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Success is not final, failure is not fatal: it is the courage to continue that counts.”― Winston S. Churchill
Today, we take a look at a small cybersecurity concern whose stock quickly found Busted IPO after coming public in 2021. The firm does have some intriguing technology and is trying to pull off a turnaround. An analysis follows below.
Seeking Alpha
Company Overview:
Arqit Quantum Inc. (NASDAQ:ARQQ) is a Cayman Islands domiciled, London headquartered cybersecurity concern focused on the marketing of its symmetric key agreement technology, which is designed to ward off an attack from quantum computers. The company’s offerings are provided directly through enterprise licenses to (mostly) government and defense contractors, and more recently through channel partners. Arqit was formed in 2017 and went public in 2021 when it reverse merged into special purpose acquisition company (SPAC) Centricus Acquisition Corp. with its first trade post-merger transacted at $14.01 a share. Its stock trades just under buck a share, translating to an approximate market cap of approximately $120 million.
The company operates on a fiscal year (FY) ending September 30th.
Arqit Technology
Arqit’s raison d’etre is a solution to a multi-decade problem in encryption. Backing up a bit, encryption systems work by scrambling data with the aid of a mathematical algorithm that transforms the data into code. Symmetric encryption employs the same key – a set of random numbers usually 128, 192, or 256 digits long – to encrypt and decrypt data. The key is sent to the sender and receiver of data. Given the truly remarkable size of the random number set involved, advanced encryption {AE} keys are computationally secure and impervious to brute force attacks.
However, there has never been a secure method to create and distribute symmetric keys electronically at mass market scale. The current solution is known as public key infrastructure (PKI), which involves two parties sharing the performance of a calculation that a bad actor using a non-quantum computer can’t solve {HACK} in a practical amount of time. However, this method, because it involves calculations, is vulnerable to attack by quantum computing, with its quasi-infinite calculating ability. As such, making the mathematics behind PKI more difficult is ultimately a futile approach. The only answer is finding a secure method of symmetric encryption key creation and distribution.
Enter Arqit. The company has developed an elegant workaround to the transfer of encryption keys by creating them at the endpoints, meaning the keys cannot be intercepted during delivery. Without getting too into the weeds, the company can deliver replicated entropy (identical sets of random numbers) to data centers hosting its Arqit QuantumCloud system. End point devices that download Arqit’s software agent securely authenticate into QuantumCloud at different data centers, which then moderates a key agreement process by sharing cryptographic information with the end points, allowing them to create a shared symmetric encryption key. The keys can be used inside an AE256 or another symmetric algorithm, engendering easy implementation.
Furthermore, the company’s platform-as-a-service initially required the orbit of quantum satellites and associated ground infrastructure, but owing to software innovation, it can now provide its encryption services terrestrially, somewhat transforming itself from a quantum encryption to a symmetric key agreement concern.
Partly due to its replicated entropy and software agent innovations, Arqit pivoted its business model from selling enterprise licenses to government and defense contractors (amongst others) to securing distribution through channel partners, such as Fortinet (FTNT), Dell (DELL), and Amazon’s (AMZN) AWS, amongst others.
Marketplace
With its universal solution for delivering symmetrical encryption keys that negates the problem-solving power of quantum computing, the market for it should be robust, especially if room-temperature quantum computing can be created at scale. Gartner estimates the total addressable market for information security services at $261.7 billion by YE26.
Arqit competes with fiber-optic based quantum key distribution concerns, which enable two parties to share a random secret key secured by third-party (interloper) detection using quantum mechanics. This approach is expensive and has a range of only ~100 kilometers, meaning its marketing is limited to data centers in metropolitan areas. There are also post-quantum cryptography technologies that aim to extend the security of PKI – the shortcomings of which have already been addressed – as well as legacy technologies, including traditional key management, machine identity management, and manual key distribution. The company believes that its scalable, easy to use, and low-cost offering is superior to anything on the market. However, it becomes a question of whether there is currently a pressing need for this technology.
Performance to FY23 Year-to-Date
Even with the pivot to channel partner distribution, the answer to this question appears to be no, as the company hasn’t generated meaningful revenue. During the first half of FY23, Arqit lost $0.17 a share (GAAP) on revenue of $2.6 million, as compared to a gain of $0.48 a share (GAAP) on revenue of $12.3 million in 1HFY22. However, these top-line figures are misleading (not intentionally) as $2.5 million and $6.9 million (respectively) came from its contract with the European Space Agency in connection with its satellite business. QuantumCloud revenue totaled a mere $19,000 in 1H23, versus $5.3 million in the prior year period.
Since it no longer needs satellites to operate its platform, it is looking to sell its partially constructed quantum orbiter, into which it has invested ~$53 million.
Balance Sheet & Analyst Commentary:
With its extremely depressed stock price, a sale would certainly help the company’s balance sheet, which held cash and equivalents of $41.5 million as of March 31, 2023, providing it a cash runway into calendar 2024. After telling CNBC at the time of the 2021 SPAC merger that, “We don’t need to raise any more money, ever,” Executive Chairman, Founder, & CEO David Williams was forced to eat those words, onboarding net proceeds of $19.6 million from both a direct public offering of stock and warrants at $2 per unit in February 2023 and an ATM facility during the first six months of FY23.
Despite operating in the massive cybersecurity space, the company is only followed by two Street analysts, both of whom lowered price targets after its semi-annual report of May 17, 2023. HC Wainwright reiterated a buy and lowered its price objective from $10 to $6; Deutsche Bank reiterated a hold and trimmed its price target from $3 to $1.50. Total revenue is expected at $9.9 million in FY23, after reaching $23.4 million in FY22.
Verdict:
Save a Hail Mary, Arqit is beset by two headwinds. First, for the present, no one really needs its solution. Despite its shortcomings, PKI operates relatively problem free on the internet and the cloud. It would take a headline-grabbing hack to usher in a mass conversion to the company’s technology. With quantum computing likely years away from becoming a ‘threat’ to commerce and security, there is no pressing impetus to convert. Second, until PKI is successfully hacked – likely a five-bagger event for Arqit – or quantum computers become relatively more ubiquitous, the company’s share price will remain depressed, meaning significant dilution through equity financing as its red bottom line and scant top line will not likely qualify for debt financing. These two issues are further exacerbated by Arqit’s bi-annual reporting, which provides fewer opportunities for the market to potentially get excited about any progress.
Arqit’s stock essentially functions as a LEAP – the equivalent of holding a long-term out of the money call, awaiting a mass conversion event. To be sure, Arqit has seemingly solved the distribution of encryption key problem, and as such has significant upside. The bet here is that a reverse stock split to maintain listing standards will occur before Arqit’s top line generates any momentum. It is one to keep an eye on, but is a pass for now.
It is curious that physical courage should be so common in the world and moral courage so rare.”― Mark Twain
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
