Will Barracuda Networks, Inc. Sink or Swim in 2016?

Shares of Barracuda Networks (NYSE: CUDA) have fallen more than 60% over the past 12 months due to slowing subscriber growth and concerns about competition in the security and storage appliance market. Will the beaten down cybersecurity player bounce back later this year? Let's take a closer look at its business, its competition, and valuations to decide.

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What does Barracuda Networks do?
Barracuda's security business offers email and web filters, a next-gen firewall, application and network security solutions, remote access, and application delivery controllers. Its storage business contains data protection products for backing up and archiving data. Many of these products and services connect to its subscription-based cloud services.

The company's main competitors include next-gen firewall leader Palo Alto Networks (PANW 0.11%) and web app firewall vendor Imperva (NYSE: IMPV). Barracuda is much smaller than both rivals, and it could be lost in the shuffle as those bigger players expand and larger cloud-based IT players like IBM upgrade their security solutions.

How bad is the slowdown?
Palo Alto continues pumping out over 50% sales growth every quarter, while Imperva's sales have been rising at over 40%, but Barracuda's growth has clearly slowed down over the past year. Total sales rose 13.8% annually to $80.1 million last quarter, missing estimates by $0.2 million.

YOY sales growth. Source: Quarterly reports.

Barracuda's billings fell 3% annually last quarter as subscriber renewal rates declined to 87% -- down from 95% in the previous quarter, and representing its lowest renewal rate since its IPO in 2013. That's bad news, since subscription revenue, which rose 17.5% during the quarter, accounted for 73% of the company's top line. For the current quarter, Barracuda expects revenue to rise just 10.8% to 13.6%.

A slow shift toward the cloud
During last quarter's conference call (as transcribed by Thomson Reuters), CEO BJ Jenkins stated that "the shift from traditional and solely on-premise IT solution deployments to hybrid, public cloud, and managed service solutions (was) accelerating faster than we expected." That shift expanded dollar-weighted sales cycles by "25% globally," caused customers to sign "one year renewals instead of multi-year engagements," and caused sales of physical appliances to drop "as more customers chose virtual appliances, cloud, and MSP-based deployments."

Simply put, Barracuda's shift from an on-premise player to a hybrid and cloud-based one hasn't gone smoothly at all. Jenkins claims that Barracuda's virtual and cloud business is growing "nearly 40%" annually, but that growth was still offset by weaker demand for its on-premise physical appliances. Barracuda acquired cloud backup firm Intronis last year to accelerate its cloud-based growth, but it might need to make more acquisitions or divestments to speed up that process.

Earnings and valuations
Last quarter, Barracuda's non-GAAP net income rose 25% annually to $4 million, or $0.07 per share, which missed estimates by a penny. Adjusted EBITDA plunged 45% to $10.6 million, while operating expenses jumped 21% to $70 million. Like many other cybersecurity players, Barracuda remains unprofitable on a GAAP-adjusted basis.

Barracuda currently trades at 2.7 times trailing sales. That's much lower than Palo Alto and Imperva's respective P/E ratios of 10.8 and 6.5. Therefore, Barracuda can be considered a "cheaper" stock, but having lower multiples in a sector filled with high-growth companies could make it a less desirable investment. As a smaller player in danger of falling behind the tech curve, Barracuda is also arguably a riskier investment than bigger companies like Palo Alto and Imperva.

Back in February, Bloomberg reported that Barracuda was interested in selling itself. That news helped the stock rebound about 50% from its 52-week low, but the stock remains sharply down for the full year. Bloomberg's sources warned that "the company's struggles may further impede a deal," since "valuation expectations between potential acquirers and Barracuda have widened."

The verdict: Barracuda will sink
Looking ahead, Barracuda will likely be marginalized by bigger cloud-based rivals and larger IT companies, which will result in declines in billings and a loss of subscribers. The company's management seems to realize this, and hopes that its lower overall valuation will attract potential buyers. But if suitors don't emerge, the stock will likely give up its buyout rumor-fueled gains and resume its decline for the rest of the year.