Qualys operates in the growing cybersecurity market, where customer needs are evolving from merely buying and deploying security point solutions to measuring and articulating the amount of risk posed to their businesses. This shift in customer focus should benefit Qualys, given its comprehensive cloud-based security and compliance solutions. However, the critical question is whether these market dynamics make Qualys a good investment. This analysis aims to investigate the potential of Qualys as an investment opportunity, considering its market position, financial performance, and growth prospects.
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 start by mentioning that at the time of writing this analysis, I do not own any shares in Qualys. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of Qualys either. Thus, I have no personal stake in Qualys. If you want to purchase shares (or fractional shares) of Qualys, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started with investing with as little as $100.
The Business
Founded in 1999 and making its IPO in 2012, Qualys is an American technology company specializing in cloud security, compliance, and related services. The company delivers an integrated suite of IT, security, and compliance solutions through its Qualys Cloud Platform. Qualys' Enterprise TruRisk Platform enables customers to identify and manage their internal and external IT and operational technology assets across various environments, including on-premises, endpoints, cloud, containers, and mobile. The platform collects and analyzes substantial amounts of IT security data, discovers and prioritizes vulnerabilities, quantifies cyber risk exposure, recommends and implements remediation actions, and verifies the implementation of such actions. This comprehensive approach helps organizations protect their systems and applications from evolving cyber threats and achieve compliance with internal policies and external regulations. The United States contributes approximately 60% of Qualys' revenue, with international customers accounting for the remaining 40%. The company offers its solutions to enterprises, government entities, and small and medium-sized businesses across various industries. Qualys believes its competitive advantage lies in the cloud-based design of its solutions, which allows for easy and rapid deployment on a global scale, enabling faster implementation and lower costs compared to traditional on-premises software products. Customers benefit from not having to buy or manage hardware, gaining real-time visibility, easy global scanning, seamless scaling, access to up-to-date resources, and secure data storage. Qualys' competitive advantages translate into the best margins in the industry. The company serves 70% of the companies in the Forbes Global 50, indicating significant trust from large customers. These high profit margins and the trust from major clients contribute to Qualys' strong moat.
Management
Sumedh Thakar is the CEO of Qualys, having joined the company in 2003 as a software engineer. Over the years, he has held various leadership positions and became CEO in 2021. Sumedh Thakar was chosen for this role due to his proven ability to execute on a vision and effectively bring together teams and ecosystems. As Chief Product Officer, Sumedh Thakar led the transformation of the Qualys Cloud Platform from a single security solution to a comprehensive portfolio of integrated applications providing 360-degree visibility across on-premises, endpoints, cloud, containers, and mobile environments. In his role as President of Qualys, he was instrumental in expanding the company's strategy, sales, and customer retention, giving him a profound understanding of the entire business—an essential attribute for a CEO. Before joining Qualys, Sumedh Thakar was an engineer at Intacct, an early cloud-based financial and accounting software provider. He also worked at Northwest Airlines, developing complex algorithms for its yield and revenue management reservation system. Sumedh Thakar holds a bachelor’s degree in computer engineering with distinction from Savitribai Phule Pune University. Reviewing earnings call transcripts reveals that Sumedh Thakar, along with the management team, is not afraid to make bold predictions when providing future guidance, demonstrating their commitment and accountability. Sumedh Thakar's extensive experience and proven track record in driving growth and innovation at Qualys instill confidence in his leadership moving forward.
The Numbers
The first metric to investigate is the return on invested capital (ROIC). Ideally, we would like to see a ROIC above 10% consistently. While Qualys has had some years with ROIC below 10%, it has maintained a ROIC above 10% every year since 2017, which is encouraging. Notably, Qualys has achieved a ROIC above 20% in three out of the past four years. This is particularly impressive given the period's challenges, including the pandemic and subsequent macroeconomic difficulties. The significant increase in ROIC over the past two years is a positive indicator of the company's momentum.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Qualys managed to grow its equity every year from 2013 until 2022. The decrease in equity in 2022 was partly due to the acquisition of Blue Hexagon's AI/Machine Learning Platform by Qualys. Encouragingly, Qualys managed to increase its equity again in 2023, although it did not reach the levels seen in 2020 and 2021. Hopefully, Qualys will be able to regain these levels in 2024.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that Qualys has managed to deliver positive free cash flow every year over the past decade. The company has increased its free cash flow in eight of the past ten years, which is impressive, culminating in its highest free cash flow ever in 2023. The levered free cash flow margin has consistently been high, exceeding 40% in four of the past five years—a remarkable achievement. Notably, the levered free cash flow margin reached its second-highest level in 2023. The free cash flow yield is currently at its ten-year average, indicating that Qualys is not trading at a low valuation. However, this will be examined further later in the analysis.
