Allot (ALLT) is undergoing a dramatic transformation from a hardware company selling systems to operators on a perpetual basis to a software company selling software on a Software-as-a-Service basis. The company’s current valuation, an enterprise value to revenue (EV/R) ratio of 1.5x, reflects its old business model and does not account for its emergence as a SaaS player where multiples range from 4x to 8x.
Allot sells a variety of products, but these fall into two broad categories. First is their Deep Packet Inspection ((DPI)) technology which they have sold to operators for over 20 years. Originally sold in a proprietary hardware package, this product allows operators to closely inspect the packets flowing on their networks to understand what types of traffic they contain. Additionally, this product allows the operators to divert or block certain types of traffic that they do not want on their networks, such as pornography, etc. Originally, this was a three-horse market with share divvied up between Allot, Sandvine, and Procera Networks. Last year, Procera and Sandvine merged, and the combination has been leaking market share to Allot since then as integration efforts have not gone well.
Over the past couple of years, Allot has separated its DPI software from the underlying hardware platform to a point that the software can now run on any off-the-shelf server. This is a trend operators have embraced but Allot’s competition has not caught up with. Allot has historically and currently sells its DPI product on a perpetual basis, meaning it recognizes all of the revenue for the sale immediately on customer acceptance. As their multi-million-dollar sales, this has led to some historical revenue lumpiness in the business.
Allot’s other business is selling security software to network operators to use either in the core of their networks or at the subscriber level. Its DDoS (Distributed Denial of Service) protection allows operators to avoid their networks breaking down under floods or service requests from malicious users. Its newer security business allows operators to sell parental controls, malware, and anti-virus software to individual users for an ongoing monthly fee. Originally deployed with Vodafone (VOD) 5 years ago, this business has been extremely successful for them with penetration rates up to 50% in some Vodafone properties. Unfortunately, for Allot, this was a perpetual license arrangement, and while it resulted in a lot of one-time revenue, there was no ongoing revenue stream.
New management came into Allot three years ago and decided that the right direction for its business was to switch to a SaaS model. With the product already in place, the past two years have been spent building a pipeline and readying the organization for this business model. The catalyst for me writing this article today is that, this morning, Allot announced its second SaaS security win with Hutchison Drei Austria which has 3.9 million subscribers. On its 1st quarter earnings call, Allot introduced a new metric by which to judge its SaaS business called “Maximum Annual Revenue ((MAR)).” This is calculated by multiplying the number of subscribers times the annual revenue per subscriber. The ultimate actual revenue will be less depending on the penetration rate, but MAR is a good way to describe the potential of the business. The company set out an MAR target of $100 million by the end of 2019. For today’s deal, we would multiple the 3.9 million subs times the annual revenue per sub of about $6 to get a MAR of $23.4 million. Combining this with a MAR of $17.4 million from their first deal in the spring gives a total so far this year of $40.8 million, which is a very good start towards their target.
What is the right way to value Allot? Looking at 2020E revenue, we estimate it to be $125 million. Assuming half of this revenue is DPI, which is perpetual but growing nicely, we would give that a 2x sales multiple. So, 2x (125/2) = $125 million. For the security side, we would give it a conservative SaaS multiple of 5x revenue. So, 5x (125/2) = $313 million. Then, add in the $101 million of net cash, so the total equity valuation comes out to be $539 million or $15.75 per share. This would result in about 100% upside from current levels.
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