Varonis - Solid Quarter; Buy On Weakness
Summary
- Varonis reported another solid quarter and guided up 2Q (June). Management continues to exude confidence in its growth prospects and position within the industry with its subscription portfolio.
- Zero trust approach to protect sensitive data, Cybercrime, and compliance with data-driven regulations are the secular growth drivers for Varonis. We expect revenue growth to remain above 30% in 2021.
- Due to the pandemic, hackers have been aggressively targeting corporations to steal data. VRNS's product portfolio has been an effective antidote to tackle the threat.
- New customer additions and upsells to existing customers to drive growth for the company. Management looks to invest in quota-carrying headcount and R&D investments to continue the growth.
- With solid execution, deep moat, and a reasonable valuation, impending multiple expansion, we believe VRNS has favorable risk/reward and is, therefore, a buy.
Following Varonis (NASDAQ:VRNS) stellar F1Q21 results, we recommend investors to remain invested in the stock and use the weakness to buy additional shares if possible. Varonis is one of the best small-mid cap growth names that is reasonably priced, growing fast, and is the best solution to protect against data theft, yet is not getting the higher SaaS/Subscription multiple it deserves. We expect the stock to appreciate from the current levels on the continued beat and raise quarters which will eventually lead to a higher multiple. Therefore, we would be buying shares on weakness. If investors do not afford the company a higher multiple, we expect a private equity investor to gobble up the company, similar to Proofpoint.
Varonis solves the data security problem very well
Varonis solves an unheralded but pressing problem within an enterprise - how to protect data from internal and external threats by determining what data is high value, what data is exposed, and who has access to the data. According to Varonis Management, the secular trends of data growth, hybrid cloud, and cyber threats from individual hackers and nation states drive the demand for Varonis's solutions. Varonis has a slew of products that address the security of sources and repositories of the data. For more details on Varonis's products and its advantage, please see our prior work on SA. The following chart illustrates the secular trends driving Varonis's growth.
Source: Varonis presentation
No real competition yet
On persistent questioning from three different sell-side analysts on emerging competition, Varonis CEO Yaki Faitelson was very confident there is no change in the competitive landscape. He noted, "we don't see any change to the competitive landscape. What is happening in reality with Varonis is that we are the only vendor that can take a lot of data and digest it and visualize the potential of access and do it in an ever-changing environment. This is a massive amount of data. Then have automated remediation and understanding of abnormal behavior of data."
We believe Varonis has a durable first-mover advantage given the complexity of the problem it addresses. We believe the volume and variety of the data and the data sprawl in a variety of locations, experience handling complex data, classifying and automating it, gives Varonis a durable first-mover advantage. In addition, Varonis has more than 69 issued and 31 pending patents that protect its IP. The following chart illustrates Varonis's first-mover advantage.
Source: Varonis presentation
Varonis reports an excellent quarter
Varonis reported results that exceeded expectations on both the revenue and EPS lines and provided guidance ahead of estimates. Revenue was about $74.8 million and was ahead of the consensus estimate of about $68.9 million. Revenue was up 38% Y/Y. ARR grew 39% Y/Y, and Subscription revenue grew 120% Y/Y as the company transitioned from a perpetual revenue model to a subscription revenue model. Varonis historically sold its software using a perpetual revenue model. Varonis now mainly sells revenue on a subscription basis. Many of the older perpetual license customers continue to buy maintenance contracts. Varonis noted that the renewal rates remain above 90% and assured investors that it is not forcing its customers to migrate to subscriptions. Varonis reported an EPS of -$0.08, which is ahead of the consensus estimate of -$0.13. EPS outperformance was driven by higher than expected revenue and good Opex control. The following chart illustrates the company's performance versus our estimates.
All-round solid performance
On the earnings call, CFO Guy Melamed said that demand for Varonis's products is strong from new and existing customers. He noted that new customers are buying more licenses upfront, five on average versus three before moving to the subscription model, while existing customers continue to buy newer modules.
Varonis revenue growth was strong in all geographies. North America revenues grew 39% to $52.8 million or 71% of total revenue. EMEA revenues grew 38% to $20.2 million or 27% of total revenue. The rest of the world's revenues were $1.7 million or 2% of total revenue. About 66% of Varonis's customers own four or more licenses, while 32% own six or more licenses. The following chart illustrates the license adoption within the Varonis install base.
Source: Varonis presentation
Guidance may be conservative
Varonis Guided F2Q21 revenue in the range of $82.5-84.0 million versus the prior consensus estimate of $82.5 million. EPS is expected to be in the range of -$0.04-to-$0.03, versus the prior consensus estimate of -$0.04. We believe these estimates are conservative, and we expect the company to beat them when it reports results in August. Historically, Varonis is known to guide conservatively and beating the guidance. The following chart illustrates the guidance.
Source: Varonis presentation
Varonis stock is Undervalued
While Varonis solves one of the most pressing problems in the enterprise, i.e., protecting the data, the company is not getting the credit it deserves. Varonis is not a flash company, and its multiple reflects that. Varonis subscription revenue grew 38%, and its ARR grew 39%. This growth rate is faster than the average growth rate of the SaaS/Subscription peer group. Yet, the stock is trading below the peer group average of 15.5x.
As VRNS continues to execute well and the company beats consensus estimates and guides up, we expect the stock to rally. We also expect a valuation reset, and the company is afforded a SaaS/Subscription multiple. We expect VRNS multiple to expand and trade in line with a slight discount to subscription/SaaS peer group. Therefore, in our opinion, investors should position themselves by buying shares ahead of this impending multiple expansion. The following chart illustrates the valuation of the subscription/SaaS peer group and the security peer group.
Source: Author based on Refinitiv data
What to do with the stock
Data sprawl continues to get worse by the day as enterprises continue to transform their businesses and employees continue to work remotely from their homes. Data continues to be created in various applications that are being hosted in the cloud. Many applications such as Salesforce, Workday, Slack, Git, GitHub, and G-Suite all create data, and hackers seek out this data. Protecting this data is hard, and we believe Varonis is one of the best technologies that exist today to protect this data. Digital Transformation and remote work from home are worsening the data sprawl problem. We believe no single vendor can solve the data sprawl problem as comprehensively as Varonis does. Therefore, we are optimistic about Varonis's prospects. We do not believe any vendor, new or emerging, can take on Varonis in the near term. We believe Varonis's guidance is conservative, given that company is known to issue conservative guidance. We expect the company to beat results when it again reports results in August. Given our confidence in Varonis and its outlook, risk-reward profile, and long-term growth prospects, we would be buying shares whenever opportunities present themselves. We expect shares to appreciate on the beat and raises quarters and multiple expansion. We would be buying shares on any weakness and build up a nice position over time.
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Analyst’s Disclosure: I am/we are long VRNS. 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.
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