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The Information Age has ushered in dramatic changes in the way we live and work, and it is far from over.  The following figure from US based software giant Oracle Inc. shows the stunning increases in data available to consumers, businesses, and government organisations to the year 2020.

Business and government organisations have struggled with storing that data, leading to opportunities for a new segment in modern society – the cyber-criminal.  Data breaches – or the more commonly named “hacking” – have become common place, reaching into the data bases of major international corporations like Sony and even agencies of the United States Government.  The dramatic growth in data available may well lead to more hacking opportunities.  

Here in Australia investors learned Pacnet, a recent acquisition for ASX Telco leader Telstra (TLS) had been hacked.  Earlier this year we learned Linux Australia and insurer Aussie Travel Cover had been hacked.  In November of 2014 Deloitte Australia released a publication called Cyber security – Empowering the CIO, in which the company states global research shows the average cost of a data breach per Australian organisation is almost $2.6 million per year; and the cost is going up.

Business and government organisations are moving to counter the threat.  Across the world software companies are developing and marketing cyber-security solutions, and Australia is no exception.  We found four small cap ASX tech companies involved in the information security market.  One is a “pure play” in that security is the primary business while the remaining three have diversified ICT (Information and Communications Technology) offerings.  Here is the table.

Company

(CODE)

Market Cap

Share Price

52 Week

 % Change

Dividend Yield

*Fully Franked

P/E

Gearing

Beta

UXC Ltd

(UXC)

$273m

$0.82

+10%

5.0%*

13.47

17.66%

0.58

Covata Ltd

(CVT)

$132m

$0.32

+68%

0

1.47

Prophecy International

(PRO)

$85.9m

$1.55

+220%

1.8%

72.2

0

1.02

PS&C Ltd

(PSZ)

$38.9m

$0.69

-9%

6.5%*

2.4

0

1.27

While technology stocks generally need healthy economic conditions to prosper, the scope of the cyber-security problem may be changing the game.  Estimates of the cost of cyber-crime to global economies range from $400 billion to $575 billion.  This is not to suggest some of these stocks are not inherently speculative.  Competition in the sector is fierce.  No matter how good your offering is there may be another company ready to surprise the market with something better.  

Arguably the least speculative of the group of four in our table is diversified ICT firm UXC Limited (UXC).  The stock’s low Beta value (0.58) means share price movements are less volatile, moving in roughly the same direction as the market.  Beta is calculated monthly, measuring the beginning and ending price of the stock and comparing the result to the overall market.  Here is a one month chart for UXC compared to the XAO All Ordinaries Index.

UXC appears to be the safer play here, for a variety of reasons.  

First, the company operates in three areas – Consulting and Professional Solutions; Enterprise Applications; and ICT Infrastructure.  In October of 2014 UXC expanded its Consulting offerings with the acquisition of the Saltbush Group, a security solutions specialist.  UXC management anticipates the Saltbush operation will allow the company to increase its presence within the federal government.

Second, UXC is the only stock in the table with a positive two year earnings growth forecast, 8.6%, along with a two year dividend growth forecast of 16.7%.

Third, the company’s current P/E of 12.79 and P/B of 1.23 are well below the sector averages of 23.79 and 3.16.  The analyst consensus recommendation for UXC is Outperform.  

Fourth, UXC has a history of providing its shareholders with positive total returns – 5.3% over ten years; 14.1% over five years; and 14.2% over three years.

Covata Ltd (CVT) is another “pure play” cyber-security provider that launched on the ASX in November 2014.  The company went public via a reverse IPO or “backdoor listing” by acquiring a defunct mining company.  Covata’s approach to security is “data-centric” in that it is the actual data that is protected.  The Covata platform protects data as it is created at the source.  In this approach, organisations do not have to worry about the security of a cloud provider or data centre.  

Covata closed its first day of trading at $0.20 per share and vaulted to a high of $0.66 on 16 April before falling back to earth.  Here is the price movement chart for CVT since it began trading.

On 4 December 2014 the company announced an agreement with NSC Global to promote Covata’s platform in Europe, targeting the top 400 enterprise customers served by German Telco Deutsche Telekom.  Market participants received the news enthusiastically.

