2023-12-29 04:00:13 ET
Summary
- Enterprises' willingness to spend and upgrade cybersecurity is increasing, and vendor consolidation is a growing theme in a historically fragmented market.
- Tenable is well-positioned as a market leader with pricing power in the cloud security market, and is the outright leader in the Vulnerability Management category.
- Tenable's management has a strong track record of outperforming on both revenue and margins, instilling confidence in their growth targets.
- Given the bullish growth context, Tenable appears undervalued at current EV/Sales valuation multiples.
- On the risks side, Ermetic acquisition was an expensive one and management is yet to prove their capital allocation capabilities.
Thesis
My bullish argument for Tenable Holdings (TENB) rests on 3 legs:
- Enterprises' willingness to spend and upgrade their cybersecurity is increasing
- Tenable is set to benefit as a market leader in a growing cybersecurity niche
- Management has an A+ track record in outperforming on revenue and margins
Enterprises' willingness to spend and upgrade their cybersecurity is increasing
Amid delays, cancellations and reprioritizations in technology spending, cybersecurity has been one area that has still managed to grow . This is driven by increased willingness to spend and consolidate their vendors into those few that can deliver on comprehensive cybersecurity solutions across a host of environments. According to Tenable CFO Stephen Vintz, this marks a shift from the historical norm of relying on a fragmented market of smaller <$20 million revenue vendors providing separate point solutions.
As we head into 2024, cybersecurity spending is expected to continue growing in importance as enterprises undergo their digital transformation journey. In fact, new AI developments only widen the scope of cybersecurity attacks, making proactive management of these risks even more critical. Vendor consolidation is expected to be a key theme, benefiting market leaders even more.
Tenable is set to benefit as a market leader in a growing cybersecurity niche
Tenable is the outright market leader in the Vulnerability Management segment within the overall cybersecurity umbrella:
Tenable's Market Leading Position (Tenable Holdings Q3 FY23 IR Presentation, Author's Highlights)
With the acquisition of cloud-native application protection platform (CNAPP) Ermetic, Tenable now has a $30 billion total addressable market in the broader $45 billion cloud security market. This market is expected to grow at an 18% CAGR over the next 3 years. Tenable's growth rate in the last couple of quarters has moderated from these levels:
Tenable Revenues (Company Filings, Author's Analysis)
However, management indicated a mid-teens (14-16%) outlook for 2024 in terms of calculated current billings, which is a leading indicator of short-term revenues. This too is likely to underestimate the true future sales potential of the company since the accounting metric here as CFO Stephen Vintz noted that this metric does not reflect the closing of multimillion-dollar deals with the public sector, where Tenable is especially strong.
A key growth driver is the adoption of Tenable One , which is an example of a comprehensive cybersecurity solution that is able to operate across different assets. This aligns precisely with the industry growth trends, which is why the company has seen 20% of new sales coming from sales of Tenable One, even when the solution is priced 70% above alternatives; a great sign of pricing power.
Management has an A+ track record in outperforming on revenue and margins
Tenable's management has delivered a positive surprise vs consensus on revenues in the Street for 22 straight quarters, averaging a beat of 293bps per quarter. It has never disappointed consensus expectations.
Revenue Surprise vs Consensus (Capital IQ, Author's Analysis)
Even more impressively, this record of 22 consecutive beats without a single miss is present even at the operating margins level, with an average beat of 435bps:
EBIT Margin Surprise vs Consensus (Capital IQ, Author's Analysis)
This A+ track record in delivering above expectations leads me to believe management's messaging on their growth targets.
Financials Review
Looking at the key numbers, I make a few observations:
- Calculated current billings saw an optical dip in Q3 FY23 because, as mentioned earlier, multimillion-dollar deals signed with the public sector were not included due to the longer-dated nature of billing recognition.
- However, the remaining performance obligations ((RPO)) numbers capture a broader set of future revenue as it includes both invoiced work and yet-to-be-invoiced work as per contracts with customers. Here, the net new RPO is growing well QoQ, indicating a growing pipeline. I would expect to see further increases here as the growth-focused thesis plays out.
- Gross margins have been stable in the high 70s; some variations here were due to temporary increases in initial public cloud setup costs.
