Symantec (SYMC, Financial), the leading cyber security firm, has been in hot water for some time now, facing one problem after another.
Back in May, the leading cyber security firm became a party to an internal accounting probe of its non-GAAP reporting practices including executive compensation, which sent the stock tumbling. Recently, the firm lowered its revenue forecast and unveiled its plans to cut 8% of its global workforce. Symantec is also in the midst of a legal battle with Zscaler (ZS, Financial) over patent infringement.
Given multiple negative developments, the stock is down more than 45% year to date, translating into a market-cap loss to the tune of $6 billion. The stock is now trading at its 52-week low, which makes it the cheapest publicly traded cyber security firm.
The accounting probe
An accounting probe is under way at Symantec since a whistleblower raised concerns over the company’s non-GAAP reporting policies back in May. While Symantec doesn’t see it having a material impact on the company's previous results, the future outlook might be negatively affected if the audit committee does find material misstatements. Symantec provided few details regarding the accounting probe on its latest earning call last week, which also raised questions about the reported earnings guidance of the company. The company also delayed the submission of its 10-Q filings with the SEC, as financial results may be subject to revision.
Naturally, investors aren’t happy and are punishing the stock. The market doesn’t like uncertainty, and that’s the primary reason Symantec isn’t the go-to cyber security stock right now despite cheap valuation.
What’s the problem?
During the first quarter of 2018, stock-based compensation and amortization of intangibles totaled $224 million, making up more than 90% of the company’s non-GAAP net income. Because the accounting probe relates primarily to stock-based compensation, a material revision in stock-based compensation can reduce the GAAP income of the company. Put simply, the stock might not be as cheap as it looks right now based on GAAP measures. In other words, an understatement of stock-based compensation would reflect negatively on the economic value of Symantec.
The negative price reaction isn’t justified though
For starters, whatever happens in the probe, it won’t affect the non-GAAP income of Symantec. If, say, the audit committee finds evidence of overstatement in stock-based compensation expense, Symantec will have to increase its GAAP guidance while non-GAAP earnings will remain unaffected. On the flip side, evidence of understatement in stock-based compensation will force Symantec to lower its GAAP income but won’t affect the company’s non-GAAP income. As Wall Street usually fixates on non-GAAP earnings, analyst price targets for Symantec won’t change much in response to potential revision in the company’s GAAP income.
What’s even more interesting is the fact that Symantec might not be very expensive even after accounting for the worst-case scenario. During the fiscal year ended 2018, stock-based compensations made up roughly 27% of Symentec’s total non-GAAP income.
A reduction of 27% from the 2019 earnings-per-share guidance results in a forward price-earnings ratio of around 16, which is cheap for a company that operates in a cyber security space.
Moreover, it’s unlikely that Symantec will have to reclassify all of its non-GAAP stock-based compensation expenses, meaning that a forward price-earnings ratio might look better than the worst-case scenario. Further, the 8% reduction in the workforce is expected to save $150 million in costs, which will also help Symantec offset any pressure that mounts from the revision of its stock-based compensation expenses.
In summary, although the accounting probe is a negative development, the market is blowing it out of proportion. Even if Symantec stops adjusting its stock-based compensation in its non-GAAP earnings, the stock is still cheap on a relative valuation basis. Regardless, non-GAAP earnings per share – on which Wall Street banks – is indifferent to changes in stock-based compensation.
Symantec is positioned well in the cyber security market
Symantec is named a leader by a well-regarded vendor analyst, Gartner, in its latest magic quadrant for the end-point protection platform (EPP), which is expected to witness double-digit growth in near future. “Symantec continues to provide one of the most comprehensive EPPs available in this market, with third-party test scores remaining in the top tier,” said Gartner.
The only other leaders in the market are Sophos and Trend Micro (TSE:5704, Financial), which, in fact, lag behind Symantec in terms of completeness of vision. Note that the endpoint security market is set to reach $7.5 billion by 2024.
Secure Web Gateways (SWG) – another key vertical for Symantec – is also witnessing growth. The cyber security firm is a leader in this space alongside Zscaler. In the past, Symantec had also filed a patent-infringement lawsuit against Zscaler, which is still underway.
Symantec holds the largest market share in SWG, thanks to its acquisition of specialist SWG firm BlueCoat back in 2016. Both IDC and Forrester placed Symantec’s BlueCoat as a leader in web gateway markets in their vendor analysis reports. It is worth mentioning that secure web gateways market is expected to grow at around 20% per year during the next couple of years.
To sum up, the cyber security market is witnessing double-digit growth, and Symantec is positioned well to benefit from end-point protection platform and web gateways, a multi-billion dollar market each.
Takeaway
- While the accounting probe and downside revenue guidance for 2019 don't bode well for Symantec, the market seems to be overreacting and unnecessarily punishing the stock.
- Excluding stock-based compensation, Symantec is still priced cheaply given the potential double-digit growth in the cyber security space.
- Symantec is a leader in secure web gateways and end-point security markets, which are expected to grow going forward.
- The recent weakness in stock price seems to be a good entry point for investors as accounting concerns are overplayed.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
