Engine Capital Urges Carbonite to Commence Sale Process

NEW YORK, Dec. 4, 2014 /PRNewswire/ -- Engine Capital LP (together with its affiliates, "Engine"), a large shareholder of Carbonite, Inc. (NASDAQ:CARB), with ownership of approximately 2.5% of the outstanding shares of the Company, today announced that it has delivered a letter to the Company's Board of Directors.

The full text of Engine's letter follows:

December 4, 2014

Members of the Board of Directors
c/o David Friend, Chairman and CEO
Carbonite, Inc.
177 Huntington Avenue
Boston, Massachusetts 02115

Dear Board Members:

Engine Capital LP, together with its affiliates ("Engine" or "we"), owns approximately 2.5% of the outstanding shares of Carbonite, Inc. ("Carbonite" or "CARB" or the "Company"). Carbonite represents a significant investment for Engine. We invested in CARB because of its strong business prospects (including its high growth SMB division), the attractiveness and stability of its business model (including a recurrent subscription-based and negative working capital model), its strong free cash flow generation and its low valuation. As you know, over the last few months, we have privately urged you to commence a strategic review process to maximize value for the benefit of all shareholders. In light of the recent $15 per share offer from j2 Global, Inc. ('j2") and considering how the Company summarily rejected a prior offer from j2 (more than two years ago), we have decided to come out publicly and urge you, the Board of Directors of Carbonite (the "Board"),  to immediately initiate a process to sell the Company. We believe that numerous parties would be interested in the Company and are confident that a strategic buyer interested in purchasing the Company at a significant premium can be found. We believe a sale of the Company at this time would be the most prudent and effective way to deliver maximum value to shareholders on a risk-adjusted basis for both the short- and long-term.

Since becoming public in August 2011 at $10 per share, Carbonite's stock has considerably lagged its peers and relevant indexes. As an example, since its IPO, Carbonite's stock price is up a mere 17.6% (based on the December 2, 2014 closing stock price) compared to a rise of more than 108% for the Nasdaq Index during the same period. We believe this underperformance is due to a combination of factors, including: (1) Carbonite's continuous shift in business models (from an initial cloud-based consumer-focused model to a cloud-based SMB-focused model to the current cloud and appliance-based SMB-focused model); (2) the perceived competitive threats from larger and better capitalized competitors; (3) the Company's inability to hit its financial targets; and (4) an under-optimized balance sheet with considerably too much cash given the stability and the free cash flow generation of the business.

More fundamentally, given the financial reporting of the Company, which doesn't separate the Consumer from the SMB division, we don't believe the Company is well understood by investors. Based on our discussions with management, we have tried to allocate R&D as well as sales and marketing expenses between both divisions. Since a significant percentage of these expenses should currently be allocated to the SMB division, we believe the profitability of the consumer division is currently underappreciated by the market. For 2014, while we expect Carbonite's overall EBITDA to be around $16 million, we expect the consumer division to contribute north of $40 million and the SMB business to lose close to $24 million. CARB is basically reinvesting a significant portion of the cash flow generated by the stable but low growth consumer division to grow the SMB business, in effect hiding the true profitability and value of the consumer division. As we have discussed with you, we believe this is likely to continue for the foreseeable future. Based on a sum of the parts valuation – using a range of EBITDA multiples for the consumer division given its profitability and stability and a range of revenue multiples for the SMB business given its high growth but lack of current profitability – we estimate a sale of the Company between $16 and $20 per share depending on the type of buyer and the level of synergies.

For all of the reasons mentioned above, we believe the stock is likely to continue to underperform and remain undervalued in the public market for the foreseeable future. Nonetheless, the Company has significant strategic value, especially for larger and better capitalized competitors with experience selling in the SMB channel. Such a buyer could take advantage of Carbonite's well-known brand name to accelerate revenue growth, remove a significant amount of overhead and optimize the balance sheet.

