Cyber security looks like it’s going to become a pretty enticing target for newsletter teasers — we all know about the risks of identity theft, online scams, and unauthorized access to your bank accounts and credit cards, and we also know, thanks to the highly publicized fight between Google and the Chinese government (among many others), that the “hacking war” reaches every corner of the globe … so of course, there must be some profit for the security companies who fight the hackers, right?
We were teased about one of these last fall, in an ad that I’ve seen repeated a number of times since — that one was more about military cyber-security, the ad came through teasing us about the “$50 Billion Shadow Syndicate,” and the stock is up quite a bit since that tease … though much of the movement could certainly have come from the newsletter’s pushing.
And now, we get a teaser from the Motley Fool, this time in a “free” report from the Stock Advisor newsletter — and no, it’s not the normal kind of “free” where you just get it and read it and your credit card remains safely in your pocket, it’s “free” as in “we just wouldn’t feel right about giving you this report if we weren’t sure you also got the big picture from us in the monthly newsletter, so you have to subscribe first at $99 a year.”
So that, of course, gets the Gumshoe on the hunt — let’s see if we can identify this stock without having to sign up for anything, shall we?
The clues are not particularly detailed here, I’m afraid, but that’s no reason for an intrepid gumshoe to give up. Here’s what we’re told to set the stage:
“The No. 1 Threat to Your Livelihood
“Everything that matters to you — your life savings, your credit, your kid’s college tuition — can be stolen in the blink of an eye.
“Ignoring this threat is a big mistake. Read on to discover the timely opportunity that protects your wealth and could hand you some truly incredible returns….
“These days you get mugged without ever setting eyes on the hoodlums who did it.
“Crooks rack up charges on your credit card, pilfer from your checking account, or rip off your Social Security number without you even knowing it.
“And they do it by barely lifting a finger… from behind a computer screen a thousand miles away.
“But just because these thieves aren’t as brash as John Dillinger doesn’t mean they aren’t dangerous…
“So who are these dirtbags?
“They’re a shady collection of hackers and grifters called “cyber thieves.” And they can strike anyone, anywhere….
“Last year, cyber thieves stole $260 million from honest, hardworking people like you and me.
“What’s even more shocking is these crooks get away with it!
“Over 95% of cyber thieves never do time. They just walk away with the money.
“It’s enough to make your blood boil!
“But I didn’t write you to fill you with rage…
“I want to tell you how to fill your pockets… full of money made from investing in the one high-tech company the world’s wealthiest banks pay top dollar to stop cyber thieves dead in their tracks.
“And that’s why this is such an incredible investment opportunity for you right now.”
Sounds good, right? One of the more successful ways to market a teaser pick like this is to start with a broad problem that everyone understands, and then quickly skip to the one little company that’s solving the problem. That makes it easy to gloss over the fact that there are also — as in almost any business — hundreds of other companies trying to solve this problem.
Doesn’t mean that the Foolies haven’t picked a good one, of course — they often recommend stocks that I like, and some of their letters have had good long-term performance over the years. This tease is for the flagship Stock Advisor newsletter, which puts brothers Tom and Dave Gardner in competition, with each picking one stock per month. Stock Advisor has been above average, according to Hulbert, for the last one, three, and five year periods (meaning it’s beating most other newsletters handily over those time periods, coming in at least in the top 20 or 30 out of the 200 or so Hulbert-tracked letters, though it looks like the results are also beating the S&P for those periods).
That good performance hasn’t always been the case, of course, and interestingly enough the Fool no longer has a prominent chart on their website detailing the relative performance of their newsletters against the benchmarks — they had been one of the few publishers that was open about overall performance, its too bad to see that go by the wayside.
But there was a point, yes? Right, we’re trying to find out which stock it is that the Gardner boys (they don’t tell us which one) has picked for cyber-security.
Other than telling us that the world’s wealthiest banks are their clients, what else do we learn about this company?
“The company stopping cyber thieves dead in their tracks
“If you recall the story of the famous bank robber Jesse James, you’ll know he was brought to justice by the Pinkertons — an elite private security force hired by the victimized banks.
“Like the Pinkertons, modern banks hire this company to protect them from cyber thieves.
“Its impenetrable, digital barrier surrounds all electronic transactions coming in and out of banks — ensuring that cyber thieves never get the chance to steal your personal information.
“This is not a ‘set and forget’ operation.
“This company has teams of engineers working around the clock to make sure that its financial customers like HSBC, ING Bank, and Wachovia are secure.”
OK, so a bit more “color” on what the company does, and the names of a few clients. Any more?
“Led by a founder-CEO with a large stake in the business, this data security leader is rapidly entering new markets — diversifying beyond its banking customer base, adding 1,480 new customers last year! …
“More than doubling its profits over the past 5 years!
“And this is only the beginning…
“This company’s goal is nothing short of protecting the world from cyber thieves.
“Fortune magazine ranks it among the fastest-growing companies in the world.
“And BusinessWeek calls it a ‘Hot Growth Company.’
“Yet, despite this company’s huge upside, it’s still a small company — unknown to most investors. Meaning right now is the very best time to invest.”
Excellent — that should be some good data for the Thinkolator … and indeed, after tossing it in the hopper we get our response quite quickly: this must be …
Vasco Data Security International (VDSI)
Vasco is indeed largely a banking security company still, though they are diversifying. They started out as a maker of those little security tokens you might get from your bank, with the special code number that changes every few seconds and that you use to access your accounts — but that business was a bit too exciting, with high margins, and too easy to enter, so they got lots of competition for those little high-margin doodads, and about five years ago they started evolving into an online security firm with a broader offering in authentication and digital signature products.
