As I mentioned in the update to my last Commvault post, I found some extra public financial data after I’d finished writing that post. It sheds some additional light on the company that helps to test what I wrote last time.
Here’s the DuPont breakdown for financial years 2006 to 2013:
Pretty similar to the last chart I showed you, but it does show a couple of additional things. For instance, it shows that Commvault’s asset turnover has been steadily dropping over time. That’s not a good trend, and it’s entirely due to Commvault hoarding cash. Cash as a percentage of total assets has been increasing steadily from 43.9% when they went public in 2007 to 71.7% in 2013.
The costs trend is also interesting:
Services costs have been creeping up the past couple of years after dropping nicely since 2007.
I stand by what I said earlier, but with some perhaps harsher criticisms now that I have more information.
Commvault’s tax rate is also higher than I would expect. The headline rate in the US is about 35%, and Commvault have been paying at least that much. Now, it’s good for a company to pay the tax it should rather than playing legal, but unseemly,games with jurisdictions to avoid paying tax, or lobbying for special tax exemptions. (Yes, it’s all legal, and I have more of an issue with the politicians who allow this to occur. Keep your pricey lawyers kennelled.)
But I digress.
It does puzzle me that Commvault should be paying all this tax when Dell is paying 25% or less, and SolarWinds is paying under 30%. Dell is ten times the size of Commvault, but SolarWinds is a similar size to Commvault. Now I don’t wish to disparage people I’ve never met, but I have to wonder if Commvault’s tax department has the right talent or resources to do their job as well as the people working at Dell and SolarWinds. Maybe there’s something else going on I don’t know about to explain the disparity, but it concerns me nonetheless.
The cash situation also bothers me. Not because lots of cash is necessarily bad, but for what it means about the way the company is run. It’s to do with sustainable growth, so I’ll explain.
A company’s sustainable growth rate is essentially the rate at which they’re able to fund growth without seeking external funding. If you’re making loads of sales, and hanging on to lots of the money (good profit margins) then you can fund your growth without getting a loan from the bank.
Commvault is a high growth company: Sales is growing every year by more than 15%, and above 20% the past couple of years. That has implications.
When sales is growing, you need to be able to fund that growth. You have to hire more staff to service these new customers: sales staff, admin staff, engineers, etc. You need to buy more equipment: factories (if you make widgets), office-space (for your staff to work in), etc.
For new companies, fast growth can actually be really dangerous; you can run out of cash. If you run out of cash, suddenly you can’t pay suppliers and you actually go bankrupt, even though everything is otherwise going well. This can happen even though you’re booking loads of sales, and may be profitable. It’s one of the main things that CFOs worry about: how much cash will we need to fund our operations, and when will we need it?
Because the cashflow problem is really one of timing. If you run low on cash, you need to get more from somewhere. Selling stock takes time to set up, and so does negotiating loans. You’re also in a really bad negotiating position if you desperately need cash to pay your rent, because anyone who might lend you money can charge you a lot. And they will, because you running low on cash increases the risk of going bankrupt, which means the lender may not ever get paid back. So the bank will charge you a motza for the emergency loan, because you weren’t on top of your business enough to notice the cashflow problem until really late in the game.
Why Am I Concerned?
And now it’s time for another chart:
One reason tech companies like to have a lot of cash around is for acquisitions. Technology changes quickly, so tech companies need to be able to move quickly to adapt to changing circumstances. That costs money, and cash is the ‘fastest’ money there is. You don’t have to go and negotiate with a bank, or potential investors/stockholders, in order to get money. You already have it. You also don’t have to sell any other assets, which can also take time.
But Commvault aren’t making any acquisitions, unless they’re saving up for something big. Commvault’s growth is all through good old-fashioned sales growth. Their product is selling really, really well. They don’t actually need any acquisitions, and it would probably be a bigger distraction that it’d be worth.
So we’re back to sustainable growth rates. Commvault need cash because their actual growth is mostly outstripping their ability to fund the growth internally.
Now most people reckon Commvault are awesome, as evidenced by the surge in their stock price over the past few years. That’s mostly about expectations of the future, and with growth forecast to be somewhere up around 30% for the next couple of years, that’s not unreasonable.
But I look at my spreadsheet and I see ROA of only 9%, and ROE of only 15%. I see cash as 71% of total assets. I see Commvault as a savings account with an OK yield. It’s only OK, because it’s a much riskier investment than a term deposit with a major bank, and I’m not being compensated all that well for taking on significant extra risk.
Unless you bring in the stock price. But now you’re speculating on the future value of the stock, not dealing with the fundamentals of the business, which means it’d better be a brilliant return, because stock price speculation (i.e. gambling) is riskier once again. This bothers me, because a company with this sort of sales growth should be able to generate a hell of a lot better return to shareholders without needing to rely on speculators driving up the stock price.
Now having said all that, the fundamental performance from Commvault has been improving. Net Income as % of Sales is up from 5.3% in 2009 to 10.7% in 2013. Operating income is up from 8.7% to 16.3%. Commvault are holding on to more of the sales money. Net income is growing at an average of 45.5% over the past 4 years.
My problem is that all that cash is just sitting there. It’s not being actively used to do anything. It’s not being invested in the business, and it’s not being given back to shareholders as dividends so that they can go invest it in other things. Its function as a liquidity hedge isn’t convincing, because the US has ridiculously loose monetary policy right now and loans are easy to get at super-low rates.
Commvault are far from alone in this regard, and no one is really sure why companies do this.
These companies have an awful lot of other people’s money just sitting around doing nothing, and I wish shareholders were grilling the executives about this more than they are.
If companies can’t find something productive to do with all that cash, then give it back so we can give it to someone who can.