Magnet Forensics Inc. T.MAGT

RBC

[retiredcf]

Magnet Forensics (TSX: MAGT)

Outperform, C$42.00 price target

We expect Magnet to report solid Q1 results, with potential upside to our estimates and consensus on stronger term license revenue. The demand environment for cybersecurity and digital forensics software remains strong, in our view. Additionally, we believe that Magnet may modestly raise its annual guidance, similar to previous quarters. Maintain Outperform, given anticipated +30% growth and valuation below peers.

Magnet to report Q1/FY22 on May 5. Magnet is scheduled to report Q1/FY22 on May 5, before market open. The conference call is scheduled for May 5 at 8:00 a.m. ET. Dial-in: [phone] or [phone].

RBC forecasts Q1 revenue to rise 33% Y/Y, in line with consensus. In three quarters as a public company, Magnet has reported quarterly revenue on average 6% above consensus. We forecast Q1 revenue to increase 33% Y/Y to $19.5MM, in line with consensus at $19.6MM. Upside to our estimates and consensus is possible on stronger term license revenue. We expect term license revenue to rise 48% Y/Y to $5MM, driven by emerging private sector demand and additional sales into existing customers. On new opex investments, we estimate Q1 adj. EBITDA falls to $1.7MM (-65% Y/Y), slightly below consensus at $2.1MM, as new investments are weighted toward the beginning of the fiscal year. Similarly, our $0.02 adj. EPS Q1 forecast is slightly below consensus at $0.03.

Magnet may raise FY22 guidance. Magnet has a history of increasing guidance through the year. Last year, Magnet modestly raised its FY21 guidance in both quarters (Q2, Q3) after the company introduced guidance with Q1 results. While the increases were modest (just $1MM increase to revenue, $2.5MM average increase to adj. EBITDA), it suggests initially provided guidance incorporates a degree of conservatism. As such, we believe that Magnet may increase FY22 revenue guidance by $1MM to $92.5-93.5MM, up from $91.5-92.5MM previously. The company may also raise FY22 adj. EBITDA guidance by $1-2MM to $14-17MM, from $13-15MM previously. Consensus FY22 estimates currently call for $92.6MM revenue and $13.6MM adj. EBITDA.

Anticipate continued solid ARR growth. Our forecast calls for ARR (annual recurring revenue) to increase 40% Y/Y to $61.8MM, outpacing revenue growth (est. 33% Y/Y). We believe there is potential upside to our estimate, which appears conservative since it implies only 1% sequential growth (vs. average of 10% Q/Q growth in FY21) and implies Y/Y growth decelerates from 48% Q4. Fundamentally, we believe that Magnet is seeing strong momentum in ARR, given the ongoing shift from perpetual to term license along with expansion into the higher- value private sector (via AXIOM CYBER). Our outlook calls for the proportion of recurring revenue (term license + maintenance) to increase to 85% of total revenue Q1 from 82% Q4.

Magnet’s strong growth momentum expected to continue. We believe that the demand environment for Magnet is likely to remain healthy. Our view reflects:

•  Ransomware/malware is fueling strong demand for digital forensics and incident response. In a survey commissioned by Magnet press released on March 22, digital forensics and incident response (DFIR) decision makers were 3x more concerned about ransomware/malware than any other threat, with more than 60% expected to make major investments in DFIR over the next two years. We believe Magnet is well positioned to meet the ramping demand for DFIR products illustrated by this survey.

•  Peer Cellebrite introduces solid 2022 guidance ahead of consensus. After delivering record revenue and ARR in FY21, Cellebrite (NASDAQ: CLBT) introduced a robust FY22 outlook on February 16. The company introduced FY22 guidance for total revenue of $285-300MM (16-22% Y/Y), which was ahead of consensus revenue estimates for $284MM, and ARR growth of 34-42% Y/Y ($250-265MM) ahead of previous guidance for ~34%. Cellebrite’s outlook calls for ARR growth to bracket FY21 growth (37%), implying strong sustained momentum of its subscription-based offerings (including upselling of new licenses to existing customers and increased budgets from global law agencies). According to the company, the solid outlook reflects the strength of the digital intelligence market, with management pointing to rapidly growing crime rates, coupled with increasing complexity of digital evidence.

•  New sales investments. Magnet is making new investments to facilitate future growth. On March 10, management indicated the company plans to hire 140 people in 2022 (vs. 127 in 2021), primarily in sales & marketing and R&D. The timing of new investments will be weighted towards 1H/FY22. As such, we forecast total opex to rise 74% Y/Y to $17MM Q1 from $10MM Q1/FY21.

  Magnet’s U.S. Federal awards fall, likely due to lumpiness and timing of deployments. Based on data from U.S. Federal government procurement databases, Magnet’s U.S. Federal awards 52% Y/Y to $186k Q1. Additionally, Magnet’s awards rose 123% Q/Q on seasonality, but this was below the 3-year average of 177% sequential growth Q1. Agencies that purchased Magnet’s software in Q1 include the Department of Homeland Security, and the Department of Commerce. Although the Y/Y decline is not positive, the timing of awards is lumpy, with significant variation between quarters. Additionally, the magnitude of orders ($186k) is a small proportion (<1%) of Magnet’s quarterly revenue.
  
  Maintain Outperform. We believe that Magnet’s stock is positioned to continue to outperform over the long term on realization of 30%+ compounded revenue growth. With the increasing strategic importance of digital forensics, Magnet has an opportunity to leverage its position as the digital dashboard for investigations to expand into additional tools and adjacencies (e.g. e-discovery) through acquisitions or product development, which suggests long-term, double-digit growth, is likely to be sustained for multiple years beyond our forecast period.