Varonis Shares Jump 100% on IPO, Offer First-Mover Advantage in Pioneering Software Niche with Wide Enterprise-Market Appeal

Varonis Systems Inc. (Nasdaq: VRNS) went public on February 28, 2014 (as an “emerging growth company” with fewer public reporting requirements) with 4.8 million shares priced at $22 per share, well above the high end of its initial price range of $17 – $19 per share. On debut, shares jumped 100% to close the day at $44 per share on strong demand, after hitting an intra-day high of $47.94.

Underwriters most likely exercised their 15% overallotment option and bought an additional 720,000 shares (of which the company offered 500,436 and a selling shareholder offered 219,564 shares). Through its IPO, the company should raise net proceeds of approximately $107 million at $22 per share, including overallotment, after underwriting discounts, commissions and offering expenses. While the IPO price of $22 per share valued the company at about $525 million, its market capitalization jumped to $1.07 billion as shares jumped 100% on debut. At current levels, valuation is excessive but reflects investor excitement about a new IT niche. Shares likely will become more attractive as they fall closer to their original IPO filing range of $17 to $19 per share.

Varonis is an enterprise software developer with an innovative platform that helps enterprises manage, analyze, map and migrate unstructured human data. The company is a pioneer in this space, with virtually no direct competitors and a solid first mover advantage in a multi-billion-dollar market. Varonis has carved a new niche in the overcrowded IT space and shares are expected to be in high demand post-IPO. The company has 12 issued patents and 94 patents filed worldwide, giving it significant IP protection in addition to its first mover advantage.

Over the past three years, Varonis has grown sales at a compounded annual growth rate (CAGR) of 37%, to $74.6 million annually in 2013, with an operating loss of $5.8 million and a net loss of $7.5 million as the company ramps-up sales to capitalize on growth opportunities. The company is debt-free.

With data complexity and data volumes increasing about 40% annually, technology research firm IDC predicts that 90% of all data created in the next 10 years will be unstructured data of the type that Varonis can help manage.

Varonis sells its products and services through channel partners (including resellers and distributors) who are supported by a dedicated sales and professional services team. Varonis targets global enterprises of all sizes, across all industry sectors. As of December 31, 2013, Varonis had over 2,400 customers worldwide.

Case Studies Highlight Varonis’ Value Proposition

Varonis was chosen by a large military customer after a trusted insider stole and sold sensitive military intelligence despite massive investments in state-of-the-art security systems such as Security Information and Event Management (SIEM) and Data Loss Prevention (DLP) software that could not monitor or stop the insider from accessing sensitive data.

Subsequently, with Varonis’ automatic alerts, the organization nabbed more than 20 insiders (within a year) for unauthorized and suspicious data access and removal, potentially heading off catastrophe and serving as a warning to others.

Another customer, a hospital, chose Varonis because the hospital’s massive amounts of patient data could not be properly classified using manual processes, be modified by qualified hospital staff or stored with secure, authorized access – exposing the hospital to regulatory violations and litigation.

In yet another example, an investment house discovered exposed financial records, which even 40 full-time IT consultants could not satisfactorily classify, search, fix data leaks, prepare an access log or safely restrict access without disrupting business – again triggering critical compliance issues and client data exposure. Varonis’ investment client finally gave up attempts to fix “holes” by IT consultants because the effort was expensive, time-consuming, frustrating and did not guarantee compliance, and has been expanding its business with Varonis.

Initial Public Offering

In its S-1 registration with the SEC, Varonis filed to sell 4,800,000 common shares. In addition, the company gave underwriters (Morgan Stanley, Braclays, Jefferies, RBC Capital Markets and Needham) a 30-day option to purchase an additional 720,000 shares of which 500,436 would be offered by the company and 219,564 by an unnamed selling shareholder (who will only be a part of the IPO if underwriters choose to purchase additional shares, with Varonis receiving none of the proceeds from shares sold by the selling shareholder).

Varonis launched its IPO to increase financial flexibility and market visibility, create a public market for its stock and facilitate future access to public equity markets. Varonis plans to use net proceeds from the IPO to grow its workforce and for sales and marketing, research and development, general corporate purposes and capital expenditures.

After the offering, the company expects to have 23,835,455 shares outstanding (24,335,891 shares outstanding if underwriters fully exercise the overallotment option), with 79.9% owned by existing shareholders (who acquired them at a weighted average price of $2.11 per share) and 20.1% by new shareholders (expected to come in at $18 per share).



 

After its IPO, and assuming an IPO price of $18, shares were expected to have a net tangible book value of $3.45 per share with new investors facing dilution of $14.55 per share. However, with shares priced at $22, the net tangible book value will be above $3.45 per share.


 

Varonis has never paid cash dividends and does not plan to pay any in the foreseeable future.

Solid Operating History – Bodes Well for Future Success

Varonis’ operating model reflects consistency, predictability and growth. As mentioned above, revenues have steadily ramped up, at a 37% CAGR over the past three years, with consistent growth in revenue from new license sales and maintenance services to new and existing customers. The company offers a try-then-buy sales approach with a low average entry price of $61,000 to $63,000, with a land-and-grow approach with a focus on up-sells and cross-sells.

