The much expected announcement that IT security company Sophos intends to list on the London market came this morning. The FT reports that the company aims to raise £100m and value the company between £300m and £500m. Sophos was founded in 1987 and has grown to be one of the largest IT security software vendors globally and competes head to head with US players McAfee and Symantec. Sophos operates on a subscription model and customers typically pay up front for 1-5 year contracts but the revenue is taken to the P&L equally over the life of the contract. As a result, Sophos enjoys highly visible revenues but because costs are taken as incurred and revenue is spread over the life of the contract, in any given year billings are higher than revenues and cash flow is significantly higher than profits. There are no revenue or profit numbers in the statement this morning, but in the last three years to March 2007, Sophos has grown billings from $134.0m to $167.0m and free cash flow from $27.5m to $29.6m. Sophos is party owned by TA Associates who are also investors in the SmartStream.
Our view
Whilst we do see the merits of the argument that a cash flow valuation is more appropriate for Sophos, it is a shame that the company lacked the confidence to provide revenue and profit numbers in the release. With regard to valuation, our analysis of the peer group (all US listed) suggests a 2008 revenue multiple range of between 2.5x and 4.0x. As a further reference point, Surfcontrol was acquired by Websense this year for 2.8x revenue. Because there are no revenue numbers in the release, it is not possible to make a direct comparison with Sophos. However, billings for fiscal 2008 were around £80m and assuming that the 30% growth in H1 continues for the rest of the year, this would imply billings of around £108m for the full year rising to perhaps £135m in 2009. At the £300m to £500m suggested by the FT this morning, that would imply a EV/billings multiple of 2.3-3.9x. However, the big question is how do billings relate to revenues. In a high growth company signing multi-year deals, revenue is likely to be well below billings, so the revenue multiple will be higher. Looking at free cash flow, the valuation range suggests a historic free cash flow yield of between 3% and 5% which doesn't look too compelling unless the company expects to significantly grow FCF this year.
As we saw with the wildly differing fortunes of the SmartStream and Telecity IPOs, the success of an IPO rests more on the investor perception of the strength of the underlying market and the company's position within it than the valuation. On that score, Sophos looks well placed but there is an added dimension with Sophos - the business model. Whilst the subscription model clearly has its merits, in our view, the IPO will succeed or fail on the company and its adviser's ability to convince the investment community to value the company on its cash flow and billings rather than revenue and profits.
