Arqit Quantum: Pioneering A New Security Standard

In the realm of cybersecurity, there's one little-known stock that has been making waves with its groundbreaking approach to encryption: Arqit Quantum (NASDAQ: ARQQ). The company has the potential to redefine encryption standards and secure digital communications. For investors, I also believe there's a strong chance of the brand to secure further large contracts from governments and corporations, which would put it on a solid growth trajectory. So let's decrypt the potential of this promising upstart in the cybersecurity industry.

Overview of Arqit Quantum

Arqit Quantum specializes in quantum encryption, which could be fortuitous timing as the world is increasingly threatened by cyber-attacks and automated threat actors. The development of quantum computing is a serious threat to communications networks worldwide. The brand's core offering is its QuantumCloud platform that allows customers to generate quantum encryption keys that will severely mitigate the security risks of quantum computers. Arqit's solution differs greatly from the traditional Public Key Infrastructure (PKI) standards, which further strengthen modern encryption methods. In recent times, Arqit made headlines due to its plans for launching quantum encryption satellites, along with its joint venture partner Virgin Orbit. It should be noted that Arqit has since revised its strategy, as it will no longer operate its own satellites, but instead sell licenses to use its quantum satellite quantum technology. This initiative would allow for a space-based encryption solution, and give it a key differentiation when compared with other quantum-based encryption providers. Arqit notes that there's a niche application of using satellites for securing communications for militaries around the world. There's also evidence Arqit has already begun to foster long-term relationships with governments and large, blue chip clients. It launched its Federated Quantum System (FQS) and started a partnership with Fortinet (FTNT). My thesis is partially predicated on these initiatives for driving new contracts, which would potentially unlock the growth of the company.

Arqit's Quantum Technology and Operations

The key to understanding Arqit's potential is also to appreciate the potential of quantum computing. When this technology is fully harnessed and realized, it's expected to be disruptive for our society in ways we can only imagine today. But one of the most crucial aspects from a security standpoint is that many algorithms we use can potentially be broken via brute force using a powerful quantum computer. These include algorithms such as Rivest-Shamir-Adleman (RSA) and Elliptic Curve Cryptography (ECC). Both security standards are ubiquitous throughout the technology landscape, with RSA being used to secure email services and the Secure Sockets Layer (SSL) that secures websites with HTTPS. ECC, on the other hand, is responsible for encrypting applications that range from mobile applications to cryptocurrencies. Intelligence agencies such as the NSA are keenly aware of the risks that quantum computers have to these security standards, and have since moved to quantum-resistant alternatives. Still, the attack surface that remains is enormous, with a quantum computer having the potential to decrypt algorithms that consumers use in their everyday lives from e-commerce to banking that keep their information and identities safe. Governments are also concerned with the ability for quantum algorithms to decrypt sensitive military communications, as well as systems maintained by intelligence agencies. To help offset these risks, Arqit allows users to generate a set of private and public keys that are immune, in theory, to computational attacks, including those that would otherwise be broken via brute force from a quantum computer. Along with future-proofing part of a large organization's security, its QuantumCloud platforms help to simplify the storage and management of those keys in a secure environment. The ease of use and deployment, along with the systemic importance that encryption has to protecting users information gives Arqit in my opinion a strong operational edge, and as these customers will be looking for a robust solution that's also easy to manage and integrate.

The Federated Quantum System (FQS)

Arqit's Federated Quantum System is the other half of how I believe the brand will successfully attract governments and large businesses to use their solutions. It consists of international organizations, and was notably unveiled at the G7 Leaders Conference in Cornwall. This is a significant development, as countries such as The United Kingdom, USA, Japan, Canada, Italy, Belgium, and Austria are presently represented in the FQS, reflecting much of Arqit's target markets already. The company is working closely with its consortium members to tailor solutions to their specific security requirements. Furthermore, its innovative solution of using satellites to distribute quantum keys to data centers effectively solves the "Global versus Trustless" problem, and has since patented it under the name of ARQ19.

