Varonis Continues To Suffer From Investor Neglect Despite Solid Quarters

Summary

• Varonis reported a solid beat and raise quarter. Management continues to exude confidence in its growth prospects and its desire to reach a $1 billion revenue goal.
• On a conservative basis, we expect the company to reach $1 billion in revenue by 2026. We expect VRNS to grow north of 20% until then.
• Digitization, remote work, the growth of SaaS applications, and hybrid multi-cloud environments are driving attack surface growth and data sprawl, making it hard to secure data.
• Varonis has the best solutions in the market to address data security from malicious insiders and hackers. Hence, we expect it to grow north of 20% for several years.
• Varonis continues to trade at a discount to its security peer group average. We believe the risk/reward is favorable for patient investors; hence we would remain invested in the shares.

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Following Varonis' (NASDAQ:VRNS) solid quarter, we recommend investors to stay invested and use the weakness to acquire more shares. We also recommend new investors take a position. For new investors who want to understand what Varonis does, please refer to my prior work on SA here and here. Varonis is a unique security name in our coverage universe. Varonis solves a dangerous but pressing problem in the enterprise – securing the data scattered across the enterprise and the various clouds. Varonis is an underappreciated and unheralded software company. Varonis software can be used to protect against malicious insiders and external hackers. Varonis has no direct competitor, and its technology is time-tested and widely deployed. The company has a first-mover advantage that is hard to overcome quickly given the complexity, volume, and variety of data that is being generated every day.

Source: Varonis Presentation

Varonis continues to execute on its product and go-to-market strategy and once again reported solid results, beating on all metrics that matter. Varonis also guided F4Q21 revenue and EPS estimates ahead of consensus. Varonis reported revenue of about $100.4 million and was ahead of the consensus estimate of $97.4 million. Revenue grew 31% Y/Y. ARR grew 36%, and subscription revenue grew 59%. Varonis reported an EPS of $0.05 versus the consensus estimate of $0.02. EPS outperformance was driven by higher than expected revenue and lower than expected operating expenses. The company continues to benefit from the reduction in travel-related costs. We expect travel to resume in 2022, leading to an increase in operating expenses. The following chart illustrates the highlights from Q3.

Source: Varonis Presentation

Varonis historically sold its software using a perpetual revenue model but switched to selling its products on a subscription basis in 2019. The company believed that selling products on a subscription basis allowed customers to adopt the platform broadly. Many of the older perpetual license customers continue to buy maintenance contracts, providing stability to revenue. Varonis also noted that the renewal rates remain above 90% and assured investors that it is not forcing its customers to migrate to subscriptions. The following chart illustrates the company's performance versus our estimates.

Guidance is likely conservative

Varonis's CFO, Guy Melamed, is known in the industry for issuing conservative guidance. CFO Melamed believes in setting expectations appropriately and exceeding them. For F4Q21, we believe the guidance is conservative. Varonis guided F4Q revenue in the range of $120-123 million for a 26-29% growth rate versus a prior consensus estimate of $117.5 million. EPS is expected to be in the $0.12-0.13 range, versus the previous consensus of $0.09. Historically, F4Q is the strongest quarter for Varonis, and we expect the company to beat estimates convincingly. The following chart illustrates Varonis's complete guidance.

Source: Varonis Presentation

Billion-dollar revenue goal reachable by 2026

Varonis believes that it is on target to achieve $1 billion in revenue. Varonis just reported $100 million in revenue per quarter. We think the company has the products and the ambition to reach $1 billion in revenue by 2026. The company sells 35 different products licenses within the six product families. A majority of its customers use fewer than six or more licenses. According to the company, 37% of its customers have adopted six or more licenses. The following chart illustrates the product and licenses Varonis sells today and their adoption within the customer base.

Source: Varonis Presentation

We believe the company has ample headroom to cross-sell more modules into its install base. Based on our conservative modeling, we expect Varonis to hit $1 billion in revenue by 2026. The following chart illustrates our $1 billion revenue forecast.

Valuation

Varonis was always underappreciated by the investor community. Investors and many enterprises do not understand the strength of Varonis's products and their relevance to data security. Varonis is not flashy or promotional like many companies in our coverage universe. Hence, Varonis continues to be overlooked by investors. Varonis subscriptions grew 59%, ARR grew 36%, and total revenue grew 31%. All impressive metrics. Yet, the company does not get an elevated multiple like our Security software peer group. VRNS is currently trading at 11.5x EV/C2023 sales versus the peer group average of 13.1x. On a growth-adjusted basis, VRNS is trading at 0.54x versus the peer group average of 0.61x. More importantly, VRNS does not have any direct competitors, making it one of the most compelling product stories with a deep moat in our coverage universe. The following charts illustrate VRNS valuation.

Source: Refinitiv & TechStockPros

What to do with the stock

Following Varonis's solid results, the stock is indicating weakness aftermarket. We urge investors to buy the weakness. Varonis is the only data-centric security in our coverage universe. Varonis's products are effective in securing data that is scattered throughout the enterprise. In addition, data is also scattered within various SaaS applications such as Jira, GitHub, Salesforce (CRM), Dropbox (DBX), presenting companies with elevated risk. As the data sprawl continued and worsened with the onset of the Covid pandemic, the attack surface continued to widen. When the attack surface widens, it is tough to secure it. We believe Varonis is one of the most effective solutions in the industry. Hence, we expect it to grow north of 20% for the next several years.

The company is conservative when issuing guidance. Hence we expect the beat and raise quarters to continue. We are highly confident in Varonis's growth prospects and its position within the data security landscape. With long-term growth prospects, reasonable valuation, and presenting an excellent risk-reward profile, we would urge new investors to buy shares here. We own the stock, and we would buy a few more shares on weakness to build a nice position over time.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of VRNS either through stock ownership, options, or other derivatives. 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.