It is also important to note that over the last couple of months, we have spoken to a number of Carbonite's large shareholders and a majority of these shareholders share our view that (i) the status quo is not acceptable, (ii) the Company is worth a lot more in the hands of a larger strategic player and (iii) the Company should start a review of strategic alternatives to maximize shareholder value. Based on our discussion with management, it is our understanding that when j2 made its first offer to Carbonite more than two years ago, the Company not only failed to start a review process but didn't even engage with j2 to determine the maximum price they would be willing to pay. Instead the Board summarily rejected the offer from j2. For the ensuing two years, the stock continued to languish while equity markets have gone up significantly.

We are concerned that the Company may take the same approach and argue that now is not the right time to sell because it is in the middle of a transformation and more value could be created over the long term by keeping the Company public. We strongly disagree. Now is the time to sell the Company for the following reasons:

• On February 10, 2014, the Company's CEO announced his intention to step down. A CEO search process has been ongoing for almost a year. The appointment of a new CEO significantly increases the execution risk of this transformation and would result in additional dilution because of the stock grants required to properly incentivize the new CEO. Why further dilute shareholders and take the risk of hiring a new CEO when value can be maximized now? The lack of a CEO would not be a concern for a strategic or private equity buyer (who often work with operating executives within their organizations).
• The offer from j2 effectively puts the Company in play, making the hiring of a top CEO more complicated and less likely.
• Interest rates are at historical lows, creating an excellent environment to sell cash flow generative businesses either to private equity or strategic buyers.
• Because of the time value of money, we calculate that in order to justify not selling now, the Board would have to be confident that the Company's stock would reach around $25 per share within 3 years (at a 12% discount rate and assuming a $18 per share transaction).
• We doubt that the Board has this level of confidence in the Company's future prospects when there has been very little insider buying over the last few years despite the stock trading at much lower levels. Instead there has been significant insider selling. Over the last 2 years, insiders have sold $16.1 million of stock (at a weighted average price of $13.55 per share) versus $1.1 million in stock purchases. 
• With the stock barely up over the last three years, this Board has already had ample time to create significant shareholder value and has failed to do so. The right thing to do is to immediately sell the Company instead of asking for more time.
• Finally, this is what a majority of your shareholders want.

If you conclude that a sale of the Company is not in the best interest of shareholders at this time because it would undervalue the Company, we would expect as a sign of confidence that all Board members buy in the market a significant number of shares of CARB (such as twice his or her annual Board compensation).  It is unacceptable for you, as Board members, to disregard a review of strategic alternatives and prevent the opportunity for a sale at a significant premium, while continuing to receive your rich annual compensation packages (close to $150,000 on average) and not having to put your money where your mouths are.

While we believe the $15.00 per share offer from j2 is low, you have a fiduciary duty as Board members to engage with j2 to ascertain the maximum price it would be willing to pay for the Company. This offer should serve as an impetus for you to engage in a strategic review process to sell the Company and to begin contacting other interested parties immediately. The offer from j2 should give you confidence that there are likely other interested parties in acquiring the Company and should provide a floor to a sale process. Time is off the essence and we hope that you will pursue this strategic review process with a greater sense of urgency than the ongoing CEO search process.

We also request that you establish a special committee consisting only of independent members of the Board to explore a sale of the Company. We, and all of your shareholders, expect proper corporate governance to be followed.

We hope that the Company will do the right thing and take the required steps to maximize value for all shareholders. We must, however, reserve our rights to take whatever actions in the future we believe may be required to protect the best interests of shareholders.  

                                                            Very truly yours,

                                                         Arnaud Ajdler
                                                                       Managing Partner        
                                                               Engine Capital LP

ABOUT ENGINE CAPITAL
Engine Capital is a value-oriented special situations fund that invests both actively and passively in companies undergoing change.

Investor contacts:
Engine Capital LP
Arnaud Ajdler
(212) 321-0048
[email protected]

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SOURCE Engine Capital LP