The Uncommon Idea in Brief
Buy Varonis Systems (VRNS) stock for the long term. (Published July 12, 2017)
-Build a long position below $38. Add aggressively on a breakout over $40 or pullback into the $32 to $34 area.
The Industry Opportunity
Cyber threats and data breaches aren’t reserved for outside hackers. Companies need to be concerned about insider threat prevention.
Insider Threat Prevention
Value: There are significant European government regulations coming in the first half of 2018, increasing data protection covering all industries and sectors. A majority of businesses will struggle to be ready without help from outside providers. By 2020, the market for Data Security Platforms in large enterprises expected to grow to 40% of large enterprises from the current level of less than the 5%.
First Mover Advantage: Companies will work with cyber security providers with affordable pricing, scale, experience and, most importantly, reputation. There is a network effect in being first to market
Economic Moat: Clients are sticky, but price sensitive initially. A low-average-selling-price cost model with a base platform and expansion model holds the highest advantage. Once clients began expanding, they become sticky and price insensitive. There is a significant amount of work in migrating from one cyber security provider to another.
The ever-evolving regulatory environments regarding data protection and deletion, along with the real dangers of hackers, presents continued challenges for companies in every sector around the world.
Varonis provides an innovative, expansion software platform with a low-base-average selling price to meet the increasing regulatory requirements of data storage, privilege and deletion for a wide variety of companies.
What Varonis Does
Varonis Systems provides an innovative software platform that protects data from insider threats and cyber attacks. Through a base platform with expansion capabilities, users can analyze, secure, manage and migrate volumes of unstructured data.
Varonis specializes in file and e-mail systems that house documents, spreadsheets, audio and video files, as well as presentations. This wide array of data often contain a company’s financial information, strategic initiatives, IP and confidential information on employees, customers and/or patients.
The company is benefiting from EU General Data Protection Regulations that are due to come into effect shortly before June 1, 2018. Businesses of all sizes will require outside resources in order to achieve compliance to avoid large fines.
The company works with a wide array of customers, more than 5,500 in total. That includes financial services, healthcare, public services (government entities), industrial, insurance, media and entertainment, energy, utilities, consumer and retail, technology and education.
The Uncommon Market Position
The needs for both internal and external cyber security and data management is an evolving marketplace.
One misstep can cost not only millions of dollars in fines, but also loss of business and customers should a business lose trust, intellectual property or other confidential data.
Recall recent security breaches at Target (TGT), Discover and, of course, the Democratic National Committee.
Stocks of breached companies on the Nasdaq underperformed other Nasdaq companies by more than 40%, according to SC Magazine, citing a study by Comparitech Analysis.
Varonis added 187 new customers in the first quarter of 2017 while achieving a revenue growth rate of 30%+ and reducing non-GAAP losses by 20% The company is heavily focused on the United States, but does have an international presence. The overall customer count has exceeded 5,500 without restriction to industry or sector.
Gartner’s 2017 Market Guide for Data-Centric Audit and Protection has included Varonis Systems as a representative vendor.
In addition to growing its customer base, Varonis recently partnered with IT service provider ShoreGroup as ShoreGroup seeks to increase its cyber-security posture with a streamlined management of unstructured data growth as the company has identified cyber security as a growing need.
What Sets Varonis Apart
Varonis’s land-and-expand business model offers a low average selling price (ASP), creating a high volume of growth and new customers. Cyber-security threats are internal and external, which is why the base platform system with software expansion capabilities will act as a strong growth catalyst over the next several years. Customers can add as much or as little as they require as they become more educated on the technology.
By maintaining a platform that stays at the front of regulatory landscape VRNS has built a moat around its core business. The switching risk for VRNS clients is significant. The integration of a new system requires resources and involves the risk of lost business, loss of confidential data or non-compliance with regulation during the integration process.
Financials — Varonis by the Numbers
Varonis System’s duel revenue model includes licensing plus maintenance and service revenue, which translates to a promising future.
Revenue won’t depend solely upon attracting new clients. That’s demonstrated by the 33% year-over-year revenue growth despite the shift of revenue from new customers to existing customers.
A year earlier, Varonis derived 63% of license and first-year maintenance revenue from new clients. In 1Q 2017, Varonis generated 53% of license and first-year maintenance revenue from new customers and 47% from existing customers. Furthermore, 49% of customers had purchased two or more products.
The company produced 33% year-over-year growth in the most recent quarter, delivering revenue of $40.4 million. This translated to a loss of $0.23 per share, or $6.1 million, a 21% decrease from the prior year.