The company sells a product that enterprises need in perpetuity, with 90%+ license renewal rates and high predictability of recurring license and maintenance revenues.

Revenues are geographically well diversified with over 40% from international operations. The company has steadily increased customer additions per year from 403 new customers in 2011 to 728 new customers in 2013, which in itself is pretty phenomenal and reflects high acceptance of the company’s product, pricing and ROI.

Its successful land-and-expand and framework strategy is reflected in the steady increase in customers that have purchased more than one product over the years, from 27% in 2010 to 39% in 2013.


 

As the graph below shows, Varonis has been steadily increasing revenue from existing customers, which underlies the visibility and predictability of its revenue stream.

 


 

The company’s business model offers significant operating leverage with high expected long-term gross margin of 90%, significant spending on sales and marketing (42% to 45% of revenue) to boost sales and operating, sustainable R&D, minimal administrative overhead and target operating margins in the 25% to 30% range. Analysts will closely be tracking quarterly metrics to see how well Varonis is moving towards these goals.

 


Varonis Opens New, Multi-Billion-Dollar Niche

Enterprises deploy Varonis for data security, governance, archives, enhanced mobile data accessibility and information collaboration. As such, Varonis’ Metadata Framework addresses markets such as storage software, IT security, data collaboration and integration, and identity and access management. IDC estimates that enterprises spent about $47 billion on these established markets in 2012, of which Varonis has a multi-billion-dollar addressable opportunity.

Across the board, organizations immediately see the value of controlling, managing and safeguarding their data, tracking normal and abnormal usage, and migrating data in a secure manner using Varonis’ platform.

IDC estimates that the world created and replicated 2.8 trillion gigabytes (zettabytes) of data in 2012, and projects information growth of 39% annually through 2020 – that’s more than a 50-fold increase by 2020. Of this, over 90% will be unstructured data generated by humans and machines (such as log files), and of this, human-generated data is what contains a company’s core intellectual property and competence.

And while business intelligence tools have helped organizations make sense of their structured data (stored in relational databases, financial applications, CRM tools, etc.), little has been done to extract value from human-generated unstructured data. IDC estimates that about 23% of all human-generated unstructured data contains information of significant value to enterprises, and points out that merely 0.5% of this data is currently analyzed.

As enterprises understand the value of managing, securing and harnessing human-generated data – partly through Varonis’ marketing and customer education – they will be drawn to the Varonis solution that easily unleashes this value.


 

Currently, enterprises spend massive amounts of money on manual processes, file classification, records management, enterprise search, migration and archiving, identity management, file sharing, strategic business intelligence and enterprise content management – through a combination of disconnected programs that address each bucket. Even so, there are several questions that IT cannot satisfactorily answer such as who has access to files and folders, which files have sensitive content, what data is exposed to someone who doesn’t need to see it or what data is of minimal or zero value and can be safely archived or deleted.

Varonis offers the opportunity to consolidate all of this onto one integrated platform at significantly lower capital and operating cost. So Varonis’ value proposition is pretty compelling.


 

Investors can think of Varonis as a sophisticated search engine for human-generated data in the enterprise, while understanding that Varonis’ modules do a lot more than search, such as making sure vital corporate data – ideas, strategies, cutting edge research and financial facts – is safe and is not exposed to insider theft.

Varonis offers solid return on investment (ROI) through automation of manual processes, reduced data risk, ease of monitoring and compliance, and productivity gains.

Growth Strategy

Varonis has positioned itself as the primary vendor for human-generated data by extending its technological capabilities through innovation, growing its customer base, increasing sales to existing customers, growing its sales force, establishing its metadata framework as the industry standard and continuing international expansion.

Varonis is a market leader in a new industry niche with little direct competition and a large, growing and under-penetrated market that offers sizable opportunities for growth, with a seasoned management team that has successfully grown revenue to $76 million in 2013.

 


 

Varonis’ Manages an Enterprise’s Most Vital Information Asset – Unstructured Human-Generated Data

Unstructured human data includes documents, audio and video presentations, emails, spreadsheets, text messages and other electronic data created, shared, stored and accessed by enterprise employees. This data holds an enterprise’s strategic plans, product details, intellectual property, financial information, research data and other vital information, but still floats around with minimal security or control in most organizations. Despite the tremendous strategic importance of such data, most enterprises have trouble tracking who has access to data, who owns the data and who is adding to, manipulating or deleting it, and in addition to potential data leaks, this creates a compliance nightmare, especially as major companies with billions in IT security are falling to hackers and data leakers.


 

Varonis’ Metadata Framework

Varonis has developed a proprietary Metadata Framework that automatically extracts metadata (“data on human-generated data”) from an enterprise’s IT infrastructure and maps functional interactions between employees, data, content, access and usage – and feeds this data across five Varonis modules for IT and business users.

