Not All That Glitters Is Gold With SecureWorks

| About: SecureWorks Corp. (SCWX)

Summary

SecureWorks will be going public this month after its roadshow starting on April 11, 2016.

The technology IPO market and the general IPO market have been relatively slow recently due to market uncertainty and volatility.

Valuation is extremely uncertain as is the projected outcome of the IPO.

Introduction to SecureWorks

If you've heard of Dell computers, which is now private, then you're close to learning about SecureWorks (NASDAQ:SCWX). Just like Dell, SecureWorks is a subsidiary of Denali Holdings and was acquired by Dell in 2011 (Nasdaq). SecureWorks is a cyber security company that helps its customers, which are a variety of corporations, protect their computer systems from hackers (WSJ) via a subscription service and contracts (Nasdaq). About 80% of SecureWorks revenues are generated from the subscription services part of the business that primarily handles the management of security (Channelnomics). The other services range from firewall protection to consulting, including web and email security as well as many other monitoring and management services. Clients vary among size and industry, but are primarily Fortune 100 or mid-size firms. SecureWorks also is a global company and has spread its services across the United States, Middle East, Europe, Asia, South America and Africa (Wikipedia). The company's largest customer is Bank of America Merrill Lynch, which brings in about 12% of revenues (Nasdaq).

Additionally, SecureWorks manages a platform focused on counter threat that focuses on preventative cyber security measures, such as suspicious activity and malicious events detection. "The platform aggregates as many as 150 billion incidents to represent activity or trends across the client's network" (Nasdaq). The platform was designed to find trends and continuously build off of its prior "knowledge" in order to pick up on security threats before they even arrive. The platform also includes incident response features (Nasdaq).

SecureWorks is looking to go public this month on the Nasdaq under the ticker "SCWX." If the company is able to follow through, it is notorious for possibly being the first US technology firm to go public in 2016, which has been very rare recently. The last company to file was a no-name Chinese company in December of 2015 (WSJ). SecureWorks plans on using any proceeds from the offering for working capital, operations, and/or investments, such as acquisitions to expand (Channelnomics).

Now let's take a look at why the SecureWorks IPO is a dangerous idea for investors to become involved with.

Why you should be cautious

Your first warning sign should be the painfully slow IPO market. The way the company is going about their initial public offering is as though it is making itself a guinea pig. According to the Wall Street Journal, "SecureWorks will likely sell a relatively small portion of itself in the offering because of uncertainty over how investors will receive it in a tough IPO market." With so much uncertainty, to the point where the company only has one foot in the door, why are they going public? If they are successful after the initial market excitement that tends to follow technology IPOs, then it is supposed to be an indication of a healthier IPO market (WSJ). Personally, I would like to see this situation turned around before I consider investing in this IPO.

With all the volatility recently, which would take a separate article of its own just to analyze, the IPO market has not been faring too well. One technology IPO is not going to turn that around. This past quarter was noticeably slower with technology IPOs, which are generally in abundance. Only nine deals pulled through and only raised about $1.2bn combined. Market analysts don't believe that this quarter or even this year is going to show a turnaround (WSJ).

As I wrote further down in this article, the valuation of SecureWorks had to be discounted because of the trend in industry peers. Market participants seem to be concerned that technology companies are far overvalued and that SecureWorks is no different, despite its age and sophistication. Many might try to say otherwise because of its connection to Dell and Denali, but the company hasn't even turned a profit yet even though its past reported annual revenues jumped by 30% (WSJ). Why would an investor put their money where there is almost no sign of making steady money? The excitement of "Mr. Market" is not enough to pull SecureWorks through.

Valuation

Before it went private, Dell acquired SecureWorks in 2011 for about $612 million when the target's revenues were just over $120 million. In FY 2015, revenues increased by about 27% from $172.8 million in 2014 to $262.1 million (Inorganic Growth). For FY16, revenues increased 30% to about $340MM. SecureWorks has not generated any profit, however. In FY14, net losses amounted to $44.5MM. In FY15, losses came in at $38.5MM. For the fiscal year 2016, SecureWorks reported net losses of $72.3MM. The primary reason for the increase in net losses was the nearly 50% spike in operating expenses. SecureWorks is expected to raise only $150MM from going public because of their small starting offer (Nasdaq).

So far, with so little time before the IPO valuation of SecureWorks is very uncertain. Originally, the company's own valuation had it pegged at $2MM (Channelnomics) with some analysts giving it a nearly $3MM value because of the increased sales (Nasdaq). Many of its peers in the industry, though have lowered their own valuations because of the rocky industry and SecureWorks followed suit to be less than $2MM (WSJ). The elephant in the room seems to be asking, though, how the valuation drastically changes from Dell's acquisition in 2011 for $612MM to the $2MM it is offering to the market this month? Going off of the 2011 valuation by Dell, one third of SecureWorks, which is supposedly the chunk being offered, would be about $200MM. Going solely off of revenues, that chunk would then be worth over $100MM (Re/Code). So where is that gap coming from? Perhaps it is all about the net losses, but there could be something else fundamentally wrong, such as the fact that it fed off of its parent like a parasite since it was acquired.

Conclusion

In the age of constant cyber attacks, a company like SecureWorks that handles IT security and cyber hackers would seem like a plausible investment choice. Its services are in high demand and has very reputable customers like JPMorgan. There are many factors that could play into the consistent losses over the past decade and a half. IT takes a lot of intelligence and R&D in order to remain successful in a rapidly growing industry. It is uncertain the real reason for such large operating expenses as there aren't any financial statements filed with the SEC right now. Simply scratching the surface, however, is enough to prove that SecureWorks is far from a stable investment choice.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.