Qualys: A growing profitable company.
I got to know Qualys through the book "The Intelligent Quality Investor" by Long Equity and was surprised to see a company that I had never heard off scored high in all metrics. Hence, I decided to investigate the company to see if it is a compounder that I should add to my copytrading portfolio.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly describe the company and if it has a moat. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in Qualys. If you would like to copy my portfolio or see the stock in my portfolio, you can read about how to do so here. I don't own shares in any of their direct competitors either. As always, I will keep this analysis unbiased.
Qualys was funded in 1999.Qualys is an American technology firm that specializes in cloud security, compliance, and related services. They deliver an integrated suite of IT, security, and compliance solutions through their Qualys Cloud Platform. Unites States contribute with approximately 60 % of their revenue, while revenue from international customers contribute with the last 40 %. Qualys believes that they have competitive advantages because their solutions has been designed to be delivered through the cloud, which means that they can be easily and rapidly deployed on a global scale, enabling faster implementation and lower cost than traditional on-premises software products. Thus, customers do not need to buy or manage hardware, they get real time visibility, easy global scanning, seamless scaling, up to date resources, and data is stored securely. Their competitive advantages means that Qualys has the best margins in the industry, which indicates that Qualys has a brand moat.
Their CEO is Sumedh Thakar. He joined Qualys in 2003 as a software engineer. He held various leadership positions until he became the CEO in 2021. He was chosen as a CEO because of his proven ability to execute on a vision and bring together teams and ecosystems. As Chief Product Officer he was leading the transformation of the Qualys Cloud Platform from a single security solution to evolving portfolio of integrated apps that deliver 360-degree visibility across on-premises, endpoints, cloud, containers, and mobile environments. As president of Qualys, he was deeply involved in expanding Qualys' strategy, sales, and customer retention. It means that he has a deep knowledge of the entire business, which I believe is great when you are serving as a CEO. When reading through the earnings call transcripts, I like that Sumedh Thakar and the rest of the management team is not afraid to be bold, when guiding for the future. It is their neck on the line after all. It is hard to judge Sumedh Thakar, as he hasn't been the CEO for long. However, he has been part of the management team that has delivered great growth over years, and he has 20 years of experience in the company. Hence, I feel confident in Sumedh Thakar leading Qualys moving forward.
I believe that Qualys has a moat, which is proven by the industry leading margins. I will give management the benefit of the doubt due to his vast experience in the company, and because he has been part of the management team for long. Now let us investigate the numbers to see if Qualys lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. As Qualys is a growth company it is not surprising to see underwhelming numbers in the past, and it shouldn't be concerning. It is nice to see that Qualys has delivered an acceptable ROIC since 2017 and it is really reinsuring to see that they managed to deliver their best ROIC to date in 2022. If Qualys manage to deliver a ROIC near to what they did in 2022, it would be fantastic.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. Qualys managed to grow their equity every year since 2013 until 2022. One reason that equity decreased in 2022 was that Qualys acquired Blue Hexagon's AI/Machine Learning Platform. Hopefully, Qualys will be back to growing their equity in 2023.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. It is very nice to see that a growth company like Qualys has managed to deliver a positive free cash flow every year in the last ten years. Not only has it been positive, but they also managed to grow it every year until 2022, and with a high levered free cash flow margin.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. Doing the calculation on Qualys, I can see that Qualys has 0 years earnings in debt, which is great to see. Now only does this growth company deliver great numbers, they also have no debt.
Like every other investment there are risks when investing in Qualys. One risk is competition. While Qualys believes that they have some competitive advantages, they are operating in a very competitive market. In their annual report Qualys mentions that many of their primary competitors have greater name recognition, longer operating histories, more established customer relationships, larger marketing budgets, and significantly greater resources than Qualys does. It means that Qualys may lack sufficient financial or other resources to maintain or improve their competitive position. Macroeconomics. In the annual report, management mentions that economic weakness, customer financial difficulties, supply chain constraints, change in interest rates, inflationary pressures, and potential recessions, could affect their results as their customers would need to reduce IT spending. In their 2022 fourth quarter earnings call, they mentioned that macroeconomic factors lead to discounting pressures from some of their competitors. Unable to renew existing subscribers or add new subscribers. As with all other software-as-a-service companies, it is a risk if Qualys doesn't manage to renew existing subscriptions or sell new subscriptions. Qualys' customers purchase a year long subscription, and the customers have no obligation to renew their subscription. Qualys' growth depends on customers renewing their existing subscription and maybe purchase additional subscriptions, or new new customers. Thus, it is a risk to be monitored.
