The deal priced below the range at $14. Since then the shares have been sitting around $13/share. Coverage should begin on or about May 17th and we expect the stock price to recover somewhat. Investors are mostly worried that SCWX is really just a services company and question whether they will be able to improve their cost structure quickly enough.
SecureWorks (SWCX) describes themselves as “holistic” approach that works better than the myriad “point products” which provide protection but still offer “holes” that hackers can exploit to breach security measures.
During a recent conference on advanced enterprise technologies hosted by PwC it became clear that the next generation of information security solutions would need to rely on machine learning and “AI” methods to build effective solutions to security threats. First we had IBM’s Watson winning Jeopardy and recently we had Google’s AlphaGo emerge as the Go champion. Light bulbs have gone off all over the information security space and there is a quiet rush to exploit this technology to combat hackers.
SecureWorks is in the “Managed Security Service Provider or MSSP” space as it is defined by organizations like Gartner group. It’s a bit different from security technology providers like Palo Alto Networks (PANW) and Check Point Software (CHKP) which are implemented and managed by the customer. The MSSP solution is a bit more like outsourcing. As such it’s really an add-on to typical information security solutions.
It’s a bit unclear however how the positioning of SecureWorks will evolve over time. We address it as an issue below but they are more of a “hybrid” since they resell third-party technology within their service offering and also have a couple of their own proprietary software products (for network intrusion detection and endpoint threat detection.)
Investors will like the solid enterprise positioning, recurring revenue stream and mature management team. The valuation is reasonable and the demand for information security software will stay strong for years to come. At the proposed valuation the P/S multiple of 2.8x is certainly reasonable given the growth and recurring revenue profile of the company. Their losses however are fairly staggering so a major question will be how quickly management can make the company more operationally efficient and prepare for greater competition.
With a projected market capitalization of around $1B shares of SCWX will appeal to a broad array of investors – it will have appeal for both small-cap and mid-cap managers, funds and ETFs. There are even some security-focused ETFs that will include SCWX in their holdings.
Our IV and comparable valuation metrics all suggest a price of $20-21/share for the stock. That’s certainly attractive relative to the current mid-point of the pricing range ($16.50) but investors will have to reevaluate after they see final pricing and initial trading level.
Concerns & Issues
High Expenses: Historical expenses are high and muddied by the separation from Dell. SecureWorks doesn’t even break out sales and marketing from general and administrative expenses. As a public company the target margins are much better but it’s not yet clear how aggressively they will move post-IPO. Shifting from a comfortable “captive” software division back to the “entrepreneurial roots” of the company may be a substantial HR and expense management challenge.
Weak Partners: As a kind of integrator of point solutions SecureWorks has “alliance partnerships” with an array of technology providers. However the list appears to be a bit “second tier” in terms of providers – Qualys, Kenna Security, Cisco, Lastline, TIBCO, Carbon Black, Wombat, Global Learning Systems. SecureWorks does integrate with other best-of-breed technology like Palo Alto Networks, Check Point Software, Fortinet, Imperva and F5 but the appear to be more “arms-length” in how they work together.
Competition: It’s early days for “learning” security systems and we expect to see a raft of competition in this market. As expected SecureWorks doesn’t paint the full picture in describing competition in their roadshow presentation. For example, IBM could be a very fierce competitor given their Global Services business and Watson technology. We’ve yet to see how companies like Akamai might play more in enterprise security. Point vendors are trying to be more general albeit with limited success so far. Many eyes (and dollars) are on private company Palantir which promises very strong data-driven security solutions for the enterprise.
Mixed Strategy: As competition heats up the questions around services versus products will get more important. At a high level it seems easy but implementation details can create major challenges in delivery (as in we work really well with XYZ firewall but not as well with ABC firewall.) Investors may also get confused about how to measure and value the company if they are neither a pure service provider nor a software company.
At the mid-point of $16.50 the shares are attractive. SecureWorks may have work to do in order to reduce expenses and get more competitive but the space is healthy and there are certainly some weak players in the enterprise market. For example, look how badly industry leader Symantec has done over the years. This should have been their market but they have completely bungled it.
Our IV of $20 to $21 is a good place to start for now until we see how the company executes and learn more about how aggressive competition will be. The future is certainly going to be about more “AI” driven models and data-driven approaches. Smarter computers are probably the only realistic solution in stopping human hackers from getting in.
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