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Fred Wang
Partner, Growth Equity
Brian Dudley
Principal, Growth Equity
Luke Prioleau
Senior Associate, Growth Equity

Key Takeaways for Q1 2021

  • After an exceptionally strong run from March 2020 through mid-February 2021, stock prices declined for 24 out of 27 public cybersecurity companies during Q1.1
  • This sector wide drop was likely due to macroeconomic factors, such as increasing interest rates and unsustainably high multiples, as opposed to a cybersecurity-specific catalyst.
  • Despite the recent pullback, cybersecurity companies are still trading at healthy valuations and we believe will continue to be strategically important to the broader digital transformation movement.
Figure 1: LTM Trading History1

Public Market Recap

“Light at the end of the tunnel” was the catchphrase of Q1 as COVID-19 cases declined and the vaccine rollout accelerated. Though the true end of the pandemic (however that is ultimately defined) is still a ways away, we believe there are more reasons for optimism now than there have been over the last 14 months. Cybersecurity companies in the public markets also saw a change in sentiment over Q1, although in the opposite direction.

Figure 2: Q1’21 Trading History1

Stock prices for 24 out of 27 public cybersecurity companies dropped within the quarter after an impressively strong run from March 2020 through mid-February 2021. Trough to peak, the index of all cybersecurity companies rose 150%+ over 11 months,1 as both macroeconomic and sector-specific tailwinds supported increased investment. While it is impossible to say what exactly spurred the selloff from mid-February through the quarter end, we do not believe that there was any fundamental impairment to the cybersecurity sector specifically. Rather, this appears to be a minor “reset” to a blazing hot market.

While it is impossible to say what exactly spurred the sell-off from mid-February through the quarter end, we believe this appears to be a minor “reset” to a blazing hot market

Multiples for the broader tech landscape were at record highs at the beginning of Q1, when looking back two decades across the public markets.1 In our view, stimulus efforts and historically low interest rates made these stocks attractive opportunities, keeping multiples buoyed at frothy levels. Specifically, investors rewarded growth and paid large premiums for companies that show steady growth at scale. Within cybersecurity, there was a stark multiple divergence between the high-growth cybersecurity index and the medium/low-growth cybersecurity indices. 15 months ago, high-growth cybersecurity companies (>25% YoY growth) commanded NTM revenue multiples roughly 2.5x those of slower growth cyber-security companies. Since then, that gap widened to 5x.1

Figure 3: TEV / NTM Revenue1

Within cybersecurity, there was a stark multiple divergence between the high-growth cybersecurity index and the medium/low-growth cybersecurity indices

We believe that the prevailing valuations for high-growth cybersecurity companies (and tech companies broadly) are unsustainable. Recently, however, there was somewhat of a reckoning for these companies as the index’s NTM revenue multiple dropped from 36x to 25x. This drop coincided with bond market interest rate movement. After a sharp decline at the beginning of the pandemic, the 10-year treasury rate remained under 1% for the better part of a year. The rate began slowly rising in late summer but accelerated during Q1 of this year, growing from 0.93% to 1.69% within the quarter. Is this connected to the decline in cybersecurity stocks? Unclear, but the timing is noteworthy. The Federal Reserve indicated that they do not plan on raising rates this year,2 but if the market remains robust and inflation rises, we believe that they could be forced to do so in the future. If interest rates continue to rise and bond markets grow more attractive, we could see a further decline in equity multiples.

Figure 4: 10-Yr US Treasury Rate1

We believe that the recent decline in cybersecurity stocks is far from a reason to sound the alarm. After all, most companies only had a single-digit percentage decline in stock price and forward revenue multiples are still meaningfully higher than pre-pandemic levels. A reset, like what occurred in Q1, is in our view natural as the markets try to establish what the “new normal” is. Zooming out, the pandemic has exacerbated the need for companies to have robust cybersecurity programs. We believe that the sector will continue to offer exciting investment opportunities as cybersecurity plays a critical role in executing against a successful digital transformation journey.

 

Data and analytics provided by S&P Global Market Intelligence. List of public cybersecurity companies compiled by Adams Street. Data sourced March 31, 2021.
1. Source: S&P Global Market Intelligence
2. Source: www.cnbc.com/2021/04/11/powell-says-its-highly-unlikely-the-fed-will-raise-rates-this-year-despite-stronger-economy.html


Important Considerations: This information (the “Paper”) is provided for educational purposes only and is not investment advice or an offer or sale of any security or investment product or investment advice. Offerings are made only pursuant to a private offering memorandum containing important information. Statements in this Paper are made as of the date of this Paper unless stated otherwise, and there is no implication that the information contained herein is correct as of any time subsequent to such date. All information has been obtained from sources believed to be reliable and current, but accuracy cannot be guaranteed. References herein to specific companies or sectors are not to be considered a recommendation or solicitation for any such company or sector. Projections or forward-looking statements contained in the Paper are only estimates of future results or events that are based upon assumptions made at the time such projections or statements were developed or made; actual results may be significantly different from the projections. Also, general economic factors, which are not predictable, can have a material impact on the reliability of projections or forward-looking statements.