Description

Based in Israel, Cognyte Software LTD (“CGNT” or the “Company”) is a leading security analytics provider for governments (80%) and enterprise (20%) with approximately 1000 customers (600+ gov’t customers).  Two customers represent 16.9% and 14.1% of revenues, respectively. Each customer represents multiple agencies within a country and are the final decision makers, so customer concentration is essentially less than stated in SEC filings.

·         CGNT’s AI-driven solutions help security organizations analyze and visualize data sets at scale to provide actionable intelligence to find the needle in the haystack. 

o   Solutions are designed to accelerate security investigations to identify, neutralize and prevent threats to national security, business continuity and cyber security. 

·         Key buyers of solutions include 1) Gov’t Head of Investigations, 2) Head of Operations and 3) CIOs. 

·         CGNT is operating in a $30BN TAM for Security Analytics growing at a 10% CAGR.

Sales cycles range from a few months to a few quarters.  Primarily competes with an organizations’ homegrown systems which are expensive to build, difficult to maintain and increasingly incapable to fit new use cases. CGNT typically does not find themselves subject to a competitive process during renewals. 10% - LDD% rev guidance is principally based on growth from existing customers. 

·         ~50% of revenue is recurring in nature and customer retention is approximately 90%.

·         While there are no pure play trading comps, one can consider FEYE (5x revs, 8% growth), PFPT (7x revs, 17% growth), FTNT (9x revs, 20% growth) and PLTR (19x revs, 30% growth) as relevant.  

Currently, CGNT trades at 3.3x 2022 revs with forecasted growth of 10% accelerating to the low- to mid-teens in 2023-2024 with continued gross margin and EBITDA margin expansion.

Why is the Stock Mispriced?

At the time of the spin (Feb 2, 2021), parent company VRNT (enterprise video security and surveillance) was trading at a 29x PE, a steep discount to its direct peer NICE. 

o   Pre-spin, investors aggressively purchased VRNT to take advantage of the price arbitrage with NICE.  Post-split, CGNT was sold so arbs could gain full exposure to VRNT.

We think several idiosyncratic spin dynamics have put additional selling pressure on CGNT:

o   Pre-Spin, VRNT shares were domiciled in the US.  Due to its administrative HQ in Israel, CGNT opted to become a 20-F filer forcing several funds, mandated to own only owned US-based names, to sell CGNT shares post spin.

o   CGNT was added to the R2K at the time of the spin due to VRNT’s domestic filing status.

o   However, during the upcoming R2K rebalance (3rd Fri of June), traders expect CGNT to be removed from the R2K (and shadow indices) given CGNT’s foreign filing status. 

§  It is estimated that there are more than 5MM shares for sale.   It is uncertain how far along we are with the selling of shares.

o   Up until recently, by design or otherwise, mgmt’s engagement with investors was limited: 

§  With two days left in the period to report earnings, on 4/29 CGNT reported Q421 results which exceeded expectations. 

§  Mgmt provided solid commentary and guidance and announced several 7 and 8 figure deal wins with new and existing customers.

·         Considering the encouraging outlook, the stock still drifted lower.

§  On my post-Q callback, I asked if the board had sorted comp plans post-spin (RSUs, etc).  I was told that this has not been publicly disclosed.  Huh? 

·         Seems like a peculiar answer from someone who likely will receive a portion of their compensation in stock. 

The good news is that the first quarter as a standalone company is behind them.  The outlook is positive, and mgmt. is extremely confident with their guidance.  They have also set out dates to speak with the investment community.  Three conference dates are set for early June.

What is of Value?

·         Established Leader in Security Analytics

o   Twenty years in the market with proven and trusted solutions.   Strong customer and reseller relationships and a market reputation for innovation. 

o   Minimal external competition.  Main competitor includes home grown systems that are becoming outdated. Top security clearances provide barriers to entry for new entrants.

·         Resilient and Stable Customer Base with Excellent Visibility

o   80% of customer base are governments.  50% of business is reoccurring. 90% customer retention rate. ~85% of revenue is software license. Majority of products are sticky.    Management’s growth outlook is based solely on growth within its existing set of government customers.

·         Continued Opportunities to Expand Margins and Cash Flow

o   Since adoption of an open analytics platform (elimination of hardware sales), sales cycles have compressed, and GMs have increased (over 1000bps over the last two years).   

o   Current backlog provides solid visibility into top line growth.  Mgmt. forecasting accelerating top line growth (10% to LDD-MSD) over the next two years with continued margin expansion including 20% EBITDA growth in FY23 to FY24.

·         Clean Balance Sheet Provides Opportunities for Increased Capabilities

o   CGNT has successfully tucked in companies under its umbrella and can add more complementary capabilities. (e.g. cryptocurrency tracking for money laundering, etc.).

o   Given CGNT’s net cash position along with its strong cash generation profile, M&A could accelerate CGNT’s overall growth profile.

·         Mispriced Security on an Absolute and Relative Basis

o   Trades at 3x forward revenues, growing at 10% annually while solidly profitable.  The cheapest trading comp in CGNT’s universe, FEYE, trades almost two turns higher.   Each turn represents approx. $7 of CGNT equity upside. 

o   Should CGNT be able to accelerate growth from its current rate of 10% through land and expand and tuck-ins, the stock can rerate to a much higher multiple (8-10x revs).

Issues to Consider

·         The key to accelerated growth lies in continued open-source transition and land and expand.

·         Due to issues secrecy, management cannot openly discuss customer relationships. 

·         Regime changes, cuts in intelligence budgets could create sales volatility.

·         Mgmt is forecasting an approx.  $15 hit to the P&L due to dis-synergies associated with being a standalone organization.

Valuation

While there is not a perfect pure play gov’t security peer in the market, the range of valuation for comparable security firms is wide with FEYE at the low end at 5x revs.

Given CGNT's superior growth and margin profile vs. FEYE, fair value currently should be at least in the mid $30s with upside as the company accelerates topline growth and drives continued margin expansion.

Capitalization and Projections

Trading Comparables

Implied Value of CGNT Shares

Catalyst

Increased Investor Coverage and Awareness

Execution and Confirmation of Strategic Plan

Tuck-in M&A

Russell Rebalance