Varonis: Value, Growth and Huge Data Security Drivers (NASDAQ: VRNS)

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Varonis (NASDAQ:VRNS) is a leader in automated data security and compliance. Businesses today have vast amounts of data and it is growing every day. In fact, the big data market was valued at $41.33 billion in 2019 and is expected to will be worth $116 billion by 2027, growing at a compound annual growth rate of 14% [CAGR] during the period. According to Varonis, “nearly every breach” involves data assets that are stored in central databases. Additionally, the cybersecurity industry is intended grow at a compound annual growth rate of 13.33% and reach $298.7 billion by 2027. Varonis is poised to take advantage of growth in these sectors. The company recently exceeded analysts’ revenue expectations and is steadily increasing its margins. So, in this article, I’m going to dive deeper into the business model, financials, and valuation of the business, let’s dive into it.

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VRNS data by YCharts

Secure business model

The rise of cloud apps means that data is shared more freely between apps and each has different permission models. A critical example would be customer relationship management [CRM] data in an application such as Salesforce. This contains customer information that must be protected under the GDPR and CCPA, but it is also critical to business success. If stolen, it would result in huge fines and extensive reputational damage to consumers.

Varonis

Varonis (Investor Relations)

Varonis solves these problems with its data protection, visibility and security platform. This identifies where sensitive customer data resides (on-premises and in the cloud), secures it, and ensures it is compliant. A common security policy that the company implements is the “Zero Trust” security model. This method means that, by default, people on the network are granted “least privileged” access only to the applications they need. This helps prevent an attacker from accessing the network through a non-critical application, but then moving laterally to a critical application such as the finance department.

Varonis

Varonis (Official site)

Varonis provides a unified view of customer data. However, the platform also automates “database hygiene” aids by automating the removal of stale data. The company’s competitive advantage is its patented technology. Additionally, the company is ranked the number one product for file analytics by Gartner customer reviews with 4.6 out of 5 stars.

Growing finances

Varonis delivered strong financial results for the second quarter of 2022. Revenue was $111.45 million, up 26% year-over-year and beating estimates $242,000 analysts. Subscription revenue was a key driver which increased to $84.4 million and jumped 44% year over year. Maintenance and services revenue was $27.1 million, with renewal rates over 90%, showing strong product adherence.

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VRNS Revenue Estimates for Next Year’s Data by YCharts

Revenue growth was driven by a strong performance from North America, with $80.8 million generated up 31% year-over-year. North America represents 73% of total revenue and the company will therefore be little impacted by the strength of the dollar, despite concerns during the conference call. EMEA revenue was $27.2 million, which showed slower growth of 11% overall. This region was hit by currency headwinds as the euro fell to its lowest level in 20 years against the dollar. Additionally, Varonis left Russia, which caused revenue to drop by $4-5 million. If I adjust for those headwinds, EMEA growth was actually 25%, which was fantastic.

Rest of the world revenue was just $3.5 million, up 47% year-over-year, but that’s off a low base. For a SaaS business Recurring Annual Revenue [ARR] is an essential measure to analyze. In this case, the ARR was $426.3 million in Q222, up 30% year-over-year.

ARR

ARR (created by author Ben at Motivation 2 Invest)

ARR’s growth has been driven by strong traction from the company’s new “bundle” offerings, as they aim to increase the number of licenses customers accept. The trend is positive so far, with 75% of their customers purchasing four or more licenses, up from 68% last year. Additionally, 45% of these customers purchased six or more licenses, up from 35% the previous year.

Adoption of the license

Adoption of the license (Investor presentation)

Despite rapid growth, Varonis is also expanding its margins. For example, its gross margin was 87.2% for Q2 22, which was higher than 86.9% for the previous year. Operating expenses were $95.5 million in the second quarter, with an operating margin of 1.5%, up from 1.2% a year earlier. Today, although the company still has a long way to go to increase its margins, it was great to see operational leverage taking hold, which is one of the benefits of a platform. SaaS.

Varonis has a strong balance sheet with cash, cash equivalents and short-term investments of $789 million, in addition to long-term debt of $248.2 million.

Going forward, the company forecasts $484 million for fiscal 2022, with an expected growth rate of 25% to 26%. The operating margin should also increase significantly in the next quarter to between 6.9% and 8%, which is fantastic.

Tips

Tips (Investor Presentation)

Advanced Assessment

In order to value Varonis, I incorporated the latest financial data into my advanced valuation model which uses the discounted cash flow valuation method. I forecast revenue growth of 25% for next year and 24% for the next 2-5 years, which is in line with management and analyst estimates.

Varonis 1 stock valuation

Varonis 1 stock valuation (created by author Ben at Motivation 2 Invest)

I projected the company’s operating margin to grow to 23% over the next 8 years, which is the software industry average. I expect this to be due to increased operating leverage and increased license sales. It’s also quite conservative given that management expects an operating margin of around 7% for FY22 alone. In order to increase the accuracy of the valuation, I also capitalized R&D expenses.

Varonis

Varonis (created by author Ben at Motivation 2 invest)

Given these factors, I get a fair value of $33/share, the stock is trading at ~$26.8 per share at the time of writing and is therefore undervalued by around 21%.

As an additional data point, Varonis is trading at a price-to-sales ratio = 7, which is 21% cheaper than its 5-year average.

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VRNS PS Ratio (forward) data by YCharts

Risks

Competition

Although Varonis has patented technology, there are competitors in the file scanning/compliance industry. These include Netwrix, Veritas, the stored IBM IQ suite and many more. The good news is that Varonis seems to be the top rated and category leader as mentioned earlier.

Recession/Slowdown in IT Spending

High inflation and rising interest rates have led many analysts to forecast a recession. This may cause companies to temporarily delay IT/security spending until more certainty is known regarding budgets.

Final Thoughts

Varonis is a leader in data security and compliance. Given industry tailwinds across big data, compliance and cybersecurity, the company is poised to benefit from secular trends. The stock is inherently undervalued and relative to historical multiples and could therefore be an excellent long-term investment.

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