This Cybersecurity Stock is Catching Fire

Cybersecurity is once again back on top of the headlines as Apple (AAPL) battles the FBI over privacy regulations surrounding its iPhone. But the broader online risks, breaches and thefts, have been rising and will continue to do for years to come. The companies creating the software and implementing the solutions to prevent online crime will benefit from the massive spending.

This one company’s shares, after suffering a major meltdown from the summertime highs, has recently caught fire and appear poised to fly higher in throughout 2016.

The major themes driving the cybersecurity industry are pretty straightforward; an increase in online crime is leading to an increase in cyber spending by both government and corporations. 

  • Market research firm Gartner says global spending on IT security is set to increase 4.7 percent in 2015 to $75.4 billion, and the world will spend $101 billion on information security in 2018.
  • The cyber security market is estimated to grow to $170 billion (USD) by 2020, at a Compound Annual Growth Rate (CAGR) of 9.8 percent from 2015 to 2020, according to a report from Markets and Markets. The aerospace, defense, and intelligence vertical continues to be the largest contributor to cybersecurity solutions.
  • The “PwC Global State of Information Security Survey 2015” found that U.S. information security budgets have grown at almost double the rate of IT budgets over the last two years.

Here’s the easy to visualize trend that results from this increase in spending.

Cyber Spending

Some industry experts believe the number could surge beyond $100 billion by the end of 2017 as a massive year-end spending measure moving through Congress includes a provision to encourage companies to share cyber threat information with the government while providing them with liability protections for not acting on information received.

Indeed, while the number of complaints about online fraud have declined the dollars lost have only increased. This suggests the crimes are being committed by more sophisticated organizations and hacking higher value targets.

Cyber dollars lost

The total losses are expected to hit $1 billion in 2015 and approach $1.3 billion in 2016.

What we are seeing is fewer attacks on individuals, but a big increase of massive data breaches across a multitude of industries. 

Even as the overall revenue pie gets bigger there is cybersecurity industry needs to consolidate. Expectations are for a larger number of mergers in 2016, as firms need to scale in size of a broader suite of product offerings to serve large organizations, such as government agencies and multinational corporations.

A recent research note from FBR & Co. forecast a 40% increase in multi-million dollar deals to cybersecurity firms, which will combine business vendors with those selling to end-users and combinations to provide end-to-end solutions.

My Sight Set on FireEye

FireEye (FEYE) is my top pick in the cybersecurity sector mainly because it is positioned to be both an acquirer and a potential takeover target. This coupled with its own internal organic 25% revenue growth makes attractive way to play the cybersecurity theme.

On February 12th the company reported fourth quarter and full 2015 earnings, mostly in line with estimates and re-affirming its previously lowered revenue guidance of a 26% increase, which was slightly below the prior forecasts looking for a 28% increase for 2016. Shares took a final dip to the $12 level, an 80% decline from the summer time highs.

But in the month since the stock has been on a steady climb, gaining some 28% to the $18 level.

FEYE chart 3.6.16

While other cyber firms such as Palo Alto Networks (PANW) and CyberArk (CYBR) had also sold off, FireEye was the most out of favor stepchild of the group. It is now playing catch up.

With a firm bottom in place and the beginnings of a new uptrend this looks like a great opportunity to use options as a low cost, low risk way to make a speculative bet this company can use the broad and favorable industry trends to generate and grow revenues, while it repairs company specific problems.

It also has sufficient cash to make further acquisitions to plug holes in its operations. If it can right the ship, it should not only become profitable in its own right but with it’s mere $2.1 billion market cap it would then be an attractive takeover candidate for one of the larger firms.

The Trade:

I want to keep this very simple, allowing sufficient time for the company to regain momentum or the possibility for a takeover event. I also want to have unlimited profit potential. For this reason I’m focused on the outright purchase of LEAP call options. Specifically;

Buy the $15 Calls with a January 2017 expiration for $5.50 per contract.

I think shares can double and get back to the $30-$35 level by the end of the year, even if they only meet the now reduced guidance. That would the calls a value of over $15 for a $9.50, or 170% gain.

If industry consolidation picks up steam and a takeover bid comes along, shares could really catch fire and move toward the $50 level.

— Steve Smith

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About the Author: Steve Smith