Last month, in his State of the Union address, President Obama made a point of underscoring the growing need for cybersecurity measures in the United States.
Specifically, he noted:
“No foreign nation, no hacker, should be able to shut down our networks, steal our trade secrets, or invade the privacy of American families, especially our kids. We are making sure our government integrates intelligence to combat cyber threats, just as we have done to combat terrorism.”
While the President’s plans regarding the issue were well-received and deemed as appropriate, truth be told, those few words probably didn’t do the problem justice.
In fact, just a few weeks after the president’s speech, one of the country’s largest health insurers got hit by a major cybersecurity breach. Hackers broke into Anthem Inc’s (NYSE:ANTM) database, accessing names, social security numbers and addresses of customers.
There’s no doubt about it: Cybersecurity is more important than ever.
Cybercrime is a Bigger Problem Than Most Realize
The statistics are staggering, but perhaps none as much as this: Cybercrime costs the global economy $400 billion per year. And in the interest of completeness, that estimate cited in a report published by McAfee and the Center for Strategic and International Studies may actually be conservative. The upper end of the annual cost of cybercrime may reach as high as $575 billion.
The problem is getting worse, too.
The official tally of 2014’s cybercrimes is still being determined, but according to a recent PWC Global State of Information Security Survey, the number of incidents hit 43 million last year — up 48% from 2013’s total.
They’re creating a bigger negative impact, too. Sony Corp. (NYSE:SNE) was forced to cancel the theater release of a film because of a hack after the film and other confidential information was accessed. Millions of customers of JPMorgan Chase & Co. (NYSE:JPM) had personal information accessed by cybercriminals. Home Depot Inc. (NYSE:HD) let credit card information for 56 million of its customers slip into hackers’ hands.
And these breaches materialized despite plenty of cybersecurity lessons being learned in 2013. With more and more successful attacks, cybercriminals probably aren’t interested in career changes.
What Investors Need to Know About Cybersecurity
So with the need clearly in place now that cybersecurity is becoming something of a government mandate, what are the investment-worthy trends within the cybersecurity realm?
The straight-forward way to play the budding trend would be buying stakes in pure cybersecurity stocks like Fortinet Inc. (NASDAQ:FTNT), Palo Alto Networks Inc. (NYSE:PANW) and Check Point Software Technologies Ltd. (NASDAQ:CHKP).
Investors would be wise to tread lightly with these focused companies, however. Cybersecurity is an amazingly competitive field (which can crimp margins) that’s still in its infancy. All the R&D required to build the right tools and achieve enough scale to make it a fruitful venture are making many of these names very expensive stocks.
Case in point? Fortinet shares are trading at a forward-looking P/E of 47.7, while Palo Alto Networks shares are priced at a forward-looking P/E of 83.5. That’s not to say there’s no room for upside. But, many of these stocks are going to need the help of a lot of hype if they want to appreciate in value anytime soon.
While some pure cybersecurity plays may be too expensive to own as their underlying companies sit right now, they may hold value as acquisition targets of larger technology companies. Big tech will want to get deeper into the cybersecurity game without the hassle of developing its own wares and platforms.
And yes, big tech names are already looking to own a piece of the pie. International Business Machines Corp. (NYSE:IBM) CEO Ginni Rometty, for example, made the issue crystal clear during its Q3 earnings call in October by saying of her priorities, “I can’t underscore enough – security.” Rometty isn’t just talk, either, acquiring cybersecurity company Trusteer in late 2013, and CrossIdeas in mid-2014. More such deals are likely.
It’s not just IBM wading into the cybersecurity pool, either. Microsoft Corporation (NASDAQ:MSFT) acquired cybersecurity startup Aorato late last year, and partnered up with Akamai Technologies, Inc. (NASDAQ:AKAM) in mid-2014 in an effort to beef up its pool of cybersecurity R&D.
The point being that the bigger — albeit more speculative — gains from the world of small cybersecurity companies will be driven by buyouts. Conversely, though the upside of cybersecurity growth within the large-cap realm is likely to be diluted by those companies’ other ventures.
The market is still in high-growth-mode, however, so it’s possible one large company will be able to leverage its size, piecing together several small companies into one profitable cybersecurity unit.
And, as it stands right now, Microsoft and IBM are the odds-on favorites.
Bottom Line
Whatever the future looks like for the industry, the overarching opportunity is undeniable.
Last August, IT consulting firm Gartner opined 2014’s total spending on cybersecurity would reach $71.1 billion, up nearly 8% from 2013’s total. The company has forecast more than 8% growth in cybersecurity spending this year, keeping it on pace to be one of the year’s fastest-growing sectors. Researcher Markets and Markets forecasts the industry will be worth $155 billion by 2019.
The catalyst for the recent growth has been the advent of mobile devices and cloud services, and neither of those trends is likely to slow down anytime soon.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
