What are Keith Fitz-Gerald’s “Cyber Military Complex” Picks?

by xiexgp | August 10, 2012 3:56 pm

Friday File look at three teaser stocks in cyber security from Fitz-Gerald's Strike Force

Some pondering was going on as I figured out what to write to you about this week for our Friday File[1] — there’ve been some developments at a handful of the companies that I follow or own, but most of the news has been fairly standard quarterly releases that didn’t shake the trees very much here on Gumshoe Mountain. But really, almost all of you are here to hear about teaser picks, and more folks have been asking about Keith Fitz-Gerald[2]’s cyber security teaser than anything else this week, so we’ll focus on that for our Friday edutainment.

Fitz-Gerald is trying to get folks signed up for his Strike Force newsletter, another in a long string of investment newsletters that use military terms to make subscribers feel extra cool. He’s teasing the idea of cyber security as a huge new growth industry, which is certainly a reasonable theme, and then goes on (of course) to tell us that he’s got a few favorite picks that he thinks will do even better than the sector as a whole.

Here’s how he whets our appetite:

“It’s been overlooked, neglected, misunderstood, even spurned…

“Yet It’s the Only Thing Standing Between Civilization and Chaos…

“It’s projected to grow up to 408% faster than any other industry tracked by the Bureau of Economic Analysis.

“And now it’s about to bust out….”

And the basic argument for the sector is laid out in the first couple lines of the ad:

“If you could personally design the safest, most lucrative place imaginable to make money, what would it look like?

“For me, it’s a no-brainer. It would be an industry that is:

• So vast that its products and services it provides are DEMANDED by every other business in the world…
• Growing exponentially with no end in sight…
• Instead of being made obsolete by new technologies… it would actually become more valuable and more in-demand with every new advance in technology…
• It would be stimulated – rather than spooked – by political and economic chaos…
• And it would have literal life-or-death importance to every person on the planet….
• It would be an industry engorged by the free-spenders in Washington, with billions pouring in.”

He also takes credit for recommending a hugely successful mobile security stock to his subscribers several months ago — which is true, at least as far as I can tell, he did tease NetQin as a mobile security play late last year[3], before they changed their name to NQ Mobile (NQ), and it was very likely a successful pick for his subscribers (the stock went from about $5 to $12 or so, though it has since fallen back to about $7). Not sure if he’s still recommending NQ, at the time he said the “worst case” was $50 in “a couple years” but he thought it would be “one of the biggest hockey stick winners you’ll ever see” and get to $300 a share when their software is installed in the lion’s share of 50 billion mobile devices (yes, in that he’s including the massive number of interconnected devices — like vending machines and pay terminals, not just the actual phones).

He says the industry’s top plays are already beating the market, and that he thinks the gains will exceed the huge gains that early investors in cell phone companies enjoyed. So what stocks are being pitched now as cyber security plays? He teases three of them, let’s have a look at the clues.

“I’ve discovered a company that’s positioned itself as one of only a few that specializes in security for devices using the Android platform.

“Now, while Apple’s iPhone grabs all the headlines, here is the truth of the matter:

“Android is the world’s most widely used smart phone platform….

“87% of U.S. smart phone users surveyed say they have something on their phone they want to keep private.

“But only 4% of smart phones and tablet computers shipped in 2010 had any form of mobile security downloaded and installed.

“This company is the ONLY pure play in the mobile security market worth talking about.

“This is the new Strike Force play I’m so excited to tell you about. And we’re among the very few who know about this.

“Plus, the timing couldn’t possibly be better. The company is supercharging its position as THE leader in mobile security on many fronts…

• Q1/2012 the company reported record net revenue: an increase of 109.6% year-over-year.
• At $16.0 million per quarter, the company is on pace for $64 million of revenue in 2012, which would represent a 57% increase over 2011.
• It has secured an agreement to pre-install its security on all Motorola Android smart phones in China[4].
• It has formed an alliance to offer a seamless mobile payment option to more than 200 million subscribers across 8 markets.
• It has struck three separate agreements to have its security solutions sold by more than 65,000 resellers and retail locations across the U.S.

Huh. Well, I guess he does still like NQ Mobile (NQ) … because that’s where those clues lead us. NQ did indeed have 109.6% growth year over year in their last quarter, ana analysts think they’ll do much better than $64 million (estimates are for revenue of $83 million this year, $132 million next year). They are a Chinese company with primarily Chinese customers right now, offering mobile productivity and security software for phones, but they are trying to expand quite aggressively, particularly within the large Android smartphone market.

