ARQQW - Arqit Quantum: Early Stage Quantum Encryption SaaS Company Speculative Buy

Summary

• Arqit has developed a leading quantum encryption solution that is implemented purely through software.
• It has signed up marquee customers on both sides of the Atlantic, including Amazon Web Services.
• While currently not profitable and losing cash, it can be considered to have just gotten past the 'proof of concept' stage.
• This makes it a good, albeit speculative, security for investors seeking exposure to the nascent quantum encryption space.

Overview

Arqit Quantum ( ARQQ ) is an encryption software company. The firm sells quantum encryption as a service, allowing networked devices to communicate over their proprietary protocol and secure data transfer against traditional as well as quantum codebreaking. Their solution is purely implemented through software and was initially designed to operate via satellite link, although the firm has recently made clear that they will not be pursuing this avenue due to advances in their software offering.

First deploying their service into production in July 2021, Arqit continued its growth and listed itself publicly via SPAC merger. Combining with Centricus Acquisition Corporation in Q4 2021, the combined entity rebranded under its current name and has been trading as such since then.

Throughout that time, the security has underperformed the NASDAQ index significantly, while also continuing to trade below its IPO price.

This article will review the company’s financial and operating position, as well as determine where things are headed from a fundamental perspective.

Financials

Arqit is quite an early stage company, made clear by the fact that it only generated $20M in revenue for fiscal year 2022. Only $7.2M of this was from its core QuantumCloud offering, with $12.8M of this stemming from a bespoke contract with the European Space Agency (please note that this is reflected as one-off line items on its accounting statements). Throughout this period the company also scaled up its headcount and expense structure, yielding $72.2M of expenses with $22.9M of that coming from share-based compensation.

Due to the company’s capital structure, it was technically able to produce a pre-tax profit of $65.1M during fiscal year 2022. This is due to the intricacies of it having listed via SPAC and should not be considered cash profit at present. Adjusting for warrants as above, the company actually generated a loss of $52.3M for 2022. This is due to the need to reprice warrants (payments made via options on shares) that it had issued previously. This is also reflected in the company’s operating loss of $52.1M for the year.

In order to cut through this accounting complexity, we can take a look at the free cash flows – which are decidedly negative. This company is neither profitable nor cash flow generative at this point, and should be expected to make further accounting/non-cash expense adjustments pertaining to its warrants. Nonetheless, it has already written off a significant portion of these and the result should be less numerically significant than what we are seeing in the previous quarter.

Overall, these financials are too sparse to establish clear trendlines at present. We can establish that the company is where it is, but it’s unclear where it is headed purely by looking at its accounting statements. The highlight here is that it is generating revenues, avoiding interest payments, and is operating with a positive cash balance at present. Since the firm’s expenses will be higher than its current cash on hand for the year going forward, however, it will likely be taking on debt in the next several quarters in order to continue to operate. Ongoing dilution through warrants as well as share-based compensation will also be a factor. We can chalk this up to it being a very early stage technology company that we can’t infer too much about at present.

Business & Operations

Arqit has been able to sign several marquee customers such as Amazon Web Services, Dell, and Fortinet, which are some of the largest providers/users of encryption software services in the world. These are great customers to have, and I agree with managements commentary that it should act as a sales catalyst to have Arqit’s software readily integrated and purchasable via these brand names. All else aside, this bodes well for the firm’s future operations.

Along with this, Arqit appears to have been selling into the defense sector. Through a contract with two ‘US government programs of record’, it appears that this has been successful. While evidently confidential, this is another vote of confidence in the quality of its technology.

Additionally, Arqit’s core business structure has now gone from hardware and software to just software. This creates much better economics and reduction in capital expenditure. If it had to proceed as before and construct satellites in order to deliver on its value proposition, it would take that much longer for it to achieve profitability and/or cash flow generation. As noted by management, it intends to deliver on its one contract for satellite construction while pivoting away from this and licensing the intellectual property going forward. I agree in that these economics should end up superior as well as providing a neater business model overall.

Conclusion

To reiterate, Arqit is an early stage company that appears to have something quite unique and in demand. While it is difficult to scope out the total market size for quantum encryption services for such a nascent industry, the customers that it has signed up to date speak for themselves. Ranging from government institutions on both sides of the Atlantic, to premier software players such as Amazon Web Services, this is all the proof that I need to believe that their technology is really that special.

With that being said, there is not a clear level of financial performance that we can expect in the following year. This company, and its stock, are speculative in that its performance can occur over a wide banding. Nonetheless, it seems to me that this firm is a genuine innovator and could capture quite a bit of market share with technology; how many other quantum encryption providers are there really? Taking all of that into consideration, I am going to cautiously call it a buy for any investor interested in this early stage space.

For further details see: