Description

ALLT is a small cap network visibility and cybersecurity software company headquartered in Israel. ALLT was previously written up by Cobiaman in late 2015 and again by tcc in 2020. TCC's Jan 2020 writeup provided a great overview of Allot's SaaS cybersecurity offering, AllotSecure and the growth math attached to that segment. We will focus our writeup on how ALLT's share price has dislocated dramatically from fundamentals in recent months, creating an extremely asymmetric setup for investors, whereby a nascent but proven SaaS cybersecurity business with a potential future value in the billions can be purchased for a negative implied value today.   

A Quick Overview of Allot's Business and Valuation:

• Allot is the technology leader in a niche, modestly growing area of networking software called deep packet inspection ("DPI"). DPI is L7 networking software used to "see inside" each packet of data transmitted over an IP network. As noted by TCC in their writeup, Allot will see a growth inflection from 5G network builds as its DPI technology is also uniquely suited to help telecom operators secure their networks against DDOS attacks that are much more difficult to block at 5G throughput and scale. Allot has already won 5G DDOS deals with DISH Networks and two yet to be named tier 1 carriers in APAC. There were once many publicly traded DPI players, including P-cube, Starent, Ellacoya, Sandvine and Procera. All of these players were purchased by private equity or strategics between 2007 and 2017, with Sandvine the freshest transaction comp at ~3x EV / TTM Sales (Sandvine was merged with Procera by Francisco Partners and is currently being marketed for sale or IPO). As the tech leader, Allot has been a share gainer in its DPI business and generated ~$140 million in revenue from this business in 2021. This is a very sticky license / maintenance business with moderate mid-term growth prospects and on the cusp of the 5G cycle; we value DPI at 2.5x EV/S or $350m ($9.50 / share), with draconian bear market downside to 1.5x EV/S or $210m ($5.80 / share).
• Allot has maintained a strong balance sheet, with $99m of net cash and equivalents ($2.70 / share). 
• Allot is the leader and category evangelist for the network-based, Telco-delivered consumer and SMB cybersecurity market. For a primer on what exactly this product is, the Allot investor day hosted in May of 2021 provides a great overview of the solution and go-to-market strategy (https://investors.allot.com/events/event-details/virtual-analyst-investor-event). Basically, this is a consumer / SMB grade cybersecurity product that requires zero installation and greatly reduces the average user's risk of being phished or taken over by ransomware by blocking such malicious links across mobile and home networks and smart home devices. Allot delivers the network-based security product, which includes a user management app console (for parental control and other features) to the telco operator (eg. Vodafone / DISH / Meo), and the operator then offers it as a white-label under their own brand. Typically there is a 5-10% ARPU surcharge per month billed to subscribers, and based on our and analyst checks, Allot's previous customer cohort data and other market sizing assumptions, the TAM for this solution could be anywhere from $3 billion - $10 billion / year addressable to Allot of high margin SaaS revenue. Currently Allot has signed AllotSecure deals with 18 telco operators, 7 of which have at least partially launched, and is generating ~5 million of SaaS ARR as of its most recent quarter (100%+ YoY growth rate). Management has guided for $20 - $30 million of ARR in this business by next December. Given the significant growth inflection, we conservatively value the 12/2022 ARR stream at 10x sales or $250m ($7 / share). Notably, holding the multiple constant to our projection of 12/23 ARR ($92m) would yield a valuation of $920m ($25 / share).  
• While the steady-state DPI business should be capable of achieving ~20%+ EBITDA margins (Sandvine / Procera is currently operating above this level), Allot is running a slightly negative P&L and will run at -10% OM in 2022 as tons of capital is being allocated to the virtually pre-revenue cybersecurity business, preventing the stock from screening well to value investors.
• The upshot is that Allot's legacy DPI business and net cash are worth ~$12, while the AllotSecure business is worth anywhere from $7 - $25, implying 1yr / 2yr upside of 110% / 310% respectively. With nearly $3 of net cash on the balance sheet and a legacy business that is performing well and boasts historical transaction comps suggesting a value near $10 / share, fundamental downside from Friday's $8.90 close is negligible. 

Why is the Stock at $9?

Obviously, we are arguing there has been a very sharp dislocation in Allot's share price vs. its intrinsic value that begs explanation. Following its well-received analyst day and the award of the DISH Networks 5G DDOS deal, Allot shares traded as high as $21 in June of 2021, but then fell by over 50% to $8.90 as of Friday. Having first invested in the company near $5 in late 2015, we have some decent historical perspective and can provide a relevant timeline:

• 2015 - 2016: Allot developed and commercialized its AllotSecure offering and ultimately won a deal with Vodafone, also its largest DPI customer, however the deal was structured as a license / maintenance contract. During this time, Allot continued to witness revenue declines and market share loss under a struggling management team; following shareholder agitation there was board and management refreshment, with Yigal Jacoby Allot's founder coming back to chair the Board (Yigal had been CEO until 2006, overseeing Allot's growth through IPO).    
• 2017: Erez Antebi joined as CEO of Allot and quickly reinvigorated the business and overhauled sales leadership, DPI revenues resumed growth under Antebi from $80m in 2017 reaching $140 million in 2021. Antebi also decided to shift the AllotSecure business model to a SaaS revenue model from license / maintenance, with ALLT to share economics with the carriers, receiving a 25 - 50% split on revenues earned from the service.    
• 2018 - 2021 fundamental performance: Allot won SaaS-based deals with several carriers, including MEO in Portgual (division of Altice), Telefonica for SMB security, Play (leading Poland-based mobile operator), Numericable (leading French T1 cable operator), and others that have been announced but not yet named. Vodafone's AllotSecure offering became a wild success, growing to ~$200m / year in high margin revenues for the carrier and achieving 40%+ penetration rates in certain markets, which made management highly enthused about its prospects with newly signed deals. However, the SaaS-based deals with other carriers generally ended up taking longer to sign, commercialize, and ramp-up than expected due to this being a new service and operators taking different approaches with different urgency in different markets. Allot ended up having to recalibrate certain aspects of its sales support and marketing strategy along the way to adjust to new data. Bookings and operator signings were very strong, but revenue generation consistently lagged behind expectations by about 1 year vs. what management expected.
• 2018 - 2021 performance versus street: After returning the DPI business to growth, Antebi established a beat and raise cadence and built strong credibility with investors from 2017 - 2020. However, with limited data to guide off of for the AllotSecure SaaS product, management overachieved on bookings (as measured by Allot's "Maximum Achievable Revenue" or MAR metric which is basically ARPU x subs x Allot's percentage split with the carrier) but underachieved on revenue generation as operators pursued incremental launches and suboptimal marketing tactics as opposed to following Vodafone and Allot's "best practices" manual. Management and the Board's background running established product cycle driven businesses rather than incrementally scaled startup SaaS offerings led them to calibrate expectations around "top down" MAR math rather than observable bottoms up behavior at the newly signed customers. In 2019, Allot expected $5m of AllotSecure revenue in 2020 and $20m in 2021 (actuals, $2m / $5m). Later, management guided to $6 - $7 million for 2021 and $25 million+ for 2022. Throughout 2021, Allot consistently trickled down its '21 guide (to ~6m, to $5-6m and finally to $4-5m) while keeping the $25m+ 2022 bogey until its Q3 earnings call, when they finally reset this number to $10 - $15m (and $25 - $30m ARR exiting 2022). Obviously, this type of street management is exactly what investors hate to see and 2021 was a painful year to be invested as momentum in new business wins was totally eclipsed by the slow-motion train wreck of misses on the SaaS revenue metric.

Why Now is the Time to Own the Stock

In addition to Allot's extremely compelling valuation, we believe management appropriately reset expectations on the Q3 earnings call which has created a favorable setup for outperformance on the critical SaaS revenue metrics in 2022. Here are some of the reasons we expect Allot to outperform and trade to fair value in 2022:

• Investors have better visibility: Allot listened to large shareholders and began disclosing quarterly SaaS revenue and ARR starting with its Q3 report, and plans to do so going forward. This gives investors a relevant way to track and model the progress of the business and appropriately value it.    
• Management has better information and are better forecasters: Rather than trying to apply top-down projections based off of old Vodafone data, management is now armed with more relevant information from a larger sample size, and has calibrated guidance conservatively to account for the new behavior they are witnessing (operators taking longer to scale the offering). We think they are in a strong position to exceed lowered expectations for 2022 as a result.  
• Improved sales and marketing coordination increases likelihood of success at new and existing customers: Allot has tasked a new overlay marketing team (hired in mid 2021) with sales support following deal signing to help operators develop optimal go-to-market approaches. Salespeople are also being compensated on residuals tied to revenue generation rather than simple MAR-based bookings compensation. For a management team and Board with prior SaaS experience, this would have been a no brainer but Allot was learning the game a bit. At this point, we think they are in a good spot to help improve performance at some of the subpar AllotSecure launches and execute well on the new ones. 
• Very large deals are in play at name brand global and US carriers, and we think Allot stands to win at least one of the US majors in 2022. If Allot wins Verizon for consumer cybersecurity as we expect they can, it will be a huge endorsement of the technology and Allot's market positioning and also very financially meaningful (potentially a $100m revenue opportunity for Allot).
• AllotSecure is highly extensible, meaning further value added features (robocall blocking) can be incorporated into the product over time, increasing its value proposition to carriers and supporting pricing power. We expect announcements on this front over the course of 2022.

Projections:           

Management assumes that penetration rates of ~25% of MAR are achievable in the long-term; our model assumes Allot reaches 12% deployment of cumulative MAR bookings by 2024E on an ARR basis. 2022 will be a tough year for operating leverage as management plans to invest to drive adoption at existing carriers, develop new products and cement large deal signings while DPI / 5G revenues are likely quite stagnant until true 5G deployments accelerate in late 2022 / 2023. We are above guidance for 2022 revenues, hence investors should expect initial 2022 guide to look more like street (operating losses roughly 7m worse than ours). 

Obviously, there is massive upside potential if the AllotSecure ramp ultimately manifests. Our checks have found no reasons yet why it should not.

The main risks are competitive as this is a rapidly changing industry, however operators are likely to be very sticky once the business is awarded, thus Allot's existing ~$500m of MAR bookings and 18 signed deals have intrinsic value that could exceed the current market cap. We believe Allot has the best offering for carriers, with Infoblox (BLOX, license software company acquired by Thoma Bravo at 3.5x sales in 2016) and Akamai (AKAM, CDN and DNS security company) offering lower-end solutions. 

Another risk is that the DPI / 5G business rolls over. Allot has overachieved in this business and Sandvine / Procera is likely to be competing more aggressively during its sales process / IPO process, so it is possible revenue here could stagnate or even decline modestly in any given year. However, we are confident in Allot's market leading position and particularly in 5G DDOS where Sandvine does not play, so at some point that business has growth prospects and will continue to provide downside support to the share price. 

We see a path to a $40+ stock in 2 years time and further compounding potential thereafter. Strategic interest in the asset (likely in the mid-teens as a starting point) is a further margin of safety.  

Catalyst

Positive revision cycle to SaaS revenue; large deal announcements; takeover interest; analyst coverage