Pretty much all small Chinese stocks trade at a hefty discount for a variety of reasons (opacity and feared fraud being among the top), but NQ is still pretty cheap for a growing and profitable company — analysts have been raising their earnings targets and the company trades for just about 12 times expected 2012 earnings and 7X 2013 estimates. I don’t know whether or not their accounting and books are clean and trustworthy, both reasons why I’ve essentially avoided all Chinese companies for the last year or so, but I don’t think there have been significant accusations. If you’d like an explanation of the company’s business and where they think they are, a good place to start is the transcript of their last quarterly conference call[5]. They now have about 200 million users, and they rely on the popular “freemium” model — free downloads of security software that helps prevent malware, with a better “premium” version available for purchase as a subscription upgrade that updates frequently for new attacks and offers additional services. Some of their apps are available on the iPhone, but they have been primarily focused on Android smart phones.

Two more to go, so we’ll keep moving along …

“Strike Force Cyber Play #2

“If you’ve been to Europe or Asia[6], you’ve probably already seen “smart cards.” They’re high-tech alternatives to the magnetic-strip credit card in your wallet right now.

“The difference is, smart cards use encryption and authentication technology that is more secure than their magnetic-strip grandparents.

“Currently, the United States is lagging the rest of the world in the adoption of smart card payments. But that won’t last long.

“My next Strike Force Cyber Play is perfectly poised to capitalize on this inevitable change in a BIG way. In fact…

• It has a client list including e-brokerage, e-banking, e-commerce, e-government, healthcare[7], automotive, social security, publishing, education, and online gaming. This company is the #1 worldwide provider of authentication and electronic and digital signatures.
• It’s had 36 consecutive profitable quarters allowing it to finance its organic growth and acquisitions.
• Total authentication market is estimated to be $1.36 trillion by 2016 (which represents a 9.06% compound annual growth rate from 2010 to 2016).
• This company reported a dominant 39% market share in 2011. The next two competitors only controlled 17% and 15% of market share.
• Its stock is currently trading at less than $10. And with a market cap of just $358 million, there is plenty of room to grow. With a PEG ratio of 1.58, it is dirt cheap.
• Because of the widespread consolidation in the CMC, this company should be considered as takeover/buyout candidate.
• Because it has no long-term debt and is sitting on a mountain of cash, investors are actually getting around 35% of their shares in cash, and are only paying around 65% for ongoing operations (based on the current price).
• The company finished 2011 with revenue up 56%, operating income up 100%, and net income up 124%.

Toss all that into the Thinkolator, and we learn that this is Vasco Data Security (VDSI), which I don’t think I’ve written about since the Motley Fool[8] teased it back in 2010. The stock isn’t far now from where it was then, it was beaten down a bit because most of their customers were banks and other financial services companies and it recovered a bit last year but has since fallen back a bit. It’s a small company that’s growing at a decent but not overwhelming clip, though they say that the first half of this year was their best ever in terms of orders, so it may be that they’re at an inflection point — a PEG ratio of 1.58, as Fitz-Gerald teases it, is not “dirt cheap” in my book, though it is perhaps reasonable, and it’s still near that number (it’s actually 1.7 now, though the PEG ratio is not exactly a number where small differences are significant — it’s really just a signpost that indicates whether a stock may be discounted relative to its growth rate).

Vasco is an authentication company — what they’re known for are those little keyfobs and smart cards that offer one-time passwords when you press a button, though they offer a variety of both physical and digital authentication products and e-signature technologies. Earnings are expected to be lower this year than a year ago, which is one reason the stock is still down below $10, but they have been consistently profitable even though they haven’t exactly been a nosebleed grower, and they are saying good things about their order pipeline, which still relies pretty heavily on banking customers who continue to be willing to invest in moving customers to online banking as a cost saving measure (even if they have to buy little keyfobs for customers, it’s a heckuva lot cheaper than opening branches) … it will be interesting to see if their new consumer-focused product, MyDigiPass for secure online logins, gets any traction — that is a complicated and tough to enter market where there are already dozens of different multi-site login technologies and a confusing array of security options[9] available, so I’m not sure what MyDigiPass will offer that might catch consumers’ or website owners’ attention.

So … it’s hard to see VDSI taking off dramatically unless they get a buyout offer (they’re still small, under $400 million market cap, so a buyout by a larger security firm would be easy), but they are consistently profitable, they do have loads of cash (more than $2 a share), and they will probably grow earnings at a decent rate (analysts are saying they’ll boost earnings 20% next year, which would get them back above 2010 earnings). Maybe not exciting, and they may not break out of their financial services authentication niche to really grow dramatically, but I suspect we could do worse. Keith Fitz-Gerald lays out a good dose of optimism that includes VDSI profiting from the switch to the “mobile wallet” (that’s the “cellphone as wallet” stuff — near field communications, which has been teased many times[10]) and he sees 527% profits ahead for VDSI, so there is some potential sexiness lurking under the covers … it’s just that it might require a bit of a leap of faith on your part that they will break out with new profitable business lines in cloud security and/or mobile payment security, since my impression is that it’s still quite early days for VDSI in those areas.

Next?

