Cellebrite Stock: Valuation Falls as Valuation Catches Up (NASDAQ:CLBT)

Summary

A quick update since my last coverage (11^th July): I gave him Cellebrite (NASDAQ:CLBT) a buy rating as the company’s strong competitive advantage, mission-critical function and excellent execution convinced me that it can continue to grow by 20%. In in this update, I revise my rating from buy to hold as valuation has caught up, making the upside much less attractive today despite a better fundamental outlook.

2Q24 results are even better than I expected.

In the latest quarter (2Q24), reported two weeks ago, total revenue was solid, growing 25% y/y to $95.7 million, which beat the consensus estimate of 4.1% and my growth expectation for FY24 of 20%. In particular, subscription software revenue grew 27% year over year. Profit numbers were also solid, with EBIT coming in at ~$20M and adjusted. EBITDA at $21.6 million. On the margin, EBIT margin improved by 300bps sequentially and ~840bps yoy, while adj EBITDA margin expanded by 290bps and 810bps yoy. With solid performance, management revised its guidance, now expecting $390 million to $398 million (implying growth of 20% to 22%) and EBITDA of $90 million to $95 million.

Several indicators and initiatives are progressing well

2Q24 results should further convince investors that CLBT can continue to grow >20% for the foreseeable future, especially with all the positive developments seen. For starters, the leading growth indicator – annual recurring revenue (ARR) – grew even faster than total revenue, up 26% y/y to $345.9 million. The key driver in the ARR growth equation is that cloud-based and SaaS solutions have nearly doubled in the past year and are now generating a low percentage of ARR in the teens. We know that subscription software revenue is growing at 27% y/y, which means ARR growth can accelerate from here as cloud-based and SaaS solutions become a bigger mix of the pie. Qualitatively, comments on Guardian and Pathfinder continue to point to robust growth going forward. For example, Guardian customers continue to grow, with the number of users (both examiners and investigators) and data storage doubling in the past five months. Pathfinder’s footprint continues to grow and should gradually accelerate as Pathfinder becomes fully cloud-enabled.

Mentioned in 2Q24 earnings call: We’re excited to see growing action for Guardian, our SaaS-based case and evidence management solution. The number of Guardian customers has continued to grow, along with the number of users in terms of both examiners and investigators, and data storage volumes have doubled in the past five months alone to over two petabytes.

We continued to grow our Pathfinder footprint with UIs during the second quarter, and I can say we’re excited about our potential to accelerate UI penetration as Pathfinder becomes fully cloud-enabled in the coming quarters.

Second, the upgrade of CLBT’s installed base at Inseyets is progressing very well, which will serve as another strong driver of near-term growth. To put things into perspective, CLBT currently maintains an installed base of ~32,000 public and private digital forensics software licenses, and the estimated completion time (for upgrades) is over 3 years. So far, conversion rates have been very healthy, so much so that management has raised expectations for conversion in 2024 from 10% to 15% of its installed base. As mentioned before, this conversion represents a 20-25% price increase, so it was very encouraging to see the conversion progressing better than expected.

Mentioned in the 1Q24 earnings call: And there’s the investigative units, we’re increasing our continued growth in the digital forensics units by accelerating our business in our customers’ investigative units, perhaps more specifically that the digital evidence captured by Inseyets, opportunities are opening up to cross-sell and upsell sample management and analytics solutions.

Now, as we advance these initiatives to leverage our upgrade, upsell and cross sell opportunities across our installed public sector customer base, we will see our technology deployed more widely as we expand our reach into new facilities, new departments and new shopping centers, which we consider to be new sub-logos within the logos we’ve already captured.

Specifically, on Inseyets, CLBT should see more upsell opportunities as it is currently upgrading the majority of its base of approximately 32,000 public and private digital forensics software licenses to Inseyets over the next three years. Execution has been good so far in 1Q24, and management expects an acceleration for 2H24 and 2025. In particular, the adoption of Inseyets gives CLBT more pricing power as it provides a better value proposition, which management they expect to see a 20 to 25 percent increase.

Finally, CLBT is progressing well to achieve FedRAMP certification and full authorization is now expected by 1H25. I see this as another growth accelerator as it will allow CLBT to deploy its cloud-based offerings at a much faster pace.

Partnerships and acquisitions to support growth

CLBT’s GTM strategy, which involves forming partnerships and acquiring other companies, also shows an extraordinary process. For example:

1. In late June, CLBT announced that the Endpoint Inspector SaaS is now available on the Amazon Web Services (AWS) Marketplace. Given AWS’s reach to thousands of end users, this greatly improves CLBT’s distribution capability
2. In mid-July, CLBT formed Cellebrite Federal Solutions and acquired Cyber ​​Technology Services, Inc. In the long term, this improves CLBT’s distribution capabilities, allowing it to participate in a wider variety of federal programs and projects across the US. Note that this development also complements CLBT’s efforts in obtaining FedRAMP authorization.

The mandates are gone

An important development in the 2Q24 earnings report was CLBT’s offer to redeem outstanding warrants to purchase common shares. These mandates include 20 million public mandates and approximately 9.7 million private mandates. The current expectation is that these warrants will be converted into 8 to 9 million shares of common stock. This is really great for shareholders as it is expected to be ~70% less dilutive than if all the warrants were exercised for cash.

ASSESSMENT

In my current model, I have revised my growth estimates up 200bps from 20%/y to 22%/y and adjusted my EBITDA margin upward from 20% to 24% to reflect the strong performance in 2Q24 and management’s revised guidance. Given all the positive progress and strong growth metrics, I think the guidance is easy to achieve and has the strength to be sustained in the near term.

However, while I am very positive about the business outlook, I believe that CLBT’s valuation has already been priced positively. The stock currently trades at 31x forward EBITDA, a significant premium to the historical average of ~24x. Investors hoping for more upside must now expect the valuation to hold at this level, which is a risky move in my view, as any underperformance is likely to send the stock lower.

Based on my conservative assumption of multiples, if CLBT trades back to its 24x average, the upside available based on today’s price is ~6%.

Conclusion

My downgrade from a buy to hold rating is because strong valuation appreciation has made the risk/reward situation less attractive today. While I’m still bullish on the fundamentals given the growth trajectory and strategic initiatives, I’m not comfortable assuming the valuation will sustain at 31x forward EBITDA just because growth is now 200 bps higher (I now expect up 22% from 20% previously). ).