over the past 2 years. Although the yellow YoY growth trend line has seen declines this year, investors must note that higher growth rates are more challenging to sustain from a higher base. Even with a lower growth rate, the company should still be able to grow its bottom line as it benefits from economies of scale. We believe that there are several growth vectors available to the company and these are discussed in the section below.
