Recent weakness has continued into the third quarter, with billing rising just 2% at constant currency. That's despite management previously guiding for a modest improvement in trends during the second half.
The shares fell 20% in early trading.
Sophos has now missed guidance repeatedly, and the network business looks like it's really struggling. To say we're disappointed in the stock is an understatement.
We feel the business has some serious questions to answer about why it's repeatedly misjudged billings growth and what management are going to do to turn the ship around.
In theory Sophos is an attractive business. It has market-leading products, and offers a high standard of both network and end user protection. Customers benefit from a joined up service under a centralised system, with sales conducted through a network of 39,000 independent partners.
Contracts usually run for up to 3 years. Sophos has delivered impressive results when renewal times have come around by consistently increasing the value of its existing contracts through upselling and tacking on additional products.
All this comes with low capital requirements. That means cash flows are significant. Although there's a yield on offer, it's negligible at present, with spare cash being ploughed back into growth.
Given the increasing demand for cyber-security, and high profile attacks on companies and governments, Sophos should have long term potential.
Unfortunately, the repeated failure to hit guidance has, perhaps irreparably, damaged the group's credibility with investors. Until that's resolved, it's difficult to buy into the investment case.
The misses are partly down to clients pulling forward spending when InterceptX was launched, which is understandable but really shouldn't be catching management by surprise. New product launches are said to be performing well, but as yet we've got no numbers to back that up, and without them it's all talk.
Prior to the share price move on the back of this last update, the shares were trading on a PE ratio of 26 - that means there is still further to fall if results don't improve.
Third Quarter Trading Update
Total billings rose 2% to £193.7m, as a 6% increase in Enduser billings was offset by weakness in the networks business. The group now expects full-year constant currency billings show a modest decline for the full year.
Revenue increased by 7.3% year-on-year, as previous billings worked their way through the income statement, and the group reported an operating profit of £23.9m in the quarter (2018: £1.6m loss).
Underlying free cash flow fell 11.3% to £14.9m.
The author holds shares in Sophos.
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.