Tenable: Get Ready For Long-Term Gains (NASDAQ:TENB)

Tenable (NASDAQ:TENB) reported another good quarter with revenue above expectations and management’s guidance. In addition, the company reported an operating margin of 5%, which showed significant improvement from -13% in the year ago period. Investors quickly applauded the strong quarterly results, and management provided 2020 guidance that was ahead of expectations.

However, the stock quickly reversed course as, the following day, the company announced an 8 million secondary offering at a price of $31.95. The stock quickly retraced the gains to trade closer to the secondary offering level, though, in recent days, the stock has slowly risen again.

Data by YCharts

The company’s strong quarterly results surprised investors to the upside as operating margins were positive and the company generated strong free cash flow. 2020 guidance also impressed investors as revenue and EPS came in above expectations, as TENB has turned the course and is now expecting much better operating margins.

After the recent pullback due to the secondary offering, valuation continues to seem attractive at ~7.5x forward revenue, which remains well below their closest competitor Qualys’ (NASDAQ:QLYS) ~12.5x forward revenue valuation. Over the next several quarters, the company will continue their strong revenue growth in addition to better than expected profitability levels. I believe this is the new differentiating factor that should drive the stock higher over time. Valuation will ultimately close that gap to QLYS as TENB becomes more profitable and revenue growth remains strong.

Below is a brief overview of Tenable, which I have previously discussed.

TENB offers cloud-based vulnerability management services that help protect an enterprise’s assets, such as network containers and web applications. Essentially, the company provides solutions for enterprises to manage and measure cybersecurity risk, specifically focusing on vulnerability assessment and management market. The company looks to quantify how much damage would be caused by a security breach – information that is very valuable to enterprises as security breaches continue to make headlines on a weekly basis.

As software applications are added to an enterprise’s architecture, this can cause challenges determining where certain security risks are and how vulnerable the overall organization is. TENB’s largest competitor is Qualys, which is one of the few companies specializing in vulnerability management. The ability of an enterprise to maintain visibility and control over the security of its assets is now essential. Enterprises are also adapting to newer technologies, such as the Internet of Things, containers, new business models, and more. All of these require increased efficient security and control measures.

Q2 Earnings and Guidance

During Q2, the company grew revenue 26% to $107.2 million, which was above expectations for ~$102 million and also above management’s previous guidance range of $101-103 million. Despite the challenging economic conditions due to the global pandemic, the company’s revenue growth decelerated a small 3% compared to the 29% growth seen last quarter. Enterprises have been keen at investing more into IT security as more of their workforce works from home, and companies can no longer solely rely on their infrastructures at their traditional office spaces.

Source: Company Presentation

Not surprisingly, the company’s subscription revenue has held in very strong during the past few months, with subscription revenue growing 33% during the quarter and now representing over 85% of the company’s overall revenue. Enterprises have been slowly moving away from licenses as this is a large one-time expense for the company. Subscription services require a much lower recurring payment, making it easier for the customer as well as for the provider. During the quarter, license revenue actually decreased 10%, but now only represents less than 10% of total revenue, meaning the negative impact becomes less profound as the revenue base gets smaller.

Source: Company Presentation

Billings during the quarter only grew 13%, which is down quite a bit from the 22% growth seen last quarter. However, enterprises are less willing to commit to future operating expenses, given the current environment comes with a lot of uncertainty. For now, companies may be delaying some IT software contracts until they have more clarity and visibility into their own business operations. I would expect, over the next few quarters, as the global economy starts to recover and stabilize, enterprises will start to pick up their discretionary IT spend, and those looking to upgrade and enhance their IT security will be afforded the flexibility to do so.

Source: Company Presentation

The company continues to make progress on their operating margins, with non-GAAP operating margin expanding from -13% in the year ago period to 5% this quarter. Given the company’s software subscription focus, gross margins tend to be high, and as the company gains scale and better leverages their expense base, operating margins should also expand. Given the company’s better than expected revenue growth and strong margins, non-GAAP EPS of $0.04 beat expectations for a loss of -$0.05.

Source: Company Presentation

Guidance for Q3 includes revenue of $108-110 million, which was close to expectations for ~$109 million. The company is also expecting a slightly positive operating margin, which leads to an EPS guidance of $0.02-0.03, which was above expectations for an EPS loss of -$0.05.

As the company gained a little bit more clarity into their full year revenue, they decided to provide 2020 guidance after withdrawing it last quarter. For 2020, revenue guidance is now $428-433 million, which was above expectations for ~$427 million. While this remains below the company’s original 2020 guidance of $435-440 million, I believe there could be some level of conservatism in guidance, given the persistent uncertainties in the current global economic environment. Non-GAAP operating margin is expected to be slightly positive, leading to non-GAAP EPS guidance of $0.00-0.03, well above expectations for an EPS loss of -$0.25.

Valuation

Immediately following earnings, the stock popped nearly 20% as investors applauded both the better than expected profitability due to higher margins as well as the company re-providing 2020 guidance. However, those nice gains were short-lived as, the following day, the company announced a secondary offering of 8 million shares for $31.95. The day after the secondary offering was announced, the stock closed at $31.97 and has slowly risen since then.

ChartData by YCharts

Currently, the stock has a market cap of ~$3.40 billion, and with cash/investments of ~$240 million and no debt, the company has a current enterprise value of ~$3.15 billion. Using management’s recently provided 2020 revenue guidance of $428-433 million, this implies a 2020 revenue multiple of ~7.3x. However, given the year is already getting close to the end, investors are starting to look at 2021 revenue for a better understanding of current valuation.

Assuming revenue grows another 25% next year, which is pretty similar to recent quarterly growth rates, the company could see 2021 revenue of ~$540 million, implying a 2021 revenue multiple of ~5.8x.

Currently, Tenable trades at a lower multiple to their closest competitor QLYS due to the fact that TENB has much lower operating margins. With TENB only now starting to break even and generate an operating profit, investors have a more profitable company in the name of QLYS. However, I am a believer that TENB can replicate QLYS’s operating margin success and will ultimately see their margins expand into further positive territory.

The current operating environment remains challenging, though, over the long term, enterprises will need to continue to invest in their IT security controls. TENB has a unique opportunity in that revenue growth can remain well above 15% over the next few years, and investors can reap the benefits of seeing operating margins expand and profitability increase.

I believe, over the next few quarters, TENB’s forward revenue multiple will slowly start to converge with QLYS, meaning the stock will continue to have further upside from current levels. As indicated immediately following the strong Q2 earnings report, investors have long-term confidence in the company. While the secondary share offering does dilute earnings, given the higher share count, investors should remain focused on the long-term growth opportunities for the company.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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