SCWX - SecureWorks: Cloud Transitioning Challenges Continue To Weigh On The Stock

2023-10-23 06:27:57 ET

Summary

• SecureWorks operates in a growing cybersecurity market and is expected to gain market share through upselling, cross-selling, and international expansion.
• The company's cloud shift is still in the early stages, which may present challenges to profitability until revenue aligns with ARR growth.
• SecureWorks' Taegis platform offers a comprehensive solution for organizations, but the company's future depends on its ability to collaborate with partners and attract more clients.

Thesis

SecureWorks Corp. ( SCWX ) operates in a growing Total Addressable Market ((TAM)), projected to surpass $98 billion by 2025. I anticipate SecureWorks to gain a larger market share due to its strategy of upselling, cross-selling, and expanding both internationally and vertically. However, the company has continued to trade downwards as its cloud shift still remains in an early stage. The development of the Cloud-native Taegis platform and the associated revenue recognition model might present challenges to profitability until revenue aligns with ARR growth, which I don't anticipate occurring until mid-FY24. I don't see any catalysts in the near term which may re-rate the stock's multiple upward, which is why I currently assign a hold rating to the stock.

Company Overview

SecureWorks specializes in cybersecurity solutions and services, with an increasing emphasis on generating revenue from its cloud-native Taegis software platform. Utilizing machine learning, threat intelligence, and security analytics, Taegis ensures integrated detection and response across customer endpoints, clouds, and networks. The platform currently features two SaaS applications: Extended Threat Detection and Response (XDR) and Vulnerability, Detection and Response (VDR). Additionally, there's a managed security service, ManagedXDR, which offers enhanced threat detection and intelligence.

Q2 Review and Outlook

SCWX announced improved revenue for the second quarter, alongside Taegis ARR, that matched expectations. However, the company adjusted its FY24 Taegis ARR to be between $285-300M (previously over $300M), FY24 MSS ARR to be $15M or lower (previously $20M or lower), and FY24 revenue to fall between $360-368M (previously $380-400M). The company attributes these reductions to the rapid decline in their MSS segment and the delayed revenue benefits from new market strategies due to extended sales cycles. I view this accelerated decline in MSS as a positive, as SCWX can overcome this challenge more quickly. I also acknowledge that many other security firms have experienced similar sales cycle extensions. The revised forecasts likely consider various potential sales cycle scenarios. However, there are also other potential influencing factors, such as heightened competition in the XDR and SIEM sectors and the early stages of SCWX's partner-first strategy, which may require more time to mature.

Large TAM and Differentiated Technology

SCWX's TAM is believed to be growing to over $98 billion by 2025 as the endpoint, SIEM, and vulnerability assessment markets converge to features of a holistic XDR solution. I think SecureWorks can gain market share from incumbents in the space primarily driven by increased customer penetration through up-sell/cross-sell and both international and vertical expansion. I think the company's focus on data-driven, automated security allows it to stand far above its peers in the space.

SecureWorks also leverages a unique automated and scalable cloud infrastructure that incorporates both machine intelligence gathered from its Counter Threat Platform ((CTP)) and human intelligence via its Counter Threat Unit ((CTU)) research teams to empower all solutions. The CTP is highly automated, processing 99.9% of the 230 billion daily data events across the company's entire install base without human input. This creates a compounding "network effect" as new information continuously enriches the data set. CTP's integrated machine-learning algorithms and analytics allow SecureWorks to use intelligence gathered over 18+ years to contextualize attack trajectories and drive effective remediation.

SecureWorks's Taegis XDR Platform

In February 2021, SecureWorks unveiled Taegis, the company's security analytics platform. SecureWorks' Taegis was purpose-built as a cloud-native platform to combine Machine Learning with security analytics and threat intelligence for unified detection and response across customers' environments. By addressing organizations' vulnerability gaps through its XDR SaaS application, SecureWorks is delivering customers better security outcomes and simpler security operations.

Cybersecurity budgets are expected to remain robust even in challenging economic conditions, with the approval process for sales becoming more stringent. SecureWorks' Taegis XDR platform offers a comprehensive solution for organizations, enhancing breach detection across customer environments and facilitating prompt responses through automated playbooks. The company's vast experience, with over 3,100 incident responses annually, strengthens its platform. The XDR platform not only replaces outdated systems like Next-Gen AV, EDR, and legacy SIEMs, leading to cost savings but also boosts workflow efficiency, potentially reducing practitioner workloads by up to 85%. Furthermore, risk mitigation offers an additional return on investment for clients.

Valuation

SecureWorks appears undervalued, trading at a forward EV/Sales multiple of 1.3x compared to a sector median of 2.5x. However, the company's growth has plateaued during its shift to Taegis and the phasing out of MSS services. The company's future hinges on its ability to collaborate with partners to attract more clients, but this strategy hasn't been validated yet. It is important to note the sector median revenue growth is currently standing at 9% and gross margins of 49% . SecureWorks revenue is expected to grow at a lower rate than the sector average, which is why the stock continues to trade at a discount. The company's cloud transition is still in the early stages of the transition, creating Revenue and OpEx headwinds, which is why, in the near term, I see very limited chances of the stock re-rating upwards. Hence, I currently assign a hold rating to the stock.

Investment Risks

Dell's majority ownership of SecureWorks since its acquisition in 2011 presents potential challenges. Any sell-offs by Dell might lead to share dilution, causing fluctuations in share price. Moreover, SecureWorks' reliance on Dell for various corporate services could result in additional transitional costs should they opt for different service providers. If SecureWorks decides to create more independent corporate services, this could increase its operating costs, potentially hindering its path to profitability. Additionally, the MSSP and broader security sector are saturated and fiercely competitive. To stay relevant, continuous technological advancements are essential. SecureWorks faces competition from well-established tech giants like Cisco (CSCO), IBM (IBM), HP Enterprise (HPE), and others, who have a significant user base, brand reputation, and extensive solution range.

Conclusion

Although the stock seems undervalued, SCWX's shift to the Cloud is still in an early phase, and the company plans to boost its investments in R&D and Sales & Marketing, which could impact earnings going forward. With the ongoing development of its Cloud-native Taegis platform and the revenue recognition model, I anticipate revenue challenges until it aligns with ARR growth, likely around FY24. Although I believe the management's strategy is sound, such transitions have traditionally been tough to manage and can temporarily reduce profitability. Hence, I currently assign a hold rating to the stock.

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