Varonis Systems Inc. (VRNS) is a developer of data governance solutions which help manage unstructured data. Over the last few years, management has been drastically increasing both revenue and operating expenses. From 2011-2013, revenue grew at a CAGR of 37.0%. So far in 2014, revenue has grown 38.3%. Revenue has grown fast but operating expenses have grown faster. Sales, marketing, general, and administrative expenses have increased at a CAGR of over 40%. These operating expenses have continued to grow over 40% in 2014. The growth in operating expenses has resulted in larger and larger operating losses. In 2013, the company's operating loss was $5.8 million. So far in 2014, the company has already amassed an operating loss of $12.5 million. Varonis has been growing fast and management believes this growth will continue. This is why management is focusing more on expanding operations than profitability.
There are significant data trends which support management's belief in future business growth. The amount of digital data is expected to increase exponentially over the next decade. The vast majority of this data is expected to be unstructured. IT departments will need to be able to better handle this data. Additionally, IT departments will have limited budgets for infrastructure over the next decade. This should represent a great opportunity for an unstructured data solutions provider. Surprisingly, Varonis is considered one of the only companies able to handle this influx of data. This means Varonis should be able to continue its rapid growth except there is one major problem.
Growing Need For Data Governance
Data governance is how an organization authorizes, controls, and shares it data. Data governance can be applied to both structured and unstructured data. Structured data is data which can easily be stored, searched, and organized. Structured data is data mainly found in databases. Currently, structured data is being used to uncover business insight through business intelligence software. Companies have found valuable insight in structured data but there is plenty of insight left to be found. However, Varonis helps companies better manage and gain insight from unstructured data. Unstructured data comes from more text-rich files like PDFs, emails, and word documents. Businesses haven't been able to gain much insight from unstructured data. This is because unstructured data isn't easy to organize and analyze. The inability to find insight in unstructured data hasn't been caused by a lack of material and this definitely won't be a problem in the future. The amount of both structured and unstructured data is expected to increase exponentially over the next decade. The IDC estimates there will be 40 zettabytes (1 billion terabytes) by 2020, which would be a 50-fold increase from 2010.
There is plenty of data which will be created over the next decade but this data will mainly be unstructured. The IDC estimates 90% of all data created in the next decade will be unstructured. IT staffs will need to handle and organize all this data without significantly larger budgets. The IDC estimates investment in IT infrastructure such as hardware, software, services, telecommunications and staff will only grow a total of 40% between 2012 and 2020. This isn't very much considering the expected massive influx of data. This should represent a huge opportunity for an organization like Varonis who can help businesses organize and gain insight from unstructured data. Unstructured data is expected to grow exponentially and Varonis is one of the only true unstructured data companies. This is why Varonis has been able to grow so fast.
Market Leader And Major Competitor
Varonis is considered the market leader in the unstructured data governance industry, according to Bloor Research. They are not only considered the market leader but the only true unstructured data company. The lack of competition has led to rapid growth and very high gross margin. In Q2 2014, the company had a gross margin in excess of 90%. Even the company's recent IPO hasn't changed the competitive landscape. On the Q2 conference call, Yaki Faitelson CEO when asked about competition after the IPO stated, "No. Even we will say that we see less...we are doing mainly one or two, a competitive situation and almost in all of them when they need to go to the deep waters of -- a massive amount of production data they vanish." Management is finding a lack of true competition. Although they do have competition, their competitors don't solely focus on unstructured data. Equifax (EFX) did select Datawatch (DWCH) to help them deal with their unstructured data. However, competitors lack top quality software and knowledge to truly compete.
Currently, there is a massive amount of unstructured data and there will be plenty more in the future. Yet, management and Bloor Research haven't found any other true competition in this market segment. Varonis is considered the market leader with only $74.6 million (2013) in sales. Why isn't there more competition coming from International Business Machine (IBM), SAP SE (SAP), or SAS? These large enterprise companies have the human capital and research and development budgets to deliver quality unstructured data governance solutions. Additionally, they compete in most other data-related market segments. Surely, their expertise would translate to the unstructured data market. Are large enterprise organizations missing something or do they not see a viable market at least not yet? Data governance isn't a new concept. Yet, data governance has failed to gain significant traction for structured data let alone unstructured data.
An Unwillingness To Spend
Executives haven't and still aren't willing to spend significant resources on data governance. This unwillingness to spend is due to their belief data governance doesn't have significant business value. In a Deloitte article, Tom Mongoven, a director with Deloitte Consulting LLP stated, "Many data governance organizations struggle to obtain executive sponsorship, in part because they have not linked data quality to improved business performance." The lack of spending has been for both structured and unstructured data. However, IT departments are starting to spend on structured data governance. In a SearchDataManagement.com article, Anna Marie Smith, principal consultant at Alabama Yankee Systems LLC. stated, "IT is just starting on dealing with structured data governance, let alone unstructured." The market for structured data governance is filled with enterprise organizations like IBM, SAP SE, and SAS. Yet, these market participants aren't competing for unstructured data. This is because there isn't enough spending on unstructured data governance. Anne Marie Smith explains, "I would venture to say that if you took the totality of companies that are engaging in some form of structured data cost governance, not even 1%, maybe one-half of 1% of them, are engaging in any form of unstructured data governance, for a variety of reasons."
Organizations are starting to spend on data governance but it is still predominantly on structured data governance. They haven't even started to address unstructured data governance. Additionally, the value of unstructured data and data governance hasn't been established. This makes spending on unstructured data a risky proposition. Executives have started to budget for structured data governance which is why there are large enterprise organization supplying solutions. Varonis is really the only true unstructured data company for a reason. Other organizations don't see a significant market for this type of data governance. Management is expanding rapidly in a market without a known value or size. Varonis profitability depends on rapid growth which isn't guaranteed due to the unknown valued of their solutions and the unwillingness of executives to spend. Additionally, their current valuation doesn't significantly improve the case for investment.
Data: Reuters Financial
Varonis is the market leader of unstructured data governance. They have grown faster than the industry and sector averages. However, they haven't generated net income or even enough free cash flow in the last year. This makes valuation dependent on one metric which doesn't give a solid valuation estimate. Varonis could be considered undervalued based on the P/S ratio. However, the market demand for their product isn't well known. There is a lack of spending on structured data governance let alone unstructured data governance. Although Varonis looks cheap on a P/S basis, the company is facing a significant lack of demand. They will need this demand to continue their rapid growth and ultimately obtain profitability.
Varonis Too Early?
Varonis is considered the leading unstructured data governance company by Bloor Research. They are not only considered the market leader, they are considered the only company able to properly cater to this market segment. Varonis operates in a market without a true competitor. This has allowed Varonis to grow revenue above a CAGR of 30%. Management is spending heavily to increase their sales personal and operations. They want to better position themselves to take advantage of the expected increase in data.
Digital data is growing rapidly and this growth will accelerate in the future. The majority of this data will be unstructured. This unstructured data will need to be managed. This should be a huge opportunity for an unstructured data governance company. However, executives aren't convinced about the business value of unstructured data let alone unstructured data governance. The market for data governance isn't very competitive for a reason. The major of enterprise companies believe the market for unstructured data governance is very limited.
This significant lack of demand combined with management's rapid expansion plan make Varonis a very risky investment. Management's growth plan depends on rapid future revenue growth. Yet, the true size and value of the market place isn't well established. Additionally, the company's current valuation doesn't give investors reason to take the risk. The company is trading at a discount based on P/S but this is only one metric. The company lacks enough free cash flow and net income to include more valuation metrics. There will be massive amounts of unstructured data in the future but the value of this data is unknown. More importantly, executives don't currently see a business value for unstructured data. Varonis has clearly found some demand for their product but they are facing an environment where the vast majority of executives aren't spending on unstructured data. Management has done a great job growing the company but their aggressive growth strategy combined with an unknown market demand makes Varonis a risky long term investment.
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