Qualys Maintains Status as High-Quality Vendor for Vulnerability Management Solutions

Equity Analyst

Malik Ahmed Khan

Associate Equity Analyst

Jivyaa Vaidya

We view Qualys as a strong cybersecurity vendor focused on providing cloud-based security and compliance solutions to its clients. The firm’s primary solutions revolve around vulnerability management, or VM, and are designed to help clients identify and mitigate vulnerabilities in their IT infrastructure. We view VM as a space poised for high-single-digit growth over the next few years, thereby providing Qualys with an additional uplift as demand for its products is expected to remain robust. We believe the company has built a narrow economic moat by developing a sticky product portfolio.

We believe Qualys is well positioned to serve a variety of cybersecurity needs for its small and medium business-leaning customer base. The firm’s cybersecurity capabilities range from VM to compliance-related security solutions. We believe this breadth of offerings can provide Qualys with further revenue expansion opportunities in its installed base and help entrench its solutions in a client’s IT stack.

While we are positive about Qualys’ growth and margin expansion opportunities, the firm operates in a tough competitive landscape. Qualys competes with larger, more capitalized vendors such as CrowdStrike and Palo Alto Networks as well as smaller private players like Axonius and Flexera. Despite the competition, we are impressed by Qualys’ ability to produce solid retention metrics, showing the stickiness of its customer base.

Overall, we believe Qualys’ strategy of developing a variety of cybersecurity solutions is a sound one as it allows the firm to upsell existing clients while improving its sales motion with newer customers. While the competitive landscape seems daunting, we think Qualys’ sticky product portfolio, combined with its years of cybersecurity expertise, can help the firm navigate this landscape and produce solid shareholder returns in the process.

Business Strategy & Outlook

We assign Qualys a narrow economic moat rating owing primarily to strong switching costs associated with its security and compliance solutions. We believe these switching costs are evidenced by Qualys’ strong gross and net revenue retention metrics. While competitive threats are on the horizon as Qualys’ platform goes into competition with larger competitors such as CrowdStrike and Palo Alto Networks, we believe the firm is more likely than not to generate excess returns over invested capital over the next decade.

Qualys offers a wide array of cybersecurity solutions, but the core business is built around its expertise in vulnerability management. VM involves regularly scanning systems and applications for vulnerabilities, assessing the severity of those vulnerabilities, and developing and implementing strategies to mitigate them. We view this space as conducive to economic moats as customers exhibit loss aversion when it comes to IT security, as there is an operational risk when switching VM vendors, including loss of analytics during the changeover, project execution, and operational disruption. 

Qualys also offers a range of non-VM security solutions. With capabilities ranging from threat detection to compliance-related security solutions, we believe that Qualys’ multisolution approach also increases its customer switching costs. In particular, we’d highlight compliance-related solutions as having high switching costs. A compliance vendor is responsible for ensuring that a business’ IT activity is compliant with either internal or external controls. A period of noncompliance can bear a heavy cost on the customer in terms of reputation damage or customer distrust. As a result, we believe the risk/reward payoff of switching compliance vendors is asymmetric, as any issues in the handover from one vendor to another could lead the firm to be noncompliant. 

Despite our confidence in Qualys’ ability to outearn its cost of capital over the next decade, we’d highlight one area of weakness in the firm’s competitive positioning. Qualys’ customer base skews more toward small and medium businesses. Generally, in the software space, we view SMB spending as more cyclical and prone to churn as SMBs either rein in spending during lean times or simply go out of business.

While Qualys’ gross retention of 90% is lower than other enterprise-heavy names in our coverage, it is by no means below par. A vendor with a 90% gross retention has an average customer lifetime of 10 years, quite high for a firm that derives the vast majority of its revenue from SMB customers. Additionally, by maintaining a net retention around 110% over time, Qualys has demonstrated its ability to expand sales from existing customers thereby entrenching itself more deeply in its customers’ IT infrastructure. 

We also believe there are secular drivers that could aid Qualys in the adoption of its solutions. With the cost of cybersecurity failures only going up, we believe Qualys’ VM solutions offer value to customers by highlighting areas of weakness within their IT infrastructures before nefarious actors exploit them.

We believe Qualys’ business exhibits strong switching costs, as evidenced by its retention metrics. These high switching costs, in our opinion, have allowed the firm to consistently out-earn its cost of capital. We believe this trend will likely continue and Qualys’ returns on invested capital will likely exceed its cost of capital over the next decade.

Narrow

Economic Moat

Qualys

Qualys, Inc. engages in the provision of cloud security and compliance solutions. Its products enable organizations to identify security risks to information technology infrastructures, help protect information technology systems and applications from cyber attacks, and achieve compliance with internal policies and external regulations. The firm also offers solutions through a software-as-a-service model, primarily with renewable annual subscriptions. The company was founded on December 30, 1999 and is headquartered in Foster City, CA.

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