Solving RiskHedge’s “Cyber Defense 7-Bagger” Teaser

Stephen McBride ad for Disruption Investor teases that we can "Grab up to 700% Gains as this Company Helps Keep America Safe on the Cyber Frontlines..."

By Travis Johnson, Stock Gumshoe, March 4, 2020

Stephen McBride has been using this ad to market RiskHedge’s Disruption Investor (currently “on sale” for $99/yr) since last Fall, but readers have continued to ask about it and I haven’t had a chance to look at it yet — so when I started seeing it again this week, it seemed like time to dig in (spoiler alert: turns out that the stock is now priced right around where it was when I first saw the ad in October).

The big pitch is that “America is Under Attack” from all corners…

“America is already being bombarded by cyberattacks…

“The government reported 245 attacks against America’s infrastructure in 2016—and cyberattacks have multiplied 4X since then….

“In 2018, 57% of federal agencies admitted they’d been targeted with cyberattacks within the last 12 months…

“And in 2019, “ransomware” became the word of the year as both private businesses and cities across America had their systems shut down with a demand for a payoff to get them running again…

“If we were under this level of attack out in the open, it would feel like World War III.”

And that the increasing government focus on cyber-defense is keeping all of this from panicking us…

“But because we have CYBERCOM—and private cyber contractors—vigilantly defending us from these attacks, you and I get to live our lives as if they’re not happening.

“And yet the threat keeps growing. Along with America’s efforts to defend against it…”

Which leads to profits for a “cyber-defense contractor” …

“A company that saw this disruption coming. And that has been ‘arming up’ in the fight against cyber threats. Ready to step in and assist America’s cyber warriors.

“Just like the government relies on private contractors such as Lockheed Martin, Raytheon, and Northrop Grumman for physical defense systems…

“They’re turning to this private contractor for help with cyber defense, too. And that means the company I want to share with you today is well-positioned to carve off a huge chunk of that $80 billion spending windfall.”

What’s this $80 billion business? More from the ad:

“America is doubling-down on cyber defense— and that’s huge news for investors…

“The Federal government currently spends about $15 billion per year on cybersecurity.

“But this growing cyber threat has disrupted the entire national security picture. So the Trump administration is making an unprecedented move.

“They just authorized $80 billion in extra spending to improve the government’s computers and cybersecurity capabilities.

“That’s more than 5X the regular annual budget.”

I don’t know whether there will be an immediate $80 billion “windfall,” but the latest budget proposal from the White House did include a 5% increase for cybersecurity spending, boosting that total to a little over $17 billion in FY 2020 (with more than half of that for the Departments of Defense and Homeland Security).

Getting too focused on the details of “government spending” is probably a mistake, if that “5X” number is based on anything real it’s at least misleading… the Federal Government has spent well over $80 billion a year on “IT” for a decade or more, and that’s certainly not doubling or increasing by 5X next year, nor is cybersecurity spending growing by 5X next year or in the next few years… but cybersecurity spending is growing, both in the private and public sectors, and the government spends a lot on technology and is pretty slow to stop spending money, so being a big seller to the government usually makes your income statement fairly stable.

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And, of course, the Federal Government is huge and complicated, and has been hugely challenged when it comes to finding enough employees (or effective leadership) for its cybersecurity efforts. I don’t know a lot about the internal workings of the government in this area, but this Politico piece about Trump, cybersecurity spending, and the troubles DHS has had focusing on cybersecurity when everyone wants to talk only about immigration and borders, is an interesting read.

But, of course, the reason we’re being pitched this idea is that there’s “one stock” that Disruption Investor can reveal to you, ready to bring you 700% gains because of this trend — here’s how the ad puts it:

“And I believe if you make one investment move today, you can collect up to 700% gains—or more—from the company helping America’s cyber warriors protect us on the front lines of cyberspace….”

“I’ll share the only stock you need to buy today to profit as cyber disrupts defense…”

So that’s what we’re going to try to ID for you, naturally. What other clues do we get about this investment? More from McBride:

“As I dug into cyber’s disruption of the defense market, one company’s name kept coming up in my research.

“And no, it wasn’t the traditional defense contractors. Not Lockheed Martin, Raytheon, Northrop Grumman, or so many of the others that still get the majority of their revenue through traditional defense equipment and support.

“Sure, some of these companies have meddled in cyber. But there’s one company alone that’s dedicated itself to military-grade cyber defense—and become the clear market leader.”

OK, so we’ve got a leading government contractor. What else?

“… it focused the entire company around becoming the US government’s top choice for cyber BEFORE the commands came down from Washington to make it a priority.

“Which has given it a huge head start and lead over competitors, competing not just for the $15 billion in annual cyber spending, but the $80 billion just approved by the Trump White House.

“Which is huge for a company with annual revenues currently around $6 billion per year.”

Other hints?

“It has scored almost 4,800 federal contracts in the last few years.

“And it typically wins 8 out of every 10 contracts it competes for….

“Although it doesn’t turn away its Fortune 100 and Global 200 clients, it collects 97% of its revenue from the US government.”

And we get some comparisons to traditional defense contractors:

“Consider Lockheed Martin. Since 2000, it delivered investors a 3,376% gain.

“Over roughly this same time period, this cyber defense leader has actually grown its revenue 3.5X faster than Lockheed Martin…

“And importantly, it’s converting higher sales into bigger profits. It paired its record revenue with record profits last year.”

And apparently they had a good year last year (remember, this ad has been circulating since at least October, and it has not been updated)… more from the ad:

“Business is SO good it actually has a $20 billion backlog of contracts to fulfill. That’s basically three years’ worth of its current revenue, guaranteed….

