2 Cybersecurity Stocks to Buy in a Growing Market

by Hilary Kramer | April 9, 2014 11:38 am

There’s no question that 2014 got off to a rocky start, as the first quarter was marked by a see-saw of new highs and sharp drops. We’ve seen this kind of volatility follow us into the second quarter, and I believe there’s more ahead as many of Q1’s storylines continue to play out.

Here are three factors I’ll be watching this quarter that could affect the market:

The World Stage: It’s no surprise that global activity will continue to be a significant factor for the markets in the second quarter. China may be the real wild card here and a big driver behind stocks in general during the period. After all, China’s demand for commodities and any number of goods from outside its own borders has helped keep the world economy growing (albeit anemically). If numbers continue to hint at slowing growth, stocks are likely to suffer.

Investor Rotation: I found it interesting that among the best performing sectors in the first quarter, high dividends and low volatility ruled the day. Healthcare and utility stocks outperformed the broader market, partly due to yield and defensive postures within the United States. Social media and consumer discretionary names suffered, as evidenced by Twitter’s (TWTR[1]) 27% drop and Amazon’s (AMZN[2]) 16% slide.

Earnings: As winter weather finally ends and the impact of the Washington, D.C. squabbling from last year subsides, we’ll get a clearer picture of just what companies are seeing “in the trenches” when they begin to report earnings this week.

Decent U.S. economic numbers, along with continued Fed dovishness, can help bring stocks higher this quarter. April is typically among the strongest months of the year, and good news from this key earnings season could go a long way to keeping that trend alive.

Banking on Security

Regardless of the unpredictable market we’re headed toward, there are still sectors that I expect to do well as they enjoy longer-term trends that are truly global. The sector I’m most excited about is cybersecurity.

As we just talked about, global issues have put pressure on stocks, including the latest uncertainty over an economic slowdown in China and concerns in Crimea. But they’ve also put cybersecurity issues back in the headlines again. There was a lot of “crossfire” between Russia and Ukraine as hacking groups in both nations have been shutting down sites across each other’s borders.  For example, Ukrainian hackers claimed responsibility for a cyber attack that crashed two NATO websites ahead of the vote that saw Crimea move to join Russia.

The NATO site attack speaks to the fragility of “Internet peace,” and I believe we’re likely to see a lot more denial of service attacks and hacking activity in the service of politics over the next several years. It also means that firms providing technology to enterprises so they can protect their data will thrive.

Forbes recently noted that spending on IT security is likely to grow as much as 10-fold over the next several years. And here in the United States, there is a lot of work to be done to thwart future cybersecurity attacks.

In early March, First Data, a provider of electronic commerce and payment solutions, held a cybersecurity summit in New York. Panelists, including the head of EMC’s (EMC[3]) security division, said the U.S. government must step up efforts to respond quickly and share information about cyber attacks – and companies themselves must do more to ensure communication about cyber threats with each other.

So who do I think stand to benefit from this trend? My two top tech picks in this sector are Akamai and Fortinet. Let’s take a look at both:

Fortinet (FTNT[4]) is a $3.3 billion market cap company specializing in network security. It focuses specifically on unified threat management, which means the typical firewall has evolved into an all-in-one product that detects and prevents intrusions. The company offers a number of application control and firewall software offerings, but its flagship device is FortiGate, a network security platform that can work for anyone from small offices and retailers to large enterprises and data centers.

The stock hit a low point last fall, dipping down to the mid-teens when CFO Ahmed Rubaie left the company after only a short time, citing personal reasons. Wall Street never likes to see senior executives leave if there’s no real turnaround in the works, and investors get jittery that the current business course may be interrupted with new management in place. However, shares rebounded nicely and have since stabilized as Andrew DelMatto was named CFO.

FTNT’s most recent results also indicate a good rebound from a tough first half last year. Last month, the company posted earnings of 15 cents a share, beating estimates by a penny, on a 17% increase in revenues to $177 million, which easily outpaced the $166 million the Street had anticipated.

Many of FTNT’s security peers have actually seen slowdowns in these segments, which further hints that the company is gaining market share. In fact, management called out a specific large deal at a telecom carrier, where it displaced McAfee and Juniper.

Firing on all cylinders, I see FTNT earning as much as 75 cents per share in 2015. Using the midpoint of the 4-8X sales multiple that peers trade at (typically used as a yardstick for “takeout” value), we get a target range of $29-$30. The company also has $161 million remaining under its buyback program, which could help boost shares in the near term.

Akamai (AKAM[5]) operates at the intersection of content delivery and network security, and has roughly 135,000 servers across the globe. These servers help its customers – including virtually all of the largest media and video-intense companies in the world like Yahoo, Facebook and Netflix – bring data faster to the ultimate user (that means people like you and me, who are busy downloading videos and photos).

The company says its servers are located on what might be termed the “edge” of the Internet, which in other words means that the servers are located physically close to end users. Because of that close proximity, content gets delivered faster. Management has claimed that as much as 30% of global Internet traffic is routed and cached across its servers. Operating across five product lines (Aqua, Sola, Kona, Aura and Terra), Akamai enables content delivery to sites, and also helps companies operate with cloud-based programs and streaming video (live and archived). Each of those “buckets” of revenues corresponds to a different customer base: Terra, for example, helps businesses connect effectively with their customers and supply chains; Kona focuses on cloud computing and security.

Since AKAM servers sit on the edge of the network and thus outside of corporate firewalls that are installed on premise or in the cloud, the Kona segment offers what can be thought of as a “first line” of defense against cyber attacks. Akamai can help deflect attacks before they ever make it to the corporate firewall.

This is a defensible niche for the company, given the size and scale of its server footprint and key customer base (comprised of many large companies, though no single customer makes up more than 10% of total revenues). That’s an attractive quality alongside a heavy focus in the fast-growing media segment and continued attention on cybersecurity.

At the moment, the Street expects Akamai to see 12% EPS growth alongside continued investment in the business as the company boosts its revenues 18% year-over-year to $1.8 billion in 2014. But that bottom line growth should reaccelerate into 2015 to around 18% or $2.63 a share. Given the media exposure, security presence and reach Akamai has, that estimate could be boosted considerably as we make our way through 2014.



  1. TWTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=TWTR
  2. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN
  3. EMC: http://studio-5.financialcontent.com/investplace/quote?Symbol=EMC
  4. FTNT: http://studio-5.financialcontent.com/investplace/quote?Symbol=FTNT
  5. AKAM: http://studio-5.financialcontent.com/investplace/quote?Symbol=AKAM

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