On 12 February Covata announced an agreement with Macquarie Telecom (MAQ) to provide Covata’s flagship product, Safe Share, to agencies of the federal government.  Market participants apparently liked that news enough to ignore a less than spectacular Half Year Financial results and kept the share price rising.  The big news came on 26 March when Covata announced it had reached a ten year licensing agreement with US based ICT giant, Cisco Systems Inc. to distribute Covata’s platform and products to Cisco clients and incorporate Covata products into Cisco offerings when appropriate.

This is a revenue sharing agreement and the stock price jumped close to 19% intraday in reaction to the news.  Shortly thereafter the company announced the agreement with Cisco triggered the conversion of company performance shares into ordinary shares.  Investors smelled dilution and the share price has been falling ever since.  

Dilution is a short term problem, as long as the company grows revenue and profit.  While there are no guarantees in life or in share markets, a long term agreement with a company as influential as Cisco Systems should put CVT on anybody’s watch list. One analyst covers Covata with a Strong Buy recommendation.

Prior to August of 2011 Prophecy International (PRO) was a standard business software developer and provider, offering billing and customer information systems (basis2) and a range of enterprise applications under the banner e-foundations.  Then Prophecy acquired Intersect Alliance, an Australian software company with an impressive array of security software and an even more impressive client list.

In one move, Prophecy entered the cyber-security market, with a product line that is now Prophecy’s flagship offering – Snare Server software.   Snare is an acronym for System Intrusion Analysis and Reporting Environment.

Snare Server Software includes event monitoring, logging, analysis, reporting and archiving.  Some notable customers of Intersect Alliance included NASA, Northrop Grumman, US Army, Verizon, US Department of Energy, Raytheon, Rolls-Royce, Fujitsu, and Vodaphone.  However, the acquisition did not immediately start the stock price on an upward trajectory.  Here is a five year price movement chart for PRO.

The stock price began its ascent on 9 January when the company pre-announced what it called “record results” for the Half Year 2015, to be released in February.  Prophecy had invested in sales and other support staff to promote Snare Server software and the announcement highlighted an 85% increase in sales over the previous corresponding period.  The actual results showed an overall revenue increase of 9% and a 29% increase in profit.  July updates from the company included the announcement of the acquisition of software developer e-mite and the news Snare Server new sales growth was up 170% on the year.  It took time and money, but it appears the acquisition of Snare Server is paying off.

The final stock in the table is PS&C Ltd (PSZ).  The company is a diversified information and communications technology company with three business units – People; Security; and Communications.  This is a company built on multiple acquisitions – Systems and People; Allcom Networks; Allcom Consulting; Securus Global; HackLabs; and Pure Hacking.  

PSZ had an offering price of $1.00 per share and began trading on the ASX in December of 2013, with an opening price of $1.08, falling to $0.81 at the close.  It’s been pretty much all downhill since.  Here is a price movement chart for PSZ since it debuted on the ASX.

Investors may have been skeptical about the difficulties of integrating so many different companies, not to mention the costs.  The first financial results reported about a month after the stock hit the market stated the company expected to meet its financial guidance as set out in the IPO prospectus.  Six months later the company revised its profit guidance downward.  

On 25 June 2015 PS&C released profit guidance to the market forecasting both revenue and profit increases for the Full Year 2015 across the board.  The Security Division is expected to show 100% increases in both revenue and profit, yet the stock price cratered.  Perhaps investors were focusing on the wording of the profit statement, which included the phrase “before head office costs.” Management did acknowledge the cost concerns for the head office as well as the investments made to grow the Security and People divisions. 

For those with patience and risk tolerance, this stock could still deserve a place on a watch list.  First, the company pays a very respectable dividend and is expected to continue to do so, with a 29.1% forecasted dividend increase over two years.  In FY 2014 the company earned $0.103 per share, which is forecasted to fall by one cent in FY 2015 and then go up to $0.10 in 2016.  PS&C’s Security division is reportedly an established player in penetration testing, or “white hat” hacking.  Here the client company hires a cyber-security firm to try to hack into its systems.  The Australian Privacy Commissioner has the power to investigate data breaches compromising customer data and fine the company whose systems were breached.  Recently the Commissioner has launched an investigation into a data breach at an iiNet subsidiary.  More investigations and higher fines could be a tail wind for penetration testing and indeed for the entire cyber-security market.

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