We live in a dangerous world

Friday, 25th September 2015 09:32 - by David Harbage

This has probably never been more true, based on the probable fact that more people died in wars in the 20th century than in the preceding 1900 years combined.

The fall of the Berlin Wall, on 9 November 1989, was acclaimed as marking the end of the 'Cold War' which would bring a peace dividend - as governments would spend less on armaments, in favour of hospitals, schools and infrastructure. Twenty five years on, the hoped-for peace has been somewhat illusory - with heightened geo-political tensions and terrorist activity very obvious, to say nothing of outright war and ongoing conflict in many parts of the world.

The threat of attack extends beyond the individual person to public bodies and corporate entities; and beyond that which the physical guard can protect. However motivated (not necessarily for financial gain), computer hackers have sought to gain access to government records and bank account details - which, like almost every area of life or commerce today is derived from an online database.

The need to combat such cyber threats has been highlighted by politicians and business leaders worldwide. The fast changing nature of technological development and need to comply with more robust regulatory standards (on issues like data protection) is creating a new industry - featuring a plethora of security firms from cyber 'defenders' to data 'monitors'. Two such stock exchange listed companies provided an update to investors this week.

Falanx is a very young, small cyber security business: joining AIM in June 2013 it has a market capitalisation of just £7 million, with its board members boasting appropriate experience in intelligence within the British Army, security & fraud risk at HSBC and counter-espionage within the Royal Military police. Based in London, but with global operations, there are three divisions: Intelligence, being political security risk and services to business. Resilience is security consultancy, crisis management and asset/facility security. Cyber is cloud-based security services.

As at 30 June 2015, the company is investing in its cyber business, developing joint ventures or partnerships, is unprofitable, but possesses £1.7million cash. Today's update features agreements with 3 financial services companies, 3 accreditations procured and 5 new corporate intelligence contract wins. Falanx have seen a pickup in exceptional projects and it is hoped that an increased sales team will boost the order book. Banks will be particularly keen to protect their clients' assets and confidentiality - and therefore their business; their huge budgets for firewalls and other tech-based security reflect this fact.

Being so small, the company will not feature on the 'radar' (please excuse the pun) of most fund managers and, being unlikely to breakeven before 2018, represents a particularly high risk-reward investment. Two board directors own almost 20%, and niche investment manager Ruffer 10%, evidencing confidence in what is clearly a 'jam tomorrow' stock operating in a growth industry. Not for 'widows and orphans' but one to watch.

By contrast with the 'cloak and dagger' world of military or corporate intelligence, the second company of interest offers a specialism in digital protection. Regenersis, which possesses global leadership in data erasure software, announced its full year results on Tuesday. More pertinently, the company has announced a restructuring of its business activities whereby it is set to dispose of its traditional electronic (phones, tablets etc) business to concentrate on digital security software - an avenue which it progressed via the purchase of Blancco in April 2014 and SafeIT in September 2014. The company have made a further acquisition this week, of the US market leader in data erasure: Tabernus for $12million.

Blancco has a Europe-wide patent for its solid state drive (ie that is found in the smartphone, tablet, newer laptop devices) erasure method, and as such Tabernus represents an excellent complimentary geographic fit. Increasingly tough legislation to protect data in both Europe and the US is set to drive demand. The customer data on old devices and computer bases must be removed by companies or face the risk of fines or being sued by the owners of such personal data - per the case of US retailer, Target. (After hackers obtained the personal information of 40-50 million credit/debit cardholders and 70 million shoppers, the CEO stood down). Besides the threat of hefty fines, the greater cost to companies could be immeasurable reputation risk.

Unlike Falanx, Regenersis has a longer track record and is a profitable  business. The disposal of its aftermarket services division - projected to complete by March 2016 - should realise a significant sum which, given the ungeared balance sheet, is likely to be distributed to shareholders. The focus on the higher growth digital security area is likely to be appreciated by investors - evident in the stock's 20% appreciation over the past few days. Broker Panmure Gordon have an ambitious 270pence share price target, reiterated in a note issued on the day of the final results and acquisition. The asset reshuffle makes estimates of future earnings somewhat redundant, but the stock is currently priced on a sub-market earnings multiple of 10 times' next year's forecast EPS. A three times covered dividend also delivers a supportive, prospective 3.5% yield.

Many fund managers now have cyber security as one of their key risks - and therefore questions - for the management of companies they own or are interested in owning. While encouraging updates from the two security-oriented via technology businesses discussed above have produced positive responses in the market's assessment of their worth, both appear worthy of following their progress over the longer term.

Written by David Harbage for lse.co.uk on the 24th September 2015

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.

See the share price for Falanx Group here

See the share price for HSBC here

See the share price for Regenersis here