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Tenable: Strong Quarter Reinforces Valuation Expansion

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About: Tenable Holdings, Inc. (TENB)
by: The Software Side of Life
Summary

Tenable reported Q3 revenue well ahead of management's previous guidance and consensus expectations.

While management raised revenue guidance for the full year, billings guidance was reiterated, which could be slightly conservative.

Valuation remains attractive at ~5x 2020 revenue compared to the closest competitor Qualys, trading ~9x 2020 revenue.

Tenable (TENB) reported Q3 revenue that was well above consensus expectations and included an operating margin that was also ahead of consensus. The shares, which have been under a lot of pressure since Q2 earnings, saw a new sign of life. Heading into earnings, the stock was down nearly 35% from pre-Q2 highs. After posting a strong Q3, the stock initially popped over 15%, though some of the gains were lost over the past few days.

Management also provided Q4 revenue guidance that was similar to expectations, though the implied billings seems to be a little soft. My impression is the company just came off a strong Q3 earnings report and there was no need to be aggressive on the guidance metrics heading into the remainder of the year, especially given the current negative sentiment on a potential economic slowdown.

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With the stock now above the $23 IPO price and the company showing they are able to produce solid revenue growth and operating margin expansion, valuation is now at a more attractive level. Even after the stock's 10% rise since reporting earnings, I believe there is still more upside to come for long-term investors.

The recent change to their sales leadership seems to have caused some uncertainty in the stock the past few months, but I believe Q3 results put most of those fears in the past. Q4 revenue guidance was close to consensus estimates, which I believe could ultimately be a little conservative as the company has no reason to become aggressive heading into the final quarter of the year.

TENB offers cloud-based vulnerability management services which help protect an enterprise's assets, such as network containers and web applications. Essentially, the company provides solutions for enterprises to manage and measure cybersecurity risk, specifically focusing on vulnerability assessment and management market. The company looks to quantify how much damage would be caused by a security breach - information that is very valuable to enterprises as security breaches continue to make headlines on a weekly basis.

As software applications are added to an enterprise's architecture, this can cause challenges determining where certain security risks are and how vulnerable the overall organization is. TENB’s largest competitor is Qualys (QLYS) which is one of the few companies specializing in vulnerability management. The ability for an enterprise to maintain visibility and control over the security of its assets is now essential. Enterprises are also adapting to newer technologies, such as the Internet of Things, containers, new business models, and more. All of these require increased efficient security and control measures.

Q3 Earnings and Guidance

Revenue grew 32% during the quarter to $92 million, which was ahead of management's previous guidance of $88-89 million as well as consensus expectations for ~$88.5 million. The 32% growth rate during the quarter was only a slight deceleration from the 34% last quarter, though gives investors confidence that the sales leadership change did not alter this quarter's revenue too much.

Source: Company Presentation

Subscription revenue continues to be the growth engine of the business, growing 41% during the quarter and represents over 80% of the total revenue. Billings were also strong at 28%, which showed a little bit of acceleration from the 27% growth during last quarter.

The company also added 51 net new $100k+ customers, which is more than the 44 they added last quarter. The larger contract value customers does mean longer sales cycles, which is partially why the implied Q4 billings guidance remains a wide range. However, I believe this could be a little conservative as if the company is able to close more of these larger deals, we could see continued billings strength, leading to accelerating revenue.

Source: Company Presentation

Gross margin during the quarter was 84.3%, which expanded by ~50bps compared to the year ago period and was also ahead of consensus expectations. The subscription revenue strength, which comes with higher gross margins, was one of the drivers behind the outperformance here.

Source: Company Presentation

Non-GAAP operating margin during the quarter came in at -8%, which improved from -12% during the year ago period and was ahead of expectations. Combined with the better than expected revenue, the operating margin expansion led to non-GAAP EPS loss of -$0.07, ~$0.04 better than consensus expectations for a loss of -$0.12.

Source: Company Presentation

Guidance for Q4 includes revenue of $93.5-94.5 million, which was close to consensus expectations for ~$94 million. Using management's 2019 full-year billings guidance of $407-417 million, this implies a wide range for Q4 of ~$117-127 million. While this remains a wide range, I believe billings will ultimately come in ahead of expectations given some of the larger deals, which the company has had success with lately, have elongated sales cycles, making it more challenging to predict.

For the full year, revenue is expected to be $351-352 million, which is raised from their previous guidance of $346-349 million. This represents growth of ~31-32% for the full year. Even though billings growth was reiterated at $413-417 million, I believe management is remaining conservative given new sales leadership in addition to larger deals being more unknown due to longer sales cycles.

Valuation

Valuation remains below select peer groups with similar revenue growth and margin profiles. After reporting Q2 earnings, TENB's forward revenue multiple dropped quite a bit as billings guidance came in below expectations, partially due to a new sales leadership change. Similar to New Relic (NEWR), who also saw their valuation fall after Q2, TENB's valuation reached a low point around 5.5x forward revenue. However, I believe the company deserves to be trading at a higher multiple.

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TENB currently has a market cap of ~$2.45 billion, and with cash/investments of ~$300 million at the end of Q3 with no debt, the current enterprise value is ~$2.15 billion. As we are getting close to the end of 2019, investors should start looking at out years when viewing revenue estimates.

Using management’s 2019 revenue guidance of $351-352 million, which represents ~31-32% revenue growth, we can extract 2020 and 2021 high-level estimates. Assuming slight deceleration in both years, we could see 2020 revenue growing ~29-30% and 2021 growing ~26-28%. Assuming this, we could see 2020 revenue of ~$455 million and 2021 revenue of ~$580 million.

With a current enterprise valued of ~$2.15 billion, this implies a 2020 revenue multiple of ~4.7x and a 2021 revenue multiple of ~3.7x. While this is a rather bullish viewpoint on revenue growth, there is the potential given the market is growing ~15% and there is a lot of opportunity to grow.

Taking a more conservative approach of ~25% revenue growth in 2020 and ~20% in 2021, this gives us 2020 and 2021 revenue estimates of ~$440 million and ~$530 million, respectively, or ~4.9x 2020 revenue and ~4.0x 2021 revenue.

I believe 5x forward revenue will be the floor, considering the company has not even reached that point over the past year despite some negative sentiment and the Q2 surprise. This means that the stock has a lot more room to run in terms of revenue growth and continued forward revenue multiple strength and potential expansion.

With the stock trading under $25 again, I believe now is a great opportunity to pick up some shares. Considering their biggest competitor QLYS trades at ~9.5x forward revenue, we could see the two multiples converge over time and potentially meet at ~6-7x forward revenue.

Over the long term, this name has the potential to trade a few multiples higher in terms of valuation given its consistent 30%+ revenue growth and market share gains. While the valuation multiple is still unknown, I believe we could see some slight expansion into the 6-7x range, giving the stock continued upside from these levels.

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.