“I expect an 826% gain on the Mossad of the CMC

“Strike Force Cyber Play #3

“The Institute for Intelligence and Special Operations, otherwise known as the Mossad, has been appointed by the State of Israel[11] to collect information, analyze intelligence, and perform special covert operations. Its reputation for ruthlessness, cunning and efficiency is known throughout the world.

“So it should come as no surprise that some of the most advanced players in the emerging CMC industry are headquartered in Israel….

“One in particular already provides proven Internet technology to more than 150 security companies and service providers, including 1&1, Check Point, F-Secure, Google, Microsoft, McAfee, Net Gear, Panda Security, Rackspace[12], U.S. Internet, WatchGuard and Webroot.

“It specializes in providing cloud-based Internet security for companies that then offer Internet security to end-user customers.

“Because this requires a massive cloud infrastructure, most companies cannot compete in this arena.

“But this company already has the majority of that infrastructure in place. So it simply sells its existing, safe, robust, and reliable infrastructure to others.

“So far, the company has only tapped about 25% of its target market. That means enormous expansion opportunity could lie ahead.

“And that’s not the only reason I like this rocket rider.

• From 2006 to 2011, the company experienced average annual revenue growth of 36.5%.
• As of March 31, 2012, the company reported $22.04 million in cash and no long-term debt.
• The company’s market cap is only $61.26 million, which means in addition to incredible upside potential, its cash represents over 35% of its current market cap.
• Shares of this gem are currently trading at less than $3.00. Considering the vast amount of cash on hand, you’re virtually buying this company for less than $2 a share.
• This company already serves multiple OEM customers (some as large as Google, Microsoft, and HP), so it’s a perfect buyout target.

He’s looking for an 826% gain in this one over the next 24 months — so who is it? Thinkolator sez: Commtouch Software (CTCH)

Which is indeed absurdly small — market cap is about $70 million, price is just under three bucks, and they do have about $20 million in cash. They’re also profitable, though they haven’t inspired investors recently — the stock has been moribund over the past two and a half years as it has gradually drifted down from about $4 to the current $3. Not the kind of drama you might expect for a company in the obviously important and growing cyber security sector, and hard to describe as a “rocket rider” just yet — though other far larger companies that also address stuff like messaging security, spam, internet security and the like, like Symantec (SYMC)[13], have also been fairly boring of late. And like VDSI, they haven’t recently shown the all-important growth that investors crave — revenue in the last quarter was just about the same as the year-ago quarter, so a bet on CTCH is a bet on their effort to reposition the company as offering a cloud based “security as a service” business (that particular service is supposed to roll out next year), as well as their efforts to sell additional security services, including in mobile.

I do like that Commtouch is OEM focused, selling their licensed solutions and services to a couple hundred key hardware and software and service developers instead of trying to get consumers to pay for the security separately, which strikes me as an easier model that requires less marketing, but that doesn’t mean they’ll necessarily be successful. They do also have a buyback authorization in place that might be helping to support the stock a little bit, but this is a tiny stock that’s owned by individuals, with very little institutional ownership, so it will likely continue to be quite volatile.

They have been profitable for several years, which is saying something for a little $70 million company, but an investment in the stock is a bet, again, that their new products will break out in a competitive marketplace and allow them to generate earnings growth for the first time since 2009 — they have seen earnings per share decline very gradually over the last three years even as revenues have shown some growth, so I guess the hope is that their investment in selling and in R&D will pay off, particularly with the “Security as a service” cloud offering in 2013. It’s not completely unreasonable to place a bet on “hope” for a $3 stock that has almost a dollar in cash and has been profitable, but growth of 800% over the next two years would be truly stupendous for this company, and would represent a huge breakthrough that I don’t think many investors are currently expecting. Doesn’t mean Fitz-Gerald will be wrong, just that growth has so far been out of character for this company.

There are growing stocks in the cyber security business — maybe the best one has been SourceFire (FIRE), which has been a growth darling in recent years (and one of those rare Naveller “promised double” stocks that actually did double, though it took two years[14]), and there are also some big players — Checkpoint Software (CHKP) and Symantec (SYMC) are the huge companies, though Intel (INTC)[15] is also active in cyber security and the effort to embed it in hardware following their acquisition of McAfee a couple years ago, but most of the companies do very different things so the fashion can fluctuate. I haven’t been able to get myself interested enough in any of these stocks to buy them personally, though I’ll confess that the emerging field of mobile security does make me want to look more closely at all three of the picks teased … since I don’t personally have much of a handle on the business, I’d kind of like to see them start to grow a bit before I buy the stock, sometimes it’s wiser to miss that first jump in a potentially fast-growing industry if it isn’t clear which of the players will break through with real earnings growth. If you’re inclined to nibble, though, all three are reasonably priced if you’re willing to accept that none of them are really on a sustained earnings growth trajectory (yet).

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