Cornerstone OnDemand: Saba Acquisition Should Deepen Its Moat (NASDAQ:CSOD)
Cornerstone (CSOD) is one of the long-time players in the enterprise LMS (Learning Management System) market. The company has been in business for over 20 years. Since its IPO in 2011, growth has decayed from +60% to +7.5% today. Considering the $1.3 billion Saba acquisition that will produce a combined entity with a +$800 million of revenue and steadily expanding double-digit FCF margin, Cornerstone presents an interesting investment opportunity. Furthermore, the added risk factors as a result of recent corporate actions and COVID-19 headwinds have also put pressure on the stock to create a good entry point opportunity. Currently, the stock is down ~65% from YTD-high.
Cornerstone’s $1.3 billion Saba acquisition will be a key catalyst. The combined entity will have a revenue of over $800 million and provide a significant boost to overall cash flow generation.
(source: company’s earnings call slide)
In addition to the potential $50 million synergies due to the consolidation of technology infrastructure, facilities, and go-to-market teams, Saba will also provide an additional $85 million of unlevered FCF to bring the total incremental cash flow to $135 million. With the expected combined unlevered FCF of $225 million by the end of the year, the figure is already higher than the total sum of Cornerstone’s FCFs in the last two years.
(source: company’s 10-K)
Given the upcoming dry powder, the company will now be presented with more optionalities to create more shareholder values. As an example, the current less favorable backdrop putting pressure on the shares price in recent times can potentially encourage the management to repurchase more shares. As it stands in 2020, over $126 million worth of share repurchase can be exercised according to its 2019 program.
It is no doubt that COVID-19 will slow down new client acquisitions considering Cornerstone’s focus on the enterprise segment, which typically requires a longer sales cycle and a higher-touch approach. Moreover, based on the Q1 earnings call, about 1% of the company’s workforce, or about 20 people, tested positive for the virus.
(source: company’s earnings call slide)
Based on the management’s comment in Q1 earnings call, the current 2 – 10 month-long sales cycle will be stretched even further into 2021. The company, however, has prepared for this scenario as it will expect at least $225 million of pro-forma liquidity at the end of next year.
On the other hand, another thing that concerns us is the timing for the CEO change, which has come at a time where the company is facing a challenging macro backdrop while in between two M&A deals. In the same quarter as the major $1.3 billion Saba deal, the company also acquired a French AI company, Clustree, for $18.5 million. Given the heavy-lifting work required between realizing the cost synergies and culture fit, COVID-19 disruption will serve as a major distraction for the management, which is currently in a major transition. As Cornerstone’s CEO of 20 years and co-founder Adam Miller is moving into the Chairman role, the Saba CEO Phil Saunders will come on board to replace him as CEO. Despite Saunders’ extensive experience in the enterprise LMS business, Cornerstone will now no longer have any founding member in its executive team.
Considering Cornerstone’s current $38 price per share and over 63 million of outstanding shares, which already accounts for the ~1.1 million additional shares issued as part of the deal, Cornerstone is valued at ~2.4 billion in terms of market cap as a standalone. With the expectation of ~$838 million of revenue as a combined entity, assuming it will conservatively trade at Cornerstone’s current ~4x P/S means the combined entity’s market cap should roughly be ~$3.3 billion.
(CSOD stock price. source: google)
With that in mind, the combined entity can trade conservatively at ~$52 per share upon realizing the synergies at the end of the year. Therefore, under the assumption that there will be seamless integration, there is a lot more upside than downside, as the ~$38 price level at the moment has potentially priced in some of the risk factors we have discussed. We will be cautiously bullish on the stock. We believe that the price provides enough margin of safety for the investors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.