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Sophos not looking secure

The cybersecurity group has changed its guidance consistently in recent updates
Sophos not looking secure

Numerous high-profile cyberattacks in 2017 were a boon for cyber securitiy firms. ‘WannaCry’, for example, affected 200,000 computers in at least 100 countries, according to the UK’s National Audit Office – hitting at least 80 out of 236 NHS trusts in England alone.This galvanised demand for the products offered by Sophos (SOPH), and particularly its ‘Intercept X’ offering, as business customers sought to protect themselves against future threats.

IC TIP: Sell at 295.4p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

$12bn-$15bn market opportunity
Comparatives should get easier

Bear points

Sluggish growth
Forecast downgrades
Weak margins
Competitive industry

However, the company has since failed to maintain momentum. Against tough comparatives, its ‘billings’ metric – pertaining to the value of products and services invoiced to clients which is historically higher than the revenue it is allowed to recognise – has proven increasingly sluggish.

The situation has been exacerbated by overly optimistic guidance. The company has disappointed several times during the recently completed financial year, leading to an abrupt about-turn in the direction of forecast revisions and the share price (see graph). 

After a bumper 12 months to March 2018, during which Sophos achieved 18 per cent billings growth at constant currencies to $769m (£586m), management predicted a “mid-teens” improvement for 2019 – including a currency benefit – and remained confident in achieving $1bn in annual billings in the year to the end of March 2020.

But the first quarter saw lower-than-anticipated billings growth attributed to “a particularly challenging comparable”. While management stuck by expectations of mid-teens constant-currency growth by the time of the November interims, the outlook changed again and with its January third-quarter update came news of an expected “modest decline” for the full year. Meanwhile, management seems to have stopped referencing the $1bn target in recent updates.

The company is up against tough competition to win new clients. To add some context, UK-listed cybersecurity player Avast (AVST) (which is largely consumer-focused) enjoyed an 8.6 per cent rise in adjusted billings to $847m for the year to December 2018, while US-based behemoth Palo Alto Networks (US:PANW) saw billings rise by more than a quarter to $853m over the three months to January 2019 alone.

For Sophos, slower billings have had a negative impact on “cash Ebitda” margins; a very heavily adjusted cash profits number using billings instead of recognised revenues, which the company argues is as a “useful supplemental measure of earnings that provides visibility on actual cash earned in the year”. Over the nine months to December 2018, the cash Ebitda margin declined from 21.2 per cent to 19 per cent. In fairness, this is an improvement on the first half decline from 19.5 per cent to 15.3 per cent, after costs tied to sales and marketing, and research and development, rose faster than billings.

Bosses may shift their reporting and guidance towards more conventional measures of sales and earnings, which would align Sophos with peers. For the respective nine-month period, revenues rose 14 per cent, buoyed by 18 per cent growth in subscription sales – but the latter figure was 23 per cent a year earlier. More encouragingly, statutory operating profits came in at $51m – up from losses of $25m.

SOPHOS (SOPH)   
ORD PRICE:295.4pMARKET VALUE:£1.4bn
TOUCH:295.2-295.6p12-MONTH HIGH:646pLOW: 273p
FORWARD DIVIDEND YIELD:1.5%FORWARD PE RATIO:19
NET ASSET VALUE:35ȼ*NET DEBT:77%
Year to 31 MarTurnover ($m)Pre-tax profit ($m)*Earnings per share (ȼ)*Dividend per share (ȼ)
201647817.711.61.6
201753033.38.14.6
201864125.79.44.9
2019**71897.119.85.3
2020**80199.619.95.7
% change+12+3+1+8
Normal market size:3,000   
Beta:1.84   

*Includes intangible assets of $852m, or 177ȼ a share

**Shore Capital forecasts, adjusted PTP and EPS figures

£1=$1.31