There are also a lot of potential for Qualys moving forward. One is a growing addressable market. Qualys is currently serving a $45 billion addressable market, which Qualys expects to grow to $64 billion by 2026. If looking at the cyber security market alone, Fortune Business Insights believes it will continue to grow moving forward and expects it to grow by a 13,8 % CAGR until 2030. Furthermore, in the 2022 fourth quarter earnings call, management said that they are growing increasingly confident in their ability to drive growth and gain market share. Thus, there are plenty of growth for Qualys moving forward. High margins. I already mentioned that Qualys has the best margins in the sector. In their investor presentation for the 2022 fourth quarter earnings, they show that their EBITDA margin was 46 % compared to the peer median at 12 %. However, It is also worth looking at other margins. Gross profit margin was 79,0 % in 2022, which is higher than the previous four years. Operating margin was 26,2 % in 2022, which has only been topped in 2020 when it was 26,6 %. However, it is because management has increased headcounts in sales in 2022. It is also worth mentioning that revenue is growing by more than 10 % each year, and if margins also grow, it will boost profitability. Share buybacks. Not many growth companies are buying back shares, but Qualys is. Qualys had 39,379 million shares outstanding in 2018 and by the end of 2022, they had 37,362 shares outstanding. By the end of 2022, Qualys had $154,5 million left in their share buyback program, but it has since been increased by another $100 million, meaning that Qualys will now buy back shares for $254,5 million.
All right, we have gone through the numbers, potential and risk regarding Qualys, and now it is time for us to calculate a price for Qualys. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 2,74, which is the one from 2022. I chose an Estimated future EPS growth rate of 15 % (which is the highest I use but is lower than the consensus the analysists expected growth rate from Finbox), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Digital Turbine has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $82,20, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Qualys at price of $41,10 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 199. The Capital Expenditures was 24. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 16,8 in our further calculations. The Tax Provision was 26. We have 37,362 outstanding shares. Hence, the calculation will be like this: (199 - 16,8 + 26) /37,362 x 10 = $55,73 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 4,83 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $76,25.
You could argue that Qualys is a growth company. Thus, it would be better valuing the company using a discounted cash flow analysis. Hence, I have done so too. To do so I will need some numbers that you can see below. The numbers are the 2022 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 3 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with the lower option in the middle. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the current market conditions. Remember that all the numbers made in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. I decided to use an EBIT growth at 27 %, Depreciation & Amortization growth at 12 % and a Net Working Capital growth at 10 %, which are the expected growth rates at Finbox. I haven't found a smart way to share all my spreadsheet here but once I did my calculations, I found that the intrinsic value of Qualys to be $176. Meaning, the price with a 50 % discount would be $88.
Qualys is a very interesting company. They have delivered great numbers throughout the last 10 years and is operating in a growing sector. Qualys does face some short-term and long-term risks, but so far, they have always managed to execute. The CEO is new but has a vast knowledge of company, which I believe is a benefit for Qualys moving forward. I believe that Qualys has shown that it is a quality company as they continue to grow revenue and margins year after the year. I'm not sure that it will be possible to get Qualys at a 50 % discount to the intrinsic value on my calculations, but it is also worth noticing that I have been very conservative in some of my calculations. EPS is expected to grow at a higher pace than the 15 % I have used. I would like to add Qualys to the portfolio at $111, as it will be the intrinsic value on the TEN CAP price and below the intrinsic value of the PAYBACK TIME and Discounted Cash Flow calculations. I may even open a small position at a higher price.
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