Proofpoint: Work From Home Trend Could Be Long-Term Tailwind For Email Security (NASDAQ:PFPT)

Proofpoint (PFPT) reported a better than expected Q2 with revenue and EPS both coming in ahead of expectations and management’s previous guidance range. Revenue growth continues to remain strong at ~21% and decelerated only slightly from 23% in Q1 despite the challenging macroeconomic conditions.

In addition, the company provided revenue guidance of $1,035-1,037 million, which was well above expectations of ~$1,020 million. While revenue guidance came in above expectations, I believe there could be a further upside as more companies work from home, which could result in greater demand for email security. However, the disappointment during the quarter was billings growth of only 8%, which slowed down from the disappointing 11% growth seen last quarter.

ChartData by YCharts

Since reporting earnings, the stock initially dropped over 15% but has slowly recovered to being down some 5% since earnings. Investors quickly sold the news on weaker than expected billings growth, which typically means near-term revenue may be under pressure. Yes, while near-term revenue may be a bit volatile given the current economic conditions, longer-term revenue growth remains bullish.

After companies rapidly transitioned employees to a work from home structure, it appears this trend may be here for the longer term. Email security should be at the company’s top of mind given the massive transition of employees from more secure IT infrastructures in the corporate office to a work from home environment. Several security firms have noted that email is the main vector of attack and the average employee is at higher risk. Given more employees are working at home for longer, companies will need to invest heavily in both email security and email security training in order to best prevent hackers from entering their database.

Valuation has also pulled back over the past week and now trades at ~5.5x forward revenue and ~5.2x my projected 2021 revenue estimate. With revenue growth potentially returning to 20%+ in the future in addition to operating margin continuing to expand, I believe the recent pullback in the stock provides an attractive entry point for long-term investors.

Long-term investors should confidently hold onto their position in PFPT, and if the chart above is any indication of the ebbs and flows of the stock price, investors should opportunistically look to add to their positions over time.

Q2 Earnings and Guidance

Even though the global economic conditions remained challenged during Q2, the company was still able to grow revenue by 21% to $258.4 million, which was above expectations for ~$253 million. In addition, revenue came in above management’s guidance of $251-255 million and showed only minor deceleration compared to the 23% growth seen last quarter.

However, for the second quarter in a row, the challenging metric for the quarter was billings growth. During Q2, billings only grew 8% to $250 million, which came in below expectations and actually decelerated from 11% last quarter.

I have started to become a little bit more cautious around billings during these volatile times as companies are likely less inclined to get a deal done in the near term and would rather focus on keeping their business afloat. Yes, the lower than expected billings growth is not good news for investors, but the average company is more focused on cost optimization and running their business appropriately given the current economic conditions rather than pushing to get their next IT capital expenditure project signed.

Companies are still focused on maintaining their operations and focusing on a successful transition to a work from home environment, which may continue for the foreseeable future. Some companies may be delaying their IT security upgrade investments in the near term in order to focus on keeping their business afloat. However, over the longer term, companies will need to continue to increase their IT security spend, especially around email security given the weaker network security protocols with employees working from home.

Source: Company Presentation

Gross margin during the quarter remained very strong at 80% and improved slightly from 79% seen in the year-ago period. Operating margin during the quarter came in at 15.9%, which improved the ~13.2% in the year-ago period. Over time, as the company continues to scale and better leverages their operating expense base, operating margins are poised to expand further.

Source: Company Presentation

Guidance for Q3 includes revenue of $260-262 million with a gross margin of ~80%. The strong gross margins led by software subscription revenue could continue to drive operating margin expansion. EPS for the quarter is expected to be $0.37-0.40.

For 2020, the company raised revenue guidance to $1,035-1,037 million, up from their previous range of $1,005-1,030 million and now represents ~17% growth for the year. Gross margins are expected to remain strong at ~80% and EPS guidance is now $1.64-1.70, which is up from their previous guidance range of $1.41-1.46 and above consensus expectations for $1.51.

Valuation

While the company reported strong quarter results that came in above expectations, billings growth remains a little challenged. The market immediately pushed the stock down last quarter after getting lower than expected billings in Q1, and Q2 seemed to be a similar story. Nevertheless, the company raised its revenue and EPS guidance for the year, which came in above consensus expectations.

While the lower than expected billings growth may mean there could be some challenges over the next several quarters, companies may need to increase their IT budget over time. With more employees working from home, companies will need to invest more in order to ensure the same security protocols as to when employees worked in a much more secure corporate office. Hackers have been known to target employees via email, and the need for continually improving email security and training will cause more enterprises to increase their security investments over time.

ChartData by YCharts

PFPT is considered to be one of the leaders of email security and training and with an increased amount of employees working from home, their training services may see increased demand over time. Revenue growth is expected to remain under pressure in the near term given global economic conditions remaining challenged; however, the long-term potential remains intact and investors could see revenue growth return to 20%+ with operating margins continuing to expand.

The company recently raised their revenue guidance to $1,035-1,037 million, which represents ~17% growth for the year. While there may be some level of conservatism baked into guidance, we are not likely to see growth return to the 20% level in 2020 given the fact that the year is almost over and the company likely has a high degree of visibility into the next 6 months of their pipeline.

The company has a current market cap of ~6.75 billion and with cash/investments of ~$975 million and debt of ~$765 million, the company has a current enterprise value of ~$6.55 billion.

Using the midpoint of management’s 2020 revenue guidance of $1,035-1,037 million, we can start to build out 2021 revenue potential. As economies continue to recover and businesses start to resume their normal capital expenditure investments, IT security spend will likely continue to grow. With more employees continuing to work from home, IT security budgets will shift in order to invest more in at-home security protocols, which includes email security and training.

That being said, I believe PFPT could see their revenue growth accelerate to 20%+ in 2021, which could result in 2021 revenue of ~$1,250 million, implying a 2021 revenue multiple of ~5.2x.

Over the past several months, the company’s valuation has retracted from ~8x forward revenue to ~5.5x forward revenue. However, as revenue growth returns to the historical 20%+ range and operating margins continue to expand, the company should start to become more deserving of a higher multiple. Considering the current valuation implies a 2021 revenue multiple of ~5.2x and the recent range has been around 5.5-8.0x forward revenue, PFPT is already trading near the low-end of forward multiple ranges. As enterprises start to resume their IT security projects in order to enhance at-home email security, we could see PFPT’s valuation start to expand.

With the stock remaining down over 5% since reporting earnings, valuation still seems to be supportive of long-term investors starting to build up a position in the name. While the stock could continue to face downward pressure as investors sell the news on lower billings growth, long-term investors should find the current entry point attractive.

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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