Varonis guided revenue higher for the new fiscal year. Expectations are for growth of 22% to 24% on revenue of $47 million to $47.8 million in the second quarter, with a non-GAAP net loss of $0.08 to $0.09 per share. For the full year, the company anticipates revenue of $201 million to $204 million and to be close to breakeven on the year.
Why the Stock Is a Buy
While the forward price-to-earnings ratio is not yet registering, Varonis has no debt, $121.3 million in cash and has posted year-over-year sales growth of 30%+ for five straight quarters.
Licensing revenue grew 38% last quarter and is expected to continue in the high 30% range for the foreseeable future.
Free cash flow of $8.3 million in Q1, along with the strong current cash position, allow Varonis to expand marketing as well as consider small, strategic acquisitions. But the more realistic expectation is that these factors position Varonis as a takeover target.
The Varonis DatAlert, DatAlert Analytics and Automation Engine platforms allow the company to significantly expand its customer base, especially outside of the United States with the pending EU Data Protection Regulations set to go into effect next year. Currently, 60% of revenue is generating in the U.S. But we expect European revenue to significantly increase over the next few years and match the 39% year-over-year growth rate experienced in the U.S. markets.
Platform-based cyber-security software is still an infant industry undergoing huge growth, along with its share of complications. Threats, both internal and externally, are constantly evolving. A land-and-expand platform offers customers the optimum approach to address the issue. A base platform (land) with expansive capabilities (expand) targeting a customer’s specific needs should excel in the exploding marketplace.
The Technical Analysis — At $38 or Lower VRNS Is a BUY
Varonis Systems has been in a strong uptrend since mid-March. Prior to the recent breakout, Varonis shares traded in a wide consolidation channel for nearly 8 months. This has created strong support at the $32 breakout level and becomes a targeted point for any break of the current $36 level of support found in the current uptrending bullish channel.
Should the current support levels fail, we would target the $32 to $33 area as a price where we’d be aggressive buyers of shares.
Traders seeking entry in the current environment should focus on the bullish channel and its two levels: $36 and $38. The first approach is to focus on support and use that area as a price target to acquire stock. A pullback to $36 should find support worthy of a buy. Furthermore, the 13-week simple moving average (SMA) has been mirroring the support levels of the channel and has acted as intraday week support when the stock dips below the channel.
For those who prefer buying breakouts, then a weekly close over $38 will get the stock new highs. Although it isn’t quite outside of the channel, we’d anticipate new high and momentum buyers to come into the stock and push Varonis through resistance.
Our initial target on a breakout, independent of fundamental views, would be $41 in short fashion with an ultimate upside of $47 within 12 months. Varonis offers up a tight channel, so whether focusing on support or a breakout of resistance, the timing for entry should come quickly.
Catalysts for the Thoughtful Investor
Varonis Systems forthcoming release of its Automation Engine and new threat models within DatAlert and DatAlert Analytics Rewind could not come at a better time as the EU General Data Protection Regulations are due to come into effect in less than a year. These new features will allow customers to analyze past user and data activity, as well as automatically find and fix some of the most dangerous file security issues so that organizations are less vulnerable to attack, more compliant and consistently enforcing a least-privilege model.
Recent results show that 75% of those organizations polled responded that they will struggle to be ready for the new EU Regulations. The biggest challenges appear to be identifying who has access to a company’s data, who is accessing the information, and when the data can and should be deleted. This extends to Article 17: “Right to be Forgotten,” where a company must discover and target specific data.
According to Brean Capital, there is high visibility and velocity in the company’s current sales process, especially as buyers become more educated regarding the technology. Many buyers have approved budgets for insider threat prevention and forthcoming regulations, which leads us to conclude Varonis Systems, with its land-and-expand business model, will win more projects and new customers than the market currently has priced into the market cap and financials.
The Bottom Line
-Varonis systems is an emerging leader in the cyber-security sector.
– The cyber-security market is growing rapidly. Governmental regulations are forcing companies to accelerate changes in the way they handle data. The ongoing and evolving risks associated with external hackers and internal threats create a pressing need to immediate and adaptive solutions. Varonis’s base platform plus expansion capabilities can remedy those concerns, so companies can focus on doing what they do best.
-Varonis has strong early penetration in the United States, but with underserved, addressable markets like the European Union instituting stricter data control regulation, as well as the Middle East, Australia, and Asia, the potential market is huge and not factored into current financial guidance.
-In the range of $32 to $38, we like VRNS as a long-term buy and hold. The small-cap nature, short interest, evolving business model and aggressive valuation will make it volatile.
-Cyber-security is an evolving and developing marketplace.
At the time of publication, neither the author nor the company held positions in the stocks mentioned, but positions may change at any time.
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