SecureWorks (SCWX) Sees Taegis Growth; FX Headwinds Remain

A Quick Take On SecureWorks

SecureWorks (NASDAQ:NASDAQ:SCWX) reported its FQ2 2023 financial results on September 1, 2022, meeting expected revenue but missing EPS estimates.

The company provides organizations with cybersecurity software and services to manage their IT threat environment.

While the firm is making progress away from its legacy business, given a slowing macroeconomic environment, strong dollar and increasing operating losses, I’m on Hold for SCWX in the near term.

SecureWorks Overview

Atlanta, Georgia based SecureWorks was founded in 1999 to provide a variety of endpoint protection and vulnerability management and response software to organizations of all sizes.

The firm is headed by Chief Executive Officer Wendy Thomas, who was previously Chief Financial Officer at Bridgevine and VP Finance at First Data Corporation.

The company’s primary offerings include:

• Taegis extended detection & response [XDR]

• Managed detection & response

• Vulnerability management

• Managed services

• Security assessments & training

The firm acquires customers through its direct sales and marketing efforts as well as through partner referrals and technology alliances.

SCWX now counts a total of 1,500 customers for its flagship Taegis XDR platform.

SecureWorks’ Market & Competition

According to a 2019 market research report by Global Market Insights, the global endpoint security market is projected to reach $7.5 billion by 2024, growing at a CAGR of 7% between 2017 and 2024.

Endpoints are considered to be the weakest links in network security; hence, securing them plays a critical role in effectively strengthening the overall network.

Additionally, growing in number and increasingly complex malware attacks force antivirus/antimalware solutions providers to constantly update their detection tools with the latest security patches.

Major vendors that provide or are developing endpoint security solutions include:

• McAfee

• Symantec Corporation

• Cylance

• Palo Alto Networks (PANW)

• FireEye

• F-Secure

• Webroot

• Okta (OKTA)

Per a market research report by Grand View Research on the Extended Detection and Response market, the firm estimated the value of the XDR market to have been $628 million in 2021 and forecasts its growth to reach $3.4 billion by 2030.

If achieved, this would represent CAGR of 20.7% from 2022 to 2030.

The U.S. XDR market history and forecast is shown in the chart below:

SecureWorks’ Recent Financial Performance

• Total revenue by quarter has trended lower in recent quarters:

• Gross profit by quarter has also been lower more recently, as the chart shows below:

• Selling, G&A expenses as a percentage of total revenue by quarter have risen in recent quarters, a negative signal:

• Operating losses by quarter have worsened as shown below:

• Earnings per share (Diluted) have also grown increasingly negative:

(All data in above charts is GAAP)

In the past 12 months, SCWX’s stock price has fallen 51.3% vs. the U.S. S&P 500 index’s drop of around 8.5%, as the chart below indicates:

Valuation And Other Metrics For SecureWorks

Below is a table of relevant capitalization and valuation figures for the company:

Measure [TTM]	Amount
Enterprise Value / Sales	1.50
Revenue Growth Rate	-10.1%
Net Income Margin	-13.6%
GAAP EBITDA %	-10.0%
Market Capitalization	$900,690,000
Enterprise Value	$747,550,000
Operating Cash Flow	-$11,400,000
Earnings Per Share (Fully Diluted)	-$0.81

Click to enlarge

(Source – Seeking Alpha)

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

SCWX’s most recent GAAP Rule of 40 calculation was negative (20.2%) as of FQ2 2023, so the firm needs substantial improvement in this regard, per the table below:

Rule of 40 – GAAP	Calculation
Recent Rev. Growth %	-10.1%
GAAP EBITDA %	-10.0%
Total	-20.2%

Click to enlarge

(Source – Seeking Alpha)

Commentary On SecureWorks

In its last earnings call (Source – Seeking Alpha), covering FQ2 2023’s results, management highlighted the growth in adoption for its Taegis XDR platform, which crossed the $200 million ARR (Annual Recurring Revenue) mark 14 quarters after launch.

Taegis is expected to account for 75% of ARR by the end of the firm’s current fiscal year.

As to its financial results, total revenue continued to drop as the company seeks to transition to a subscription model led by its Taegis platform.

Management did not disclose the company’s net dollar retention rate, which is an important indicator of customer churn, product/market fit and the company’s sales & marketing efficiency.

Gross margin expanded to 61.3%, but sales and marketing have also increased relative to revenue, resulting in increasing operating losses and net losses.

For the balance sheet, the company ended the quarter with cash of $167 million, no debt but using operational cash of $17 million.

Looking ahead, the firm guided revenue lower due to foreign exchange headwinds and a drop in professional services revenue.

Regarding valuation, the market is valuing SCWX at an EV/Sales multiple of around 1.5x.

The SaaS Capital Index of publicly held SaaS software companies showed an average forward EV/Revenue multiple of around 6.8x at August 31, 2022, as the chart shows here:

So, by comparison, SCWX is currently valued by the market at a significant discount to the broader SaaS Capital Index, at least as of August 31, 2022.

The primary risk to the company’s outlook is an increasingly likely macroeconomic slowdown or recession, which will slow sales cycles and reduce its revenue growth trajectory.

SecureWorks is seeking to make a turn toward a cloud-centric approach and appears to be making good progress in that regard with its Taegis platform generating impressive growth.

Management sees fiscal year 2023 as being ‘an inflection point in the company’s transition as we shed non-strategic services and complete the resolution of our base to Taegis with a significant majority of customers completing that transition by FY 2023 year end.’

However, it’s difficult to see a meaningful upside catalyst with a stronger US dollar and management continuing to invest at a level that generates increasing operating losses.

While the firm is making progress away from its legacy business, given a slowing macroeconomic environment, strong dollar and increasing operating losses, I’m on Hold for SCWX in the near term.