Sophos crash completely unwinds spectacular rally

A series of shocks has plunged this mid-cap tech stock to a 19-month low, but where to from here? Graeme Evans finds some positives among the wreckage.

Having been one of the hottest properties in the FTSE 250 index last year, cybersecurity firm Sophos is finding it much harder to live up to the City's heightened expectations in 2018.

Today, the shares slumped another 25% to leave Sophos back where it was in May 2017, when the Oxfordshire-based firm was on its eye-catching journey to an eventual peak of 656p in January.

While Sophos continues to enjoy support in the City, there's understandable disappointment that its latest update only talks about "modest improvement" in billings growth for the rest of the 2019 financial year.

The trouble as far as 2019 is concerned is that Sophos is up against testing comparatives from the previous year, when publicity around Wannacry ransomware and other cyber attacks boosted demand and investor sentiment.

Source: TradingView      Past performance is not a guide to future performance

The "modest" guidance in today's half-year results compares with the double-digit growth it forecast in July, when the company's shares were also sharply lower in the face of continued high market expectations.

Interestingly, there's no mention today of the group's long-standing goal to deliver annual billings of $1 billion by 2020, alongside operating profits of greater than $100 million.

These targets are likely to have been pushed back, although Sophos does point out it has a strong subscription renewals base from which to drive a significant improvement in its rate of growth in 2020.

It is also on track to deliver two significant new releases in its flagship products - Intercept X with EDR, and XG Firewall v17.5 - as it also looks to achieve cross-selling and the concept of "synchronized security" for its customers.

Stifel said this approach could be significant in unlocking operational leverage and was one of the reasons why it remains a fan of the stock.

The broker has retained its 'buy' recommendation, although the price target has been reduced to 630p from 641p previously.

Stifel analyst George O'Connor said: "It is trying to change buyer behaviour from a 'point product' market to a product suite approach (success is happening - customers have about 1.5 products each).

"It is a lofty goal and one that may have created short-term sales execution wrinkles; however, it is a compelling narrative."

Analysts at Shore Capital point out that Sophos now trades at a significant discount to its peer group on cash flow and EV/sales metrics. They reduced their billings estimates for this year and next by 5%, but shares are a "buy" at 476p.

The company's cloud-based products protect over 317,000 organisations and over 100 million end users in 150 countries. In the $40 billion cybersecurity market it estimates that there is a $10-12 billion opportunity for the company.

Sophos says it is the only vendor of any scale to explicitly focus on the mid-market, designing enterprise-grade, industrial-strength security solutions. And as a subscription software business, Sophos benefits from the financial visibility that this offers.