Arqit's approach

Arqit is exploring a unique approach to quantum encryption that I feel will give it an enduring edge in the market to secure contracts with customers in its target market. In December last year, Arqit unveiled that it had shifted its focus from using satellites to using a terrestrial distribution method, despite its satellite encryption technology still being licensed and sold to satellite operators. Here's why I believe this was the right approach. First of all, the costs and complexities of launching a satellite distribution network are immense. Launching and maintaining a satellite network involves significant spending in capex, recurring operational costs, as well as technical challenges that introduce additional uncertainties into its business model. As a tech start up that specializes in quantum encryption, plans for operating such a network might have been too ambitious for its time, as there's a wide chasm between that and taking on industry traits of aerospace. To give a ballpark figure, the cost of launching a single small satellite can range from $10,000 to $40,000 per kilogram, depending on the launch provider and the specifics of the mission. A small satellite, weighing around 500 kilograms, could therefore cost upwards of $20 million just to launch. This doesn't even account for the manufacturing costs of the satellite itself, which can easily exceed the launch costs, especially for sophisticated communications satellites. Then there's the ongoing operational expenses, technical complexities, and regulatory hurdles, which all detract from the company's core focus of encrypting communication networks for its clients. Furthermore, being able to license its quantum satellite technology to companies that actually specialize in maintaining satellite networks keeps its in its competitive swim lane, and allows it to focus on what it does best. With this in mind, I applaud the strategic decision to move away from maintaining satellites, while still retaining the ability to sell quantum satellite encryption technology to the key industries of defense and intelligence.

SPAC funding

Arqit Quantum raised $400 million via a Special Purposes Acquisition Company (SPAC) deal that unfolded in 2021. The deal would imply that it had a valuation of around $1.4 billion and raised $400 million. After the deal finished, however, its valuation rose to $4.5 billion. This allowed the company to do two things in a relatively short period of time: Quickly raise funds while also expediting the process of creating a publicly-traded company, compared with launching an IPO. The deal had its downsides, however, as it caught the attention of the SEC, and overall highlights some of the risks involved with SPAC deals in general. At the time of writing the probe into the deal is still pending and there have been no further updates since last year. The SEC is in a fact-finding phase at the time of writing.

Financials

As a very early stage startup company, it's hard to make logical comparisons and analysis based on its financials due to a lack of trends and reportable information. However, there are a few useful observations we can make about the company's current financial health. The first is that it had an incredible run of revenue growth in 2022, with revenues surging 14953.22% from the previous year. However, as natural for a tech stock, its free cash flow is currently negative at $51,348,000.00.

The company's significant investment in intangible assets, such as patents and intellectual property, could provide a significant opportunity for future growth and revenue generation. However, the company's heavy reliance on debt financing could pose a risk if the company is unable to generate sufficient cash flow to service its debt obligations, which could limit its ability to invest in future growth opportunities. Still, it remains in a healthy financial position with a current ratio of 2.37 and a debt ratio of just 0.36 at the time of writing.

Valuation

The valuation ratios of Arqit are one of the company's strongest draw cards, with the company trading at a significant discount in terms of its earnings. The company's P/E is just 1.05 at the time of writing, while the industry stands at 36.78.

I believe a large part of the reason why Arqit trades at such a large discount to its peers is due to the speculative and technical nature of its solutions. Using satellites to help its clients secure their infrastructures is an innovative solution that the market may find hard to draw comparisons to and estimate how successful such a venture might be. The fact that it trades at a premium on per-sale basis, on the other hand, may be chalked up to the fact that it's still in its very early stages of development. We may have a better idea of how the stock will perform as a company once it has onboarded some of its key clients.

Risks

While Arqit Quantum does, in my opinion, have its upside skewed to the positive, there are some risks that investors must pay attention to. The first is that Arqit faced an investigation by the SEC over its SPAC merger. This shows there are some regulatory risks here that may meaningfully impact the stock, and that investigations that reveal non-compliance or irregularities could lead to future penalties and fines. The second is that Arqit faces steep technology risks and market adoption risks. Its solution, while innovative and solid in theory, is still susceptible to failure if it doesn't perform as expected or if adoption is slower than forecasted, which could negatively impact its growth prospects.

Conclusion

Arqit is a buy due to its innovative and fascinating approach to secure sensitive digital communications, which is a problem currently being faced by many large commercial organizations and governments around the world. Quantum mitigation is something I foresee that will appear on the roadmaps of many executives as time moves forward, and innovative companies like Arqit that develop their solutions early will be the ones that benefit from the rising demand for these services. The company is undervalued in comparison to its earnings, and getting a few key clients under its belt will likely attract new ones. As a high-risk moonshot with a strong possibility of working out, I feel this is a great opportunity for investors.