Given today's cyber security report by the FT I felt I should post my recent blog on an investment opportunity in the UK, especially given the diversification this would offer Alpha readers. For the full blog post and my other investment ideas, please go to https://midcapadvisor.wordpress.com/
An unusual event happened at the outset of July, a software company listed in the UK and the valuation was above £1bn, in fact this was the largest IPO for a software company the London Stock Exchange has ever seen. This was enough to catch our attention here at MidcapAdvisor, but to keep our attention we needed to look into the detail and particularly the growth prospects of the company.
Sophos (SOPH) specialises in offering IT security software for instance viruses, malware, spyware and so on. Furthermore, this software applies to mobile devices which are linked to the same network, as companies increasingly have employees working in different locations and on different devices. The company has a cloud based solution which provides a unified view across an organisation. However, one of the key strategies for the company is to keep security simple.
The company was set up in the 1980's and has since then built itself up into a strong up-and-comer in the market, but crucially and music to our ears, has specialised in the mid-market segment where the company felt the large competitors were not servicing sufficiently. The company now has over 2,500 employees, 200,000 customers worldwide and is protecting over 100mio end-users.
In 2010 the founders of Sophos sold a majority stake in the company to Apax Partners in a deal worth $830mio. At the time, revenue growth was 27% year-on-year. Apax remain majority owners wtith 40% post-IPO and have seen a solid return on their investment so far following the IPO. Apax are well-known private equity expert investors in such names as New Look and Travelex.
The figures stack up nicely, with billings coming in at $476mio for 2014, a 22% increase, (2013-14: 4%) and EBITDA of $101mio, up from $97 and $92mio in the previous years respectively. The company is also highly liquid, cash was at $73mio for 2015. These were generated by sales of over half in Europe, a third in the U.S and the remainder in Asia and the rest of the world. The company operates a 'channel first' sales model where products and services are sold to end customers principally through a network of over 15,000 channel partners. Notable clients include Cisco, Marks & Spencer and Harvard University. The income stream of the company is quite predictable in that 81% of the billings represent subscription agreements which are recognised over the course of the agreement (68% over one year, 48% in the 2-3 year bracket). Furthermore, these agreements are usually paid in full up front, assisting the cashflow of the group. The outset of the year 2015-2016 continues to see good growth, with billings increasing 19% in the first two months compared to the previous year.
The market for worldwide IT security was $32bn in 2014 with the mid-market segment representing both the largest segment in terms of numbers and of spending. According to industry experts, the market is set to grow 7%pa to 2018. Notable competitors in the market are Symantec Corporation, McAfee division of Intel, IBM and Cisco Systems. As an indication of the size of these companies, McAfee was sold to Intel in 2010 for $7.6bn. With anti-virus software market share in 2013 of only 3.2% for McAfee, this shows there is a huge market and there is huge growth potential for Sophos, notably specialising in the largest segment of this market in terms of customer base. Sophos primarily operate in the end-user, network and email segments of the IT security market. Sophos identify within this two markets, end-user security group and network security group, the end-user being the largest segment today (with mobile security being a key trend), but is projected to be surpassed by network security in the future.
IPO proceeds and re-organisation
The IPO proceeds will be used to pay down debt, to increase brand awareness, to assist in recruitment and retaining key personnel and provide a source of capital for general corporate purposes. The sum raised was $100mio after fees of $25mio for the IPO. The company intends to pay off an exiting credit facility and organise a new facility. Given, the current levels of interest rates, this should reduce interest costs and add to bottom line profits. Furthermore, a shareholder loan, previously charging 14%, will be capitalised, further decreasing interest expense. While this will not assist the EBITDA key performance indicator (as this specifically excludes interest), but it will assist net profits and dividend payment possibilities.
As we at MidcapAdvisor are in the habit of holding our positions for a sufficiently long time to earn a good return, we also thrilled at the prospect of targeted 20% dividend policy, generous to say the least (new Shares issued by the Company will rank pari passu in all respects with the existing Shares).
A strong growing market, a strong financial position and dividends in the pipeline, look no further than SOPHOS PLC.
Disclosure: I am/we are long SOPH.