VDSI had a lousy year in 2009, which probably won’t surprise anyone who notices that banks still supply the lion’s share of their revenue … but things did start to turn around in the fourth quarter, it appears, so there’s hope that the worst is behind them. The sales in 2009 dropped for the first time in many years (or maybe ever), and profits, which had flattened out in 2008 as well after several years of near-doubling, fell significantly, with operating income falling by more than 50% in 2009, back down to levels not seen since 2005. Not what you want to see in a high-growth stock, which goes a long way toward explaining their stock chart — the share price got a bit over $40 back in late 2007, before inklings of growth plateauing sent the shares falling, and then actual earnings drops (not just “growth slowing”) and fears of the banking collapse helped drive them further still until they got down to near $3 when pretty much all stocks were in the merde a year ago.
Today things seem to be normalizing a bit for Vasco, and the shares are back up to about $8. Analysts are seeing better things ahead for VDSI, with the expectation that they’ll earn 26 cents in 2010 and 35 cents per share in 2011, so depending on how far down the road you want to look the forward PE is either 30 or 22, not bad if you think that the earnings will really grow 30% in the next year and if you think that growth will continue. Those numbers are from Yahoo Finance’s summary, Morningstar has more optimistic numbers (36 cents in earnings this year on average, from a smaller number of analysts).
I don’t think Vasco gave specific earnings guidance, but in their year-end press release they did say they expect 15-20% sales growth this year and 5-10% operating margins. I don’t know whether to trust those numbers, but unless they’re really trying to “underpromise” that means their margins could easily tighten this year and remain far below the 20% operating margins they enjoyed in the mid-2000s. Fifteen percent sales growth would be strong compared to last year, but likewise would certainly not represent a full recovery to the breakneck growth of a few years ago.
Vasco did add 1,485 new customers in 2009, so that’s within a rounding error of the teaser’s 1,480 — and the vast majority of those customers are in the higher margin non-banking business and “enterprise security” (211 new banking customers, the balance non-banking). Still, the vast majority of their sales — 74% in 2009 — continue to come from banking customers. They describe their banking clients as providing “high volume, lower margin” sales and their non-banking business as “small volume, high margin.”
The company is on Fortune‘s list of the 100 fastest-growing companies (though it’s falling on the list — it was number 41 last year, number 89 this year).
The appeal of a stock like VDSI is that, like most software providers, they have very strong margins — which means that if they do return to a significant level of sales growth, it is easy to imagine the earnings moving up parabolically.
But they do need the sales growth to come back — and there is competition. VDSI has a nice focus on banking that has built up a strong and probably pretty loyal group of financial services customers, but as they continue to move into enterprise security and those tempting high-margin contracts for software the helps to protect corporate networks, and develop new businesses with uncertain business models (ie, will customers pay to protect their transactions online?), they compete with lots of other fish. The cybersecurity space has lots of different businesses, many of which I have no particular understanding of, but security is a focus of not only the direct players in this business, but also the big IT services and hardware firms — small security companies have also been snapped up by folks like Cisco and IBM over the years, and it’s clear that many companies see security spending as a growth driver.
Currently, the sector includes some very big companies like Symantec (SYMC) and Checkpoint Software (CHKP) which are multi-billion dollar firms that are also fighting for growth and, at the moment, are downright cheap based on projected earnings … and probably more stable, given their multibillion dollar market caps. But Vasco is not alone in the small cap space, there are handfuls of smaller companies that are roughly similar in size, companies like SourceFire (FIRE), SonicWall (SNWL), Fortinet (FTNT), Radware (RDWR) and others that flow in and out of investor awareness as they report breakout numbers or come in tragically below estimates.
Vasco has some interesting products and “cloud computing” ideas, like their “Digipass” service that authenticates users across platforms and creates recurring fees, but I certainly can’t tell you whether their products are stronger than competitors — if you’d like some more background, there was a good interview with the CEO back when the market was still in the doldrums last year, and they have a pretty thorough investor presentation on their website.
Of course, the small guys are always where temptation lies — because if VDSI can get a few big contracts the growth will pick up very quickly, and make a large dent in their bottom line thanks to the company’s relatively small market cap (about $300 million). And VDSI does also have something that many investors love to see: an executive founder with a large ownership stake. There hasn’t been any insider buying to speak of over the past year, but founder, Chairman and CEO Ken Hunt still owns about 20% of the company.
I’m guessing Vasco Data Security was Tom Gardner’s pick (as opposed to his brother Dave), but I don’t really know for sure, that’s largely because he has a bit of a history with the stock. Back in December of 2004 Tom called attention to VDSI as a “watch list” idea for his Hidden Gems newsletter, when the price was around $6, so there’s a chance that some of the subscribers to that letter could have caught the impressive move to $40 over the ensuing years … assuming, of course, that they sold before the collapse.
I love the idea of investing in these high-margin security software companies — the pool of business seems like it almost has to increase, given the vulnerabilities we all hear about nearly every day, and growth and high margins are always wonderful to see riding together. I haven’t studied the sector enough to say whether I’d choose a larger and cheaper company like Symantec, or a smaller firm like Vasco Data Security that presumably has more growth potential, but it’s an intriguing sector with a lot of stocks that could, with a jolt of sales growth, go up very, very quickly. If you’ve got a fondness for VDSI, or other favorites in the sector, feel free to let us know with a comment below.
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