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Sophos - Shares fall on weaker than expected new billings

George Salmon | 8 February 2018 | A A A
Sophos - Shares fall on weaker than expected new billings

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Sophos Group plc Ordinary 3p

Sell: 572.30 | Buy: 572.30 | Change 0.30 (0.05%)
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Sophos' third quarter trading statement covering the nine months to 31 December shows continued growth in revenue, billings and cash flow.

However, cash EBITDA (earnings before interest, tax, depreciation and amortisation) and billings are behind expectations. The shares fell 12.5% on the news, more than erasing recent gains.

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Our View

A string of high-profile hacks mean the consequences of not investing in cyber security are all-too evident. Companies are scrambling to shore up their cyber defences, providing fuel for IT security provider Sophos' growth.

The group uses a network of over 30,000 independent partners to sell and distribute its products. Over 100m users in 150 countries now rely on it for IT security.

It has market-leading products, and is the only company to offer a high standard of both network and end user protection. Customers benefit from a joined up service under a centralised system. Contracts run for up to five years, retention rates are impressive and last year Sophos increased revenues from contracts up for renewal by 29%.

While the group generates significant cash flows, it's focused on capitalising on the growth opportunity rather than paying dividends. Although there is a yield on offer, it's negligible at present.

The group's long-term potential has turned heads, lifting the share price up to a premium valuation of 84 times expected earnings. That's put pressure on the group to deliver stellar numbers.

Unfortunately, despite remaining on track to hit expectations for the full year, the third quarter didn't back up a strong first half. Billings were up, but not as much as had been expected, and the group's cash flow also disappointed the market. The shares duly dropped sharply.

However, those weaker cash flows were due in part to investment being pulled forward from Q4 to Q3. With this in mind, we're willing to give it the benefit of the doubt for now but will be looking for a notable uptick in the final quarter of the year.

The recent share price moves on the up and downside have been volatile and there could be further short-term volatility, especially since private equity group APAX will unwind its stake at some point. However, in the long run, we continue to believe the group has the capability to capitalise on the opportunity in front of it.

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Trading details (Constant exchange rates)

Revenue rose 19% to $166.4m, with deferred revenue up 33% year-on-year to $687.6m.

Third quarter billings rose 27% in Enduser and 15% in Network. Overall, billings of $194.8m are 14% ahead of last year at constant exchange rates. While this is below the 22.8% growth reported at the half year, Sophos says the drop coincided with lapping the launch of enduser product Intercept X last year. The proportion of subscription revenue continues to grow.

Year-to-date, net cash flow from operations was $98.2m, up 21%. Due to increased investment in new product releases, free cash flow rose only 9.8% to $88m, with Q3 cash EBITDA falling 5.3% to $46.7m.

Kris Hagerman, Chief Executive Officer, said: "The strong demand for our industry-leading cybersecurity solutions continued in Q3... the Board is confident both in the outlook for the full-year and the longer-term prospects of the Group."

Sophos expects 20-22% billings growth at the full year, with a 50-100 bps improvement in Cash EBITDA margin and modest growth in free cash flow.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.