Description

Summary

Proofpoint presents an opportunity to buy in to a sustainable growth story at an attractive price point. This is a high-quality SaaS name with a highly cash generative, predictable business that’s likely to continue growing at close to 20% p.a. with a FCF margin in the low to mid-20s. This performance will be driven by its successful strategy of constantly increasing its wallet share of customer security spend by introducing new complementary products alongside winning new clients. Despite these points, the company currently trades at a meaningful discount to peers.

Background

Proofpoint is a software as a service (SaaS) cybersecurity company providing cloud-based solutions. Its core focus is email security, where the company launched its first product and has become a significant player. In recent years, the company has expanded to protect from attacks targeting users via social media, the web, networks and cloud apps in addition to email. Additional services include archiving, information protection and advanced threat protection.

The markets which they target all fall under what the company describes as a people-centric approach to cybersecurity – focusing on products that protect users rather than infrastructure. Threats are increasingly focused on people with 93% of security breaches attacking users (96% through email). This makes a people-centric approach appealing to enterprise customers.

Proofpoint’s customers are mostly large and medium enterprises. The company is increasingly introducing products targeting smaller businesses however this is not their main focus.

The company competes against other cybersecurity firms and large technology companies like Microsoft and Google. Their strength is their specialisation. As the largest pure play email security provider, they’ve introduced key products which have enabled them to take market share from other players like McAfee and Symantec. This has required investment in R&D and sales and marketing. Proofpoint has shown their ability to execute well on their strategy, attract new customers and increase wallet share from existing customers. Their current renewal rate is 90% with over 95% of revenue recurring.

Thesis

Larger TAM than expected with good track record of realising opportunities

Proofpoint’s core market is the c.$2.1billion email security market. They currently have a c.20% market share which they continue to grow by taking market share from incumbents like Symantec. This market grows at 6-7% p.a. The company’s overall TAM is greater than traditional email security when considering adjacent markets. This increases their TAM from only $2.1billion to over $13billion (expected to grow to $15billion by 2023).

Proofpoint has a solid track record of moving into these adjacent markets via M&A and R&D. They’ve been able to successfully move into the archiving, privacy and governance markets. Proofpoint’s position as a large pure play email security company leaves the company well-placed as an acquirer in this space.

The CEO has described how a significant opportunity exists for acquisitions in cybersecurity because the venture community tends to overinvest in development in this space. This means that Proofpoint can cherry-pick the companies with the right products and still obtain them at a reasonable price. They currently acquire about 3 companies a year. Their scale in the industry leaves them well-positioned to make these acquisitions.

Perfect match of sticky customer base and strong cross-sell capabilities

Proofpoint has an impressive 90% renewal rate. The high volume of data processed by the company creates a barrier to entry in the enterprise market and makes customers sticky. This is strengthened by Proofpoint’s cross-selling capabilities. Once Proofpoint introduces a new product, the company is highly skilled at maximising adoption by its existing customer base through cross-selling. Currently, almost half of their customers purchase three or more products from Proofpoint compared to 2012 (time of IPO) when 98% of their customers only had 1 product from Proofpoint.

Superior sales and marketing efficiency

Proofpoint’s relatively low marketing spend per unit of growth vs revenue per customer is due to their self-described efficient renewal cycle. They “typically incur a cost that’s roughly 2% of the renewal in terms of overall sales and marketing cost”. This low sales and marketing spend is on top of an already high GP margin of c.78%, increased from high 50s when the current CFO joined in 2007. This efficiency in renewal coupled with their main goal of increasing wallet share from existing customers drive its high FCF margin in the low to mid 20s.

Capital allocation

Proofpoint has just under $1billion on the balance sheet. The company’s capital allocation is about investing in the right R&D, acquiring new customers and giving cash back to shareholders, when appropriate. For R&D, M&A has been an effective strategy of supplementing in-house R&D with M&A. M&A is used to acquire new products which can be used to increase their wallet share from customers (increasing basket size also lowers sales and marketing costs with renewal cheaper than buying new customers). Management has invested significantly in sales and marketing at c.50% of revenue. The 90% renewal rate and consistent growth in billings shows the success of this investment.

No dividends are paid but the company plans to take advantage of the current low share price to repurchase shares. A $300million repurchase program was announced in August 2020. Management has stated that they think buybacks make sense right now because the stock is undervalued compared to peers and given its potential.

Impact of the pandemic

Proofpoint has benefitted with new products being launched to cater for more employees working from home. There has also been an adverse temporary impact on about 20% of their business which represents customers in sectors such as travel, retail, energy and other sectors impacted by the pandemic. Some of these customers have entered into shorter contracts to conserve cash and implemented layoffs (lowering revenue given per seat model). Their renewal rate is expected to decline to the high 80s in the short term. This impact represents a slowdown in revenue growth, not a decline in revenue. We don’t see this as an indication of a long-term trend given their successful entrenchment in customers’ operations (not just security but also data retention, etc.).

Valuation

Proofpoint currently trades at just over 5.0x EV FY21 sales – a discount to peers and a conservative value, given its growth prospects and high profitability.

Catalyst

Returning to steady-state recurring revenue rate; increased expansion of product offering, particularly through M&A and consistent performance in FCF margins leading to FCF/share growth.