Debt
Another important aspect to investigate is a company's debt. It is crucial to determine if the business has a manageable level of debt that can be paid off within three years. This can be assessed by calculating the long-term debt to earnings ratio. Analyzing Qualys, it is evident that the company has no debt. In fact, Qualys has never had any debt since its IPO, which is a very positive indicator. Therefore, debt is not expected to be an issue when considering an investment in Qualys.
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Risks
Like every other investment, there are risks associated with investing in Qualys. One significant risk is competition. Qualys competes in a highly fragmented and competitive environment against a wide range of established and emerging vulnerability management, compliance, and data security vendors. The company faces significant competition for each of its solutions from organizations with broad product suites, greater name recognition, and more substantial resources, as well as from smaller companies focused on specialized security solutions. Qualys competes with both large and small public companies, such as Broadcom (Symantec Enterprise Security), CrowdStrike, Palo Alto Networks, Rapid7, and Tenable Holdings, as well as privately held security providers. Additionally, Qualys seeks to replace IT, security, and compliance solutions that organizations have developed internally. As Qualys continues to extend its cloud platform’s functionality by further developing IT, security, and compliance solutions, such as Cybersecurity Asset Management and Patch Management, the company expects to face additional competition in these new markets. Competitors may also attempt to further expand their presence in the IT, security, and compliance market, directly challenging one or more of Qualys' solutions.
Another significant risk for Qualys is macroeconomic conditions. The company's business depends heavily on overall demand for IT and the economic health of its current and prospective customers. Factors such as economic weakness, customer financial difficulties, supply chain constraints, changes in interest rates, inflationary pressures, the potential for a recession, and constrained spending on IT security have impacted Qualys. Longer sales cycles, which Qualys experienced in 2023, have resulted in decreased revenue and earnings. Management has indicated that these challenges persist in 2024, with deal scrutiny continuing for many organizations and the upsell environment remaining difficult. Additionally, the challenging macroeconomic factors have led to customers taking longer to make decisions on larger projects, especially when considering the adoption of new Qualys products. Uncertainty about future economic conditions also complicates Qualys' decision-making regarding future investments.
Another risk for Qualys is the potential inability to renew existing subscribers or add new ones. Qualys operates under a software-as-a-service (SaaS) model, offering its cloud platform and integrated suite of solutions through annual subscriptions. Customers are not obligated to renew their subscriptions after the subscription period expires, and they may choose not to renew at the same or higher levels, or at all. As a result, Qualys' ability to grow depends partly on customers renewing their existing subscriptions and purchasing additional subscriptions and solutions. Customers may choose not to renew for various reasons, including their satisfaction or dissatisfaction with Qualys' solutions, the pricing of these solutions, and the prices of competitors' products or services. If customers do not renew their subscriptions, renew on less favorable terms, or do not purchase additional solutions or subscriptions, Qualys' revenue growth may slow or decline, adversely affecting the company's operating results.
Reasons to invest
One compelling reason to invest in Qualys is its recently launched Enterprise TruRisk platform. The Qualys Enterprise TruRisk Platform is designed to help security leaders measure, communicate, and eliminate cyber risk, making them partners in de-risking their businesses. The platform translates risk signals into measurable scores and provides optimized remediation actions based on business impact. Management believes that the Qualys Enterprise TruRisk Platform, which aims to reduce friction, risk, and cost, offers organizations a foundational risk management tool for the future. This platform serves as a structural competitive advantage for both Qualys' customers and the company itself. The Enterprise TruRisk platform functions as a dashboard. While Qualys does not expect to monetize it directly, it will serve as a tool to convert detected risks into optimized remediation actions across Qualys' platform solutions. This approach not only simplifies risk detection for customers but also acts as an upsell tool for Qualys, enhancing the overall value proposition of its platform.
