Is Home Automation a Smart Investment?

Home automation is driving investors toward Control4, but the valuation doesn't match the growth profile.

Jan 24, 2014 at 7:00AM

If it wasn't for the excitement over wearable devices, the "connected home" might have gotten significantly more attention at the Consumer Electronics Show. The purchase of Nest Labs by Google (NASDAQ:GOOGL) for over $3 billion placed the sector in "overheated" mode. One company taking part in the CES excitement over this concept, and boosted by the Nest Labs purchase, was recent IPO Control4 (NASDAQ:CTRL). The company has some interesting products and a surprisingly solid financial position for a modern technology firm, yet the valuation is very rich for the growth rate.

Control4 is headquartered in Salt Lake City and provides automation and control systems for the connected home. The company gives consumers the ability to integrate music, video, lighting, temperature, security, and communications into a unified home automation solution. Homeowners can leave their houses and automatically lock exterior doors, adjust the thermostat, and turn off televisions at the push of a button on a smartphone.

The stock surged at the news of Nest Labs' acquisition due to the extreme valuation paid by Google, and the recent announcement that Nest products were integrated into the automation platform. Considering the subsequent jump in the stock price, GSV Capital (NASDAQ:GSVC) provides an interesting way to play this investment theme with its position in Control4.

Nest Labs
Last week, Google agreed to buy Nest Labs for the incredible sum of $3.2 billion in cash. The company is focused on reinventing unloved, but important, devices in the home such as thermostats and smoke alarms. The Nest Learning Thermostat is a web-connected appliance that learns users' habits over time and adjusts the temperature accordingly. The devices run algorithms that profile human behavior to anticipate the users' needs before they're even aware of it.

Google hopes to use these devices to pioneer its move toward the Internet of Things, or IoT. Control4 hopes the valuation paid by Google confirms the future value of home automation solutions.

Control4 solution
The company's controllers connect thousands of products, delivering an improved lifestyle to consumers. The solution doesn't come cheap, with the average cost for a medium installation at $9,600. Even a small, single-room solution costs, on average, $3,500 with Control4 obtaining $1,400 for its products. The company estimates that mainstream opportunity includes over 24 million homes with household incomes of over $100,000. Nearly 50% of the market opportunity is in houses occupied by residents with incomes exceeding $250,000.

The company offers an exciting concept, proven by the huge gains seen as share prices soared from $18 to $32, boosted by news of the Nest Labs deal. However, the platform requires dealers to install the products, somewhat limiting the growth profile. During the third quarter, Control4 generated 21% revenue growth to reach $33.6 million. Even more impressive, the company recorded income of $0.12 per diluted share.

Analysts only expect 17% revenue growth in 2014, for a total of $150 million. Considering the dealer network and installation process, analysts only expect 20% annual earnings growth, with an expectation of $0.43 in 2014.

GSV Capital angle
GSV Capital is an investment fund that invests in pre-IPO, venture-backed firms. The fund is typically required to keep investments for a six-month lockup period. In the case of Control4, the fund owns 782,821 shares totaling $12.4 million, based on the end of the third quarter. The investment only accounts for 4.9% of the fund, but it is the fifth largest investment. Considering GSV Capital currently trades considerably below net asset value due to huge gains in the fund's largest holding, Twitter. The recent large gains in Control4 provide even more upside. Presently, the current price places the fund's position at over $22 million, providing investors a solid gain and an increase in net asset value that could exceed $18. Note that the stock only sits at around $13.

The six-month lockup period is approaching an end, so it will be interesting to see if GSV Capital chooses to unload this stock on the recent strength.

At a market value of only $630 million, it is easy to understand why the market got so excited about the lofty valuation Google paid for Nest Labs. Unfortunately, Control4 doesn't offer the fast growth that the stock price suggests due to the labor-intensive requirements for installing the home automation controller. The company has a promising future with years of growth ahead, but the valuation is now very questionable, considering the earnings level. With the recent increase in net asset value not reflected in the stock price, GSV Capital provides an interesting way to play the recent jump in Control4. Google is building a leading position in the IoT market, but it doesn't move the needle with a market cap approaching $400 billion.

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Mark Holder and Stone Fox Capital clients own shares of GSV Capital. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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