Questor: the Americans may always buy our tech in the end but it’s no guarantee of profits

James Ashton 20 October 2019 • 5:58am

A network security installation of internet security firm Sophos — Credit: Mauritz Antin/EPA/REX

Questor share tip: as cyber security specialist Sophos is taken private by a US buyout firm, we look at the lessons for private investors

Amid minor wailing over the fall of another British technology star to American ownership, investors might reasonably ask what took the buyers of Sophos so long.

Here was a mid-sized technology company with an impressive reputation for battling ever-bigger cyber threats in a consolidating industry. The weak pound only sweetened the appeal for US private equity group Thoma Bravo, which has had its $7.40-a-share cash offer – the equivalent of 583p on the day – accepted by the board.

How ironic that earlier this month Sophos announced the availability of its Managed Threat Response product, the latest method for firms to ward off attacks on their IT systems and cloud services.

If there was a threat that the company’s shares would carry on falling after an erratic few years, by backing this deal they have certainly managed it.

Sophos operates in two main areas: providing software to keep networks safe, and protecting remote end-users who might be working away on laptops or smartphones that could be targeted by dangerous downloads. Its meat and drink are the small and medium-sized firms that lack big IT departments and it has 400,000 customers to date, spread all over the globe.

Cyber remains a hot area for investment. Memories of the WannaCry attacks are enough to make business chiefs break out in a sweat; worse still is the havoc of Ryuk ransomware that demands payment to disappear. Yet Oxfordshire-based Sophos has been on a bumpy ride since the company missed City guidance several times last year.

That can quickly smooth itself out, as the latest trading update showed. With interim figures due on Nov 6, chief executive Kris Hagerman’s expectations for the period include 9pc underlying growth in billings, the company’s preferred metric. That is three times the rate pencilled in by company watchers at Stifel, the broker.

However, there are signs of growing pains ahead. Group sales are forecast to bump up by $100m over the next two years but at a cost to operating profit, which is forecast to almost halve. There is some suggestion that Sophos is struggling to keep pace with the likes of Symantec, which pours the best part of $1bn into research and development annually.

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At 5.2 times the current year’s revenues, the offer sounds generous. But this is the tech world, where analysts at Megabuyte point out that Sophos’s listed peers trade more expensively, including Proofpoint (7.5 times), Rapid7 (seven times) and Mimecast (5.6 times) – and that is without any takeover premium.

Thoma Bravo has been collecting cyber assets lately so knows where to price its pitches. The deal is in line with what it paid last year for California-based Imperva. Short of places to park their funds profitably, tech is too tempting for the big buyout funds – but can be risky for small shareholders. It is worth remembering that those who invested as recently as January or June last year are still out of pocket, despite a premium of 37pc to the undisturbed share price.

They are unlikely to do any better because this is the only offer in town. Thoma Bravo has 28pc of irrevocable acceptances from the two founders, Jan Hruska and Peter Lammer, plus Apax, the private equity group that brought Sophos to market in 2015 and surprisingly remains its largest shareholder. Mr Hruska and Mr Lammer set up Sophos in a front room in 1985 after meeting as postgraduates at Oxford.

Sophos offers a salutary lesson for investors in British tech: the Americans may snaffle the asset in the end – but that is no guarantee their risk-taking will convert to a profit.

Given that sterling could rally from here after last week’s Brexit developments, investors are better cashing in now and reinvesting elsewhere rather than waiting for the deal to close early next year. NCC Group, operating in the same field and tipped here two weeks ago, continues to prosper.

Questor says: sell

Ticker: SOPH

Share price at close: 565.8p

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