LogMeIn IPO: Slight Disconnect

After a busy week, in which four IPOs made their way to the market, software solutions provider LogMeIn  will unveil its own offering on Wednesday. The offering will total 6.7 million shares with a price range of $14-$16 per share. Morningstar equity analyst Rafael Garcia likes the firm's products, but is a little sour on the economics of the business. He values the company at $14 per share, at the low end of its range, and further expounds on LogMeIn's long-term prospects in his thesis:

"LogMeIn deserves high marks for its software solutions, but the economics of its business are discouraging. We think the firm is well positioned to capitalize in the near term on the growing adoption of remote-access solutions for personal computers. However, its long-term success rests on its ability to convert its users of free services to paying customers.

LogMeIn's software solutions allow users to remotely access and control any computer connected to the Internet, using an ordinary Web browser. Its flagship product, LogMeIn Pro, enables a computer to transmit its screen content to another remote computer. Once connected, users gain seamless control and access to the remote computer's resources. This on-demand software is hosted on LogMeIn's data centers and provided as a service on a subscription basis. Clients find the firm's remote-connectivity applications valuable because the software enhances the productivity of mobile workers and reduces support staff time and resources by enabling access to remote computers.

To differentiate itself from its competitors, LogMeIn offers its low-cost solutions to individual users and small and medium businesses, which are attracted to remote-connectivity applications that require low cost of operation, negligible infrastructure investments, and minimal IT support. Accordingly, its strategy has been to quickly build a lar ge user base by offering free applications along with premium products, which the company presumes will enable it to capture paying customers at a lower cost than its competitors. LogMeIn's solutions have proved highly popular. The number of electronic devices remotely accessed through its services has increased from 13 million in 2003 to around 70 million at the end of March 2009. Despite the fast adoption, almost 90% of LogMeIn users do not currently pay for the services. Therefore, the company's long-term profitability largely depends on its ability to convert users of free services into paying customers and retain them. This is a tall order, in our opinion."

 

Rafael goes on to give credit to the firm's early expansion, but notes that it suffers from lack of an economic moat that would protect its business:

"We believe LogMeIn's rapid expansion--from $1 million in revenue in 2003 to $52 million in 2008--highlights the strong demand for remote-access s olutions. However, we do not believe the company has an economic moat. End users face low switching costs because remote-access tools are easy to use and such products are becoming harder to differentiate. In addition, LogMeIn's target customers tend to be more price-sensitive than large corporate customers are; thus, we believe the company's pricing power is limited. Lastly, we believe LogMeIn's current competitive advantage lies in its state-of-the-art technology, which allows it to offer free services to its large user base at a low cost. However, technology-based advantages tend to be ephemeral. LogMeIn's technology can be matched by larger and well-funded competitors such as  Citrix , which offers the also-popular GoToMyPC service, and  Cisco's (CSCO) WebEx solution.

LogMeIn has added several premium solutions that pose intriguing opportunities. The firm now offers products to support remote connectivity to smartphones--a well-timed and shrewd move, in our opinion. Smartphones like  Apple's (AAPL) iPhone and  Research in Motion's (RIMM) BlackBerry have experienced explosive growth over the past few years. We believe LogMeIn will benefit as users and manufacturers adopt its solutions to gain remote access to and from smartphones and other electronic devices. In addition, the firm has a licensing and revenue-sharing agreement with  Intel (INTC) to develop services that work with the chipmaker's hardware an d software products. While it is too early to estimate the value of this relationship, the contract represents a potential source of significant revenue for LogMeIn."

With respect to his fair value estimate of $14 per share:

"While LogMeIn dominates only a small piece of the remote-connectivity market, we believe its focus on individual users and small businesses will propel impressive growth in the near term. Long term, however, persuading its customers to pay for premium services will prove to be challenging. In our base case, we expect revenue to expand at a 26% compound annual rate through 2013, including a 58% increase in 2009 and 34% growth in 2010. Revenue should increase as a result of higher LogMeIn premium service adoption, revenue-sharing agreement with Intel, and licensing of its RemotelyAnywhere product. However, we expect revenue growth to gradually diminish because of competition. While LogMeIn has been unprofitable on an operating basis over the past six fiscal years, the firm broke even during the third quarter of 2008 and its operating margins have steadily increased ever since. We assume that operating margins will expand from negative 10% in 2008 to the mid-20s by 2013, as the company benefits from the leverage of its operations. To discount future cash flows, we use a weighted average cost of capital of 13%."