Another compelling reason to invest in Qualys is its expanding presence in the public sector. Management has emphasized the significant opportunity within the public sector and is actively investing to capitalize on this potential. Recently, Qualys has acquired several federal government agencies as customers. Although these represent a small percentage of Qualys' overall bookings, the company sees substantial growth potential in this segment. Qualys is working towards obtaining its FedRAMP High final certification, which is a mark of excellence in cloud security for handling highly sensitive data. This certification indicates that a cloud service provider has met the most rigorous security requirements and can be trusted to protect critical federal information. Qualys expects to obtain this certification by the end of 2024. Achieving this milestone will open up a vast market of potential government contracts, as Qualys will be the only provider offering a combined FedRAMP High vulnerability and patch management solution. This unique position is expected to prompt federal agencies to switch to Qualys from their current providers, who only offer scanning solutions. Federal agencies currently need separate patch management tools, but Qualys' integrated solution will streamline this process, making it a more attractive option for government entities.
Share buybacks. Qualys diluted its shares until 2018, with shares outstanding reaching 39,379. However, since 2018, Qualys has initiated a share repurchase program. By the end of 2023, the number of shares outstanding had decreased to 36,785, representing a reduction of approximately 6,5% since 2018. While this may not seem significant, it is noteworthy considering that Qualys is still considered a growth company. This share buyback history indicates a positive commitment to enhancing shareholder value. Moreover, at the end of 2023, Qualys' Board authorized an additional $200 million share repurchase program, bringing the total available amount for share repurchases to $283,7 million. This approach not only helps offset the equity dilution from stock-based compensation but also returns value to shareholders through buybacks, demonstrating that management is investor-friendly.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 4,03, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 18,1% in the next five years, but 15% is the highest number I use . Additionally, I have selected a projected future P/E ratio of 30, which is double the growth rate. This decision is based on Qualys' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $120,90. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Qualys at a price of $60,45 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 245, and capital expenditures were 9. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 6 in our calculations. The tax provision was 27. We have 36,785 outstanding shares. Hence, the calculation will be as follows: (245– 6 + 27) / 36,785 x 10 = $72,31 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Qualys' free cash flow per share at $6,41 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $101,19.
Conclusion
I believe that Qualys is an intriguing company due to its industry-leading margins and its client base, which includes some of the largest companies in the world. I also have confidence in the CEO, given his extensive experience both in the industry and within the company. Qualys has delivered an impressive ROIC recently and continues to grow its free cash flow, which are compelling metrics for most investors. Qualys operates in a competitive industry, facing competition from both larger and smaller companies. While Qualys has managed to handle competition effectively so far, it is a risk worth monitoring to ensure that the company can maintain its high profit margins. Qualys has indicated that macroeconomic factors affected their results in 2023 and are likely to do so in 2024 as well. Although these factors will eventually improve, the timing is uncertain. Until then, the challenging economic environment will continue to impact Qualys. Qualys' business model relies on renewing current subscribers and acquiring new ones. The company has been successful in this regard, and there is no indication that this trend will not continue. However, it remains an area to monitor when investing in Qualys. Qualys has recently launched its Enterprise TruRisk platform, which aligns with the evolving needs of customers who are shifting from simply deploying security point solutions to measuring and articulating business risk. This platform is expected to drive more upsells for Qualys. Additionally, Qualys anticipates receiving the FedRAMP High final certification in 2024. This certification should boost sales to federal agencies, as Qualys will be the only company with this certification offering both scanning and patch management tools. While some companies repurchase larger amounts of shares annually, it is a positive sign that Qualys is reducing the number of shares outstanding at this stage of its business cycle. This practice could be beneficial for long-term investors. Overall, I am optimistic about Qualys and the sector in which it operates. Thus, I believe that buying shares below the Payback Time price of $101 could be a good long-term investment.
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