On the Road: Magnet Forensics

In this issue of Perspectives, we want to highlight an excellent example of how deep research coupled with patience and a long-term horizon allows for superior investment performance. In the case of Magnet Forensics (“MAGT”), this philosophy enabled us to take advantage of a significant market dislocation when most other investors were too scared to act.

The Company

Magnet Forensics, based in Waterloo, Ontario, is a global cyber security software company that provides digital forensics solutions to public law enforcement agencies and private enterprises. The company was founded in 2011 by Jad Saliba and Adam Belsher, a former VP at BlackBerry. Saliba, who previously in his career was a frontline police officer and digital forensics specialist, had realized that the tools police agencies had at their disposal were insufficient to investigate cyber-related crimes. As a result, many forensic labs were overwhelmed. His solution? Innovation.

Together, Saliba and Belsher grew Magnet to over $80m in annual recurring revenue, with over 4,500 accounts globally. Today, the company is still growing by over 40% year-over-year, while generating industry-leading 93% gross margins and normalized free cash flow margins between 20 and 40%. Such a performance is remarkable for a company of that size, with that level of growth. This is a testament to founder-led companies, with leaders who have skin in the game and a long-term horizon.

Magnet is now the world’s foremost digital forensics platform. It is a must-have mission-critical platform for police departments and law enforcement agencies around the world. The company’s penetration into private enterprises is also proving highly fruitful.

The Context

Magnet generates high profitability because it faces little competition, as replicating the technology would take many, many years, and a lot of capital. Magnet also has an advantage when acquiring new customers due to its reputation in the world of law enforcement. It is “the go-to platform”, as one customer puts it. Moreover, switching costs are high and churn is low. Thus, the cost of stealing share from Magnet for a new entrant or would-be competitor is prohibitive.

We were fortunate to have acquired a small position in Magnet at $17 per share during its oversubscribed Initial Public Offering (IPO) in April 2021. In the following four months, Magnet’s stock was caught up in the tech bubble with institutional and retail traders piling into the name with hopes of selling to the greater fool. The stock shot up to $65 and traded at a whopping 154x EBITDA (earnings before interest, taxes, depreciation and amortization). Then the bubble burst and the stock fell to $24.

The Investment Opportunity

Over this time, we continued to carry out research on the company, the industry and competition, and met with Belsher and his team multiple times. We developed strong conviction in the business model. At $24, we thought the share price started to offer an attractive risk-adjusted return, so we added more to our position in February 2022.

Then, as the market’s inflation and interest rate concerns continued to worsen, the stock fell another 45% (along with most high-growth stocks), to a low of $15 per share in June 2022. Given Magnet’s strong competitive positioning, profitability, balance sheet and growth runway, we decided to double our ownership at about $17.

All our knowledge and analysis of the company pointed to a large margin of safety in terms of valuation and business quality. The future return structure of the stock was heavily skewed to the upside. In other words, there was a low probability of permanent capital impairment, and a high probability of making a lot of money.

We were right.

After twelve successful years, Magnet announced on January 1, 2023, that it entered into a definitive agreement to be acquired for $1.8 billion by Thoma Bravo, a global private equity juggernaut with a focus on high-quality high-growth software companies. The proposed acquisition price of $44.25 per share represents a return of 160% on Magnet’s $17 per share IPO in April 2021. Since the acquisition price was fair for the business, we sold our position.