Varonis Systems, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

A cybersecurity company specializing in data security and analytics, primarily offering solutions for data protection, threat detection, and compliance.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Varonis Systems, Inc. is a software company specializing in data security and analytics, offering a variety of solutions for data protection, threat detection, and compliance in the cloud and on-premises infrastructure. The company’s offerings are primarily aimed at enterprises that need to protect their sensitive data from internal and external threats.

  • Revenue Distribution: Varonis generates revenue primarily through subscription licenses for its software and related support and maintenance services. These licenses are available on a subscription basis, meaning the company receives recurring revenue from its customers. The company is moving more and more into subscription revenue models, therefore reducing lumpy lincensing revenue.

    • The majority of revenues comes from the US (~70%), then EMEA (23%) and Rest of the world (7%) in the fiscal year of 2021. Although, revenues from Rest of the World in the trailing nine months of 2023 have jumped to 13.4%.

  • Industry Trends: The cybersecurity industry is experiencing strong growth due to an increase in cyber threats and new regulations that require companies to take better measures on protecting user data and other sensitive information. The market is moving towards SaaS solutions which makes a good transition into Varonis new cloud based products.

  • Margins: Varonis’ gross margin is very high at around 80%, as is common for many software businesses. However, they operate with a net loss, mostly because of high opex which is mainly in the research and development and sales and marketing. The company is also focusing on free cash flow growth which suggests improving profitability in the coming years.

    • In Q3 2023, gross margins improved slightly to 82%, however operating margin was -4% in 2023, compared to +3.2% in 2022.

  • Competitive Landscape: The cybersecurity market is highly competitive, with numerous established players and newer entrants vying for market share. Some competitors offer point solutions to specific security needs, while Varonis offers a more comprehensive platform. The company competes with both larger companies (like Microsoft and Palo Alto Networks) and smaller, niche-focused competitors.

  • Differentiation: Varonis primarily differentiates itself through its focus on data-centric security, which means it focuses on protecting the data itself. This unique approach, combined with a broad and integrated solution, is a key selling point for the company. They focus on where sensitive data resides, and which users have access to it. It doesn’t rely on endpoints and firewalls like many others in the security market.

  • Recent Concerns:

    • The company is continuing to make adjustments in the business in order to drive revenue and reduce costs, because they are spending more to acquire and retain customers with a focus on the cloud. This is an ongoing process that can continue to affect profitabilty negatively in the short-term.
    • The stock price has seen a significant decline, with shareholders being significantly negatively impacted, due to the high spending to acquire customers.
    • There’s uncertainty surrounding the long-term contracts because they are new, and the long-term value of these can not be fully accessed.
    • There’s a threat from a variety of security vendors such as larger companies entering their space which can cause increased competition.
    • The company has missed its guidance, due to macroeconomic conditions and elongated sales cycles.
  • Management’s Response to concerns
    • They are shifting more and more of their business to subscription revenue and are expecting this to become the major revenue driver.
    • They are slowing down hiring and other expenses to become profitable.
    • They are focusing on recurring revenue and their long-term contracts which are becoming an important part of their business.

Financials

Varonis’ financials indicate a company in a growth phase, with increasing revenues but yet to reach profitability. The company is focusing on growing its subscription revenue base while optimizing costs, a good strategy to pursue.

  • Revenue Growth: Varonis has demonstrated solid year-over-year revenue growth, driven by the increasing demand for its data security solutions and is expected to continue growing in the future.
    • For the quarter of Sep 2023, the revenues came at 110.8M, a 15.5% increase Year over year, while for Dec 2022 revenues came in at 111.7M a 13% increase. This shows a trend of declining growth YoY, a worrying sign for investors.
    • On a nine months basis for 2023, the total revenue amounted to 324.7M, versus 282.4M a 15% increase.
  • Profitability: The company is still running at a net loss, with negative operating and profit margins. This is due to the high expenses associated with investments in R&D and sales and marketing. However, recent moves seem to point towards a more profitable company with focus on cashflow growth.
    • Although gross margins remain very strong in the 80% range, the operating margins in 2023 has decreased compared to 2022 to -4% and 3.2% respectively.
    • In Q3 2023 the net loss was -23.4M compared to -34.3M a reduction from the previous year but still a loss for shareholders.

  • Cash Flow: The cash flow trends are similar to profits, with negative cash flow from operations and a slow progress towards positive free cash flow. However, in 2023, free cash flow has improved significantly to 11.5M for the first three quarters vs. 50.3M in 2022, which again shows positive progress to profitability.

  • Balance Sheet: Varonis has a strong balance sheet. A significant portion of assets are in the form of cash and marketable securities, indicating sufficient liquidity. It should also be noted that the company has a reasonable level of debt.
    • Cash and equivalents are strong at 443.5M vs 307.9M in December 2022.
    • Liabilities have declined to 498.6M from 543.2M in Dec 2022.
    • Equity has increased to 905.8M from 897.7M in December 2022.

Moat Analysis

While Varonis has a differentiated product in a growing sector, its moat is not that wide and could be easily copied by the competition.

  • Intangible Assets: Varonis benefits from brand recognition in the cybersecurity space, and from a portfolio of patents that protect its technology. However, the value of the brand is questionable, and the patent portfolio isn’t enough to make it unbeatable against competitors.

  • Switching Costs: Customers incur moderate switching costs due to the need to retrain employees and reconfigure their IT systems. Though these are not that high and can be easily bypassed by the customers, and this reduces the moat.

  • Network Effects: There are very limited network effects. There are minor network effects where users of the same product can share information, but it isn’t a key driver of moat.
  • Cost Advantages: Varonis doesn’t have a notable cost advantage. They are not the cheapest vendor in their space, with much of their focus placed on growing in a rapidly expanding market.

Moat Rating: 2 / 5 While Varonis has some factors that contribute to an economic moat, such as its focus on data-centric security, and patents, the overall competitive landscape is extremely tough. These factors will act as a barrier for competition, however, these are not that strong enough to constitute a wide moat, making the current moat a ‘narrow’ one with a rating of 2/5.

Risks to the Moat

The company faces several potential risks that could erode its moat and the company’s resilience, including:

  • Increased Competition: The cybersecurity market is very competitive, and a number of vendors are trying to gain market share. Increased competition would likely pressure on the company’s pricing and margins.
  • Technological Disruption: The cybersecurity sector is rapidly evolving and there is a chance new technologies may supplant the company’s solutions and offerings.
  • Changing Regulations: New regulations could reduce or entirely eliminate any of the advantages currently held by the company, also potentially increasing the operating costs.
  • Execution Risk: Since the company is in a stage of transitioning to SaaS subscription model, this poses execution risks which could impact the company.

Resilience

Varonis has demonstrated some resilience through periods of economic volatility, by being able to maintain their revenues even through macro-economic downturns, and is also likely to perform well in the long term with the industry trend toward data protection. However, the high competition and risks from technological changes still pose some threats to the company’s performance.

Understandability Rating

Understandability: 3 / 5 Although Varonis operates in a complex sector of cybersecurity, their business model can be understood with adequate research. However, some of the technology may be difficult for non-technical investors to fully grasp, therefore a rating of 3 out of 5.

Balance Sheet Health

Balance Sheet Health: 4 / 5 Varonis’ balance sheet indicates a sound financial standing, with strong liquidity and reasonable debt levels. This strong financial foundation makes it unlikely the company will fall into financial distress, with it being easily able to finance its operations in the foreseeable future. This is why the balance sheet health was given a rating of 4 out of 5.