Varonis’ Metadata Framework can be used to create a searchable log on human-generated data, such as when files are accessed, moved or modified, with real-time alerts on prohibited access, more-than-normal usage, forensic investigations, etc. IT and business personnel can have better visibility into the access and use of this data, search file systems for sensitive content patterns to track access patterns and reduce potential exposure using multi-variable search; identify and track data ownership, and assign responsibilities; enable authors and owners to easily grant, revoke and review data privileges and activity based on accessibility, context and usage; and intelligently archive, migrate or quarantine data on strategic value and usage patterns.

In addition, Varonis creates secure hybrid clouds for content collaboration as employees increasingly store corporate data on public or private cloud services for remote working, smartphone access or sharing with associates and business partners, often without corporate or legal oversight or approval – potentially risking the leakage of proprietary or regulated data.


 

Varonis’ has five key product modules.

Datadvantage (for IT users) helps visualize data, analyze access and activity, generate automatic alerts on abnormal data access or usage patterns and centralize administration.

 


 

Dataprivilege (for business users) empowers users through data ownership, updating/deleting and access privileges, and helps bring order to the chaos of data generation and management through a self-service module.


 

The IDU Classification Framework (for IT users) helps tag and organize data, develop visual maps of sensitive content and improve data compliance and reporting, while reducing risks associated with data theft or inappropriate access.

 


 

The Data Transport Engine (for IT users) helps organizations smoothen data migration, archiving and deletion, while also helping the company easily quarantine or restrict sensitive content.


 

Datanywhere (for business users) brings order, visibility, security and safe access to human-generated data that resides in the cloud – while giving the organization complete visibility on that data. Datanywhere is a critical new addition to Varonis’ software framework because of the increasing migration of data to the cloud.

 


Risk Factors

Varonis is a pioneer in a new market, and while management has shown revenue growth potential, the market may not recognize the full potential of or the need for the Varonis solution, and this could lead to fluctuating revenues and adversely impact profits and share prices. The company’s success also depends significantly on key engineering staff and on being able to retain talent that understands the product, in the context of customer needs, and on developing innovative solutions in a timely manner so they are well-received by customers. As with most software companies, a superior product alone is not enough for sales growth – the company must complement its engineering capabilities with savvy sales, marketing and channel relationships.

So while the good news is that there aren’t any real competitors to V, the flip side is that the onus of developing this market rests with V. And while Varonis has first mover advantage, deep-pocketed enterprise software firms could develop competing solutions down the road, and knock-out Varonis’ competitive advantages.

Also, in addition to revenue growth, it would have been nice to see a history of profitable income, the company currently runs at a loss, and will need to quickly turn losses into profits or ramp revenues at a significant pace to justify its share price and valuation.

Varonis management is new to the Wall Street game of successfully running a public company, so despite management’s best efforts institutional investors may not flock to the stock and shares could drop.

Proven Management Team But Relatively Inexperienced at Running a Public Company

Varonis is headed by Yakov Faitelson who has served as CEO, President, Co-Founder and Board Chairman since the company’s founding in 2004. Before founding Varonis, Faitelson served in professional services and systems integration roles at NetVision Inc. and NetApp Inc.

Ohad Korkus is a co-founder and serves as CTO and a Board Director, and held architecture, design and development positions at NetVision Inc. and NetApp Inc.

Gili Iohan serves as CFO and has been with the company since 2005. Iohan has a background in finance, accounting, back office operations and human resource management.

James O’Boyle serves as Senior Vice President of worldwide sales, and has been with the company since 2006.

Collectively, the team is relatively young and inexperienced, with the exception of O’Boyle, and is a risk factor in the coming’s sustainability as a publicly traded concern because it lacks significant public company operational experience. However, to their credit, they have successfully delivered sales growth and carved out a new market niche, so they are definitely very capable.

Financials Reflect Strong Revenue Growth, Commitment to R&D and Sales

Varonis has grown revenues from $39.8 million in 2011 to $74.6 million in 2013, with strong gross margin of 91.3%. The company’s strong push on R&D for new products, and on sales and marketing, resulted in a net operating loss of $5.8 million and a net loss of $7.5 million, which should be easily surmountable as sales rally and operating leverage kicks in.


 

At year end 2013, the company held cash of about $14 million which should jump substantially after the company collects IPO proceeds. Accumulated losses have resulted in total stockholders’ deficit of $43 million, but these net loss carryforwards should reduce taxes as the company turns profitable. Varonis has zero debt.


 

Summary

Varonis has timed its IPO well. Capital markets have been very receptive to technology IPOs of late, and Varonis’ new and attractive niche – in data theft – has received significant high-profile coverage over the past few years. Moreover, Varonis’ impressive track record – with customer and revenue growth, a solid land-and-expand strategy, good revenue visibility and reasonable average selling price – should help the company grow revenues (with expanded sales and marketing from IPO proceeds) and turn profitable. While there are significant risks related to the company and the new IT niche it has carved out, its first mover advantage could result in significant demand for shares.

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