- The company has made steady progress in FY23 in realizing operational efficiencies via lower personnel costs in the S&M and R&D teams. Going forward, I anticipate higher growth levels to aid its transition into GAAP-profitability (which I prefer to look at since I view share-based compensation as a real cost to the business) in H1 FY24. The numbers support this too, as incremental EBIT margins are much higher than current EBIT margin levels (>40% on a QoQ basis). The incremental EBIT margins are a good indicator of how much the company is keeping after paying off its variable costs.
- On the balance sheet side, Tenable's position is healthy, as the company is in a net cash position of $333 million; almost 6% of the current market capitalization of $5.53 billion. So solvency issues are irrelevant. And current assets alone cover for all liabilities 1.67x over, so I do not see any liquidity or issues either.
Valuation
As Tenable has still not reached steady-state profitability levels yet, I have decided to assess its valuation using the EV/Sales multiple. This will also help make sense of the multiple with better context, vis-a-vis previous growth rates:
Tenable Holdings 1-yr fwd EV/Sales (Capital IQ, Author's Analysis)
Currently, Tenable is trading at a 1-yr fwd EV/Sales of 6.00x, which is 10.8% below the ~5-year average of 6.72x. Since the start of 2022 - the year where the macro environment took a turn for the worse due to rate hikes - the average 1-yr fwd EV/Sales has been 6.34x; 5.8% above the current valuation multiple. Now, considering that cloud spending is expected to increase and the macro environment likely to improve due to the Fed's relatively more dovish stance on rates, I reason that the growth outlook now is rosier than it has been over the last 2 years, so it demands a higher multiple than 6.34x. Therefore, the current 6.00x 1-yr fwd EV/Sales signals undervaluation to me.
The comparables peer set includes other companies with cybersecurity offerings: Cloudflare ( NET ), CrowdStrike Holdings ( CRWD ), ZScaler ( ZS ), Qualys ( QLYS ), SentinelOne ( S ), CyberArk Software ( CYBR ), Varonis Systems ( VRNS ), Okta ( OKTA ), Rapid7 ( RPD ) and SolarWinds Corporation ( SWI )
On a comparable valuation basis too, Tenable's 1-yr fwd EV/Revenue of 6.00x is 38% below the median of 9.62x, signaling potential undervaluation again. I believe it is not unreasonable to expect Tenable to move towards the current sector median multiple, particularly as the entire sector enjoys valuation upgrades as it benefits from increased cybersecurity spending. This means the ask on Tenable's relative re-rating upgrade is not demanding; we do not have to assume it would command a sector-premium multiple to make a case for a buy.
Key Risk: Was The Ermetic Acquisition Too Expensive?
Ermetic is estimated to have posted $14.3 million in revenues in 2023. Tenable Holdings is paying a total consideration of $265 million for the business ($245 million in cash and $25 million in RSUs). This implies an EV/Sales multiple of 18.5x, which I believe is quite pricey. Management expects to achieve breakeven operating earnings and unlevered FCF on this transaction by Q4 FY24. However, whilst management has strongly proven their operational execution skills, I believe their M&A capital allocation skills remain to be proven.
Takeaway
Cybersecurity spending has seen resilient growth over the last 2 years in an environment where technology spending have been rationalized. 2024 is expected to propel further growth in this sector, particularly for market-leading vendors as enterprises look to consolidate their spending into more comprehensive solutions. Tenable Holdings is well-set to be a beneficiary of these trends, given its leadership position in the cloud security market, particularly in the area of Vulnerability Management, where it is the outright leader. The company is on a healthy growth track and management has proven their skills in outperforming operational expectations; 22 consecutive beats on both revenues and margins vs consensus. Given the growth prospects, the valuations seem attractive as the stock trades at an EV/Sales multiple discounts over both the last 2 years (when enterprises have witnessed technology spending cuts) and the last 5 years. The main risk to watch out for would be the realization of benefits from Ermetic; a pricey (18.5x EV/Sales) bolt-on acquisition.
All in all, I rate Tenable Holdings a 'Buy'.
How to interpret Hunting Alpha's ratings:
Strong Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis, with higher than usual confidence
Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis
Neutral/hold: Expect the company to perform in-line with the S&P 500 on a total shareholder return basis
Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis
Strong Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis, with higher than usual confidence
For further details see:
Tenable Holdings: An Attractive Play In The Growing Cybersecurity Sector