“In the first six months of the year, its stock already climbed 51%—as just a taste of what’s coming…

“And yet—it’s NOT too late for you to get in.”

A $20 billion backlog isn’t enough to guarantee success in any endeavor, of course — it matters how much it costs you to fulfill that backlog of contracts, as McDermott International found out when it filed for bankruptcy despite a similar-sized backlog (though, to be fair, they’re in the energy business and their contracts come not from the pretty-steady Feds, but from oil and gas companies that are suffering).

But anyway, that’s the tease… what’s the answer?

Thinkolator sez this is Science Applications International Corp (SAIC), which was one of the huge IPOs of the mid-2000s (2006, I think) when it went from being a longtime employee-owned and science-focused government contractor to a public company. It later split, with the broader government contracting services part of the business changing its name to Leidos (LDOS) in 2013 and aiming to build on their defense business and also expand to include non-government work, while SAIC was split off from the larger firm and kept the historic name and the government IT focus. SAIC is still really a focused IT-services contractor, almost entirely for the Federal Government (and pretty much US-only, despite the “International” in its name), and its shares have done reasonably well, slightly beating the S&P 500 (LDOS has done better, thanks to a big surge in 2019). Here’s how they describe themselves to investors:

“Science Applications International Corporation (SAIC) is a premier technology integrator solving our nation’s most complex modernization and readiness challenges. Our robust portfolio of offerings across the defense, space, civilian, and intelligence markets includes high-end solutions in engineering, IT, and mission solutions. Using our expertise and understanding of existing and emerging technologies, we integrate the best components from our own portfolio and our partner ecosystem to deliver innovative, effective, and efficient solutions.

“SAIC is a large, market leading service provider to the U.S government with approximately $6.5B in annual revenues, strategically aligned to areas of national importance and increased customer investment. With a stable, recurring revenue base, significant margin expansion opportunities and strong free cash flow generation, SAIC has a history of disciplined capital deployment for shareholder value creation through a balanced mix of dividends, share repurchases, and acquisitions.”

And the big news this year, which came out well after McBride’s ad, is that SAIC is buying another one of its competitors — they are acquiring Unisys Federal, which does a lot of the same things SAIC does but is smaller and has been growing faster and, partly because the acquisition is being done with cash and debt, not stock, it will be immediately accretive to earnings (that just means earnings per share will grow as a result of the deal — by 6-8% in the first year and 10-12% the second year, they think).

I like the acquisition, the government seems always to have the need to spend heavily on technology modernization even if cybersecurity is not always specifically the top priority, and this will help boost their business using cheap debt… so that’s hard to argue with, and given the prevailing sentiment that deficits don’t matter and nobody in government has to be fiscally conservative it seems unlikely that we’ll have a serious showdown in Congress anytime soon that leads to major cuts in government spending.

So that’s probably the largest risk, as is the case for all government contractors — they could either face a big drop in government spending if Congress cuts the budget, or they could lose a major contract or two to competitors. My perception is that this is a fairly low risk at the moment, but you never know when the tide will shift in DC… I lived there through several government shutdowns, and certainly I knew folks who were government contractors in those days who thought they might have to find a new career.

COVID-19 and the spread of the coronavirus shouldn’t have any real impact on SAIC, but, of course, that doesn’t mean panics about coronavirus won’t impact the stock — when the market fell last week, SAIC fell right along with it, so the stock is now down 10% or so from those February highs… but it’s not a stock that’s obviously cheap, and it was at all-time highs just a couple weeks ago. Revenue is variable, it has moved up over the past five years but hasn’t moved in a straight line — some years it has been nearly flat or down a little, some years up by 10-12%, and profit growth has been similarly lumpy… but if you go by their adjusted EPS, the valuation looks pretty rosy right now.

SAIC is expected to have earned $5.44 per share in its just-completed year (their fiscal year ends in January, so they won’t report until late March), so if that forecast holds (they usually post a small “beat,” like everyone else), that would mean you’re paying about 16X trailing earnings for SAIC shares… and with the boost to growth from the acquisition in 2021 (their FY21 has already started) you’re looking at a forward PE of under 14 using those adjusted numbers (the GAAP PE is much higher, of course, since it doesn’t incorporate employee stock compensation or other “smoothing,” but analysts and investors have pretty persistently been happy to accept “adjusted” earnings numbers).

And that valuation is pretty compelling, frankly. They’re not going to have an $80 billion boost to revenues anytime soon, but they have been buying up other companies to get scale in their government IT business (and to better compete with their former partners at Leidos), and that might continue to work out well — the Engility acquisition wasn’t initially beloved by investors, and was largely a stock deal, but this Unisys acquisition is both smaller and probably more immediately positive (and they might have gotten a better deal, since Unisys was in some serious “too much debt” trouble and really needed to sell some of their businesses to raise money).

Assuming the deal goes through (the presentation about it is here), I’m inclined to think this is a decent idea — and they might even announce a dividend increase when they report their earnings on March 27 (the dividend is smallish at 1.8%, but they did increase it a year ago), so I’ll keep thinking about this one a bit… they won’t be the only cyberdefense contractor for the government, but they do have a decent backlog of government IT work in general, and government spending in all the key tech areas is projected to keep growing at well over the rate of inflation, so there’s probably a decent tailwind for the business absent a major Washington shakeup that results in spending cuts.

But that’s just my opinion, and I don’t own shares of SAIC or have a burning urge to buy them immediately… so since it’s your money, you’ll have to make your own call… think this is a compelling cybersecurity play for government spending largesse? Have other government contractors or cybersecurity businesses you prefer? Let us know with a comment below.

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vivian lewis
March 4, 2020 4:12 pm

rats. I thought it was Boeing