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Next Wave Portfolio—Updates on Zendesk & Varonis Systems

Wall Street continues to get more bullish on Zendesk (ZEN), provider of a cloud-based customer service platform. Canaccord Genuity early last month named Zendesk a top small-cap pick, saying the company is evolving its business model to a multi-product platform offering from a single solution. The move to an expanded customer-support feature set (including advanced analytics and live chat) will help Zendesk continue to attract larger customers and enable it to charge more.

Zendesk is already gaining traction with larger enterprise accounts. In the latest quarter, the number of customers with 100 or more software seats represented 31% of recurring revenue, vs. 23% in the year-ago quarter. Zendesk as of the September quarter had a total customer base of more than 64,000, an increase of 32% year over year.

Goldman Sachs in December initiated coverage of Zendesk at ‘Buy’ with a price target of $33, citing the company’s longer-term growth potential. BofA/Merrill named Zendesk a top 2016 small-cap software pick. Pacific Crest last month raised its price target to $35 from $30 based on incremental revenue opportunities from new products and enhancements.

Zendesk can see the most upside from three new offerings, each of which has revenue potential of $100 million, according to Pacific Crest. The first, Facebook Messenger connection, enables call center employees to use the increasingly popular messaging service to communicate with customers. The Advanced Voice platform includes improved voice communication features, while Satisfaction Prediction is a customer care tool that uses machine learning to discover situations that may lead to customer dissatisfaction.

Pacific Crest believes consensus expectations call for too much growth deceleration this year, saying Zendesk is likely to continue to beat and raise estimates on a quarterly basis. The 2015 consensus revenue estimate of $206.3 million represents growth of 62%, while the 2016 consensus of $289.1 million indicates growth of 40%. The Street-high revenue estimate for this year currently stands at $303 million (growth of nearly 47%).

In early January, Varonis Systems (VRNS), a provider of solutions to manage and secure unstructured data, appointed Eric Mann to the newly created role of chief operating officer. Mann is a talented sales leader who can help Varonis go after larger customers. He has a lot of experience in building out sales teams and the partner channel. This was an important management win for Varonis because Mann can really focus on expanding the customer base (63% of license and first-year maintenance revenue on a quarterly basis already comes from new customers).

Mann joined Varonis from networking security vendor Fortinet (FTNT), where he served as vice president of the Americas sales region. Previously, Mann over the course of 12 years held a range of sales leadership positions at storage systems provider NetApp (NTAP), ultimately serving as vice president/general manager of Americas sales. Before that, he was with EMC (EMC) for 11 years, leading that company’s Americas sales team through a period of rapid penetration into enterprise accounts.

Lake Street Capital last month started coverage of Varonis at ‘Buy’ with a price target of $25, saying the company’s highly differentiated technology is well-positioned for the next big market opportunity in security: insider threat prevention. The company’s software monitors unstructured data and analyzes the activity of users to establish a baseline of what is considered normal. Organizations can quickly defend against insider threats to their unstructured data by using Varonis’ platform of offerings.

Since 70% of companies find out about breaches through their customers and third parties, there is plenty of market potential, More organizations are realizing they should be keeping track of their sensitive data via real-time monitoring. Lake Street views the stock’s risk/reward balance as attractive at the current valuation. The firm expects market demand for Varonis’ solutions to materialize this year following the company’s challenging 2015. Varonis last year flubbed its first quarter, but managed to beat revenue and earnings expectations in both the second and third quarters. Lake Street views the stock’s risk/reward balance as attractive at the current valuation.

For 2015, analysts on average expect Varonis to have delivered revenue growth of 23.5%. The 2016 consensus revenue estimate of $152.5 million represents growth of nearly 22%. Varonis will report its fourth quarter results on February 11.

Varonis shares have begun to attract some institutional buying interest. In the third quarter, mutual fund giant Fidelity increased its Varonis position by 55%, adding more than 692,000 shares; the firm now owns 1.93 million shares and is the second largest holder after Cadian Capital, which owns 2.19 million shares. Jennison Associates was another big buyer in the September quarter, increasing its position by a third. Jennison now owns 942,968 shares and is the #4 holder. BlackRock Institutional more than tripled its position and is now among the 10 largest holders.

Both Zendesk and Varonis Systems remain a ‘buy’ in the STI Next Wave Portfolio.

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