Aladdin: Will Strategic Value Be Realized?

Dec.17.08 | About: Aladdin Knowledge (ALDN)

Aladdin Knowledge Systems Ltd. (ALDN) has a strong product offering in the growing software digital rights management, authentication and secure Web gateway markets. The shares may be cheaper than they appear, as the enterprise security segment has posted losses, masking the strong profitability of software DRM. However, we question the company’s acquisition strategy, as it appears to have negatively affected earnings even while boosting growth and strengthening the product offerings. Nonetheless, the current enterprise value may be less than the intrinsic value of just the software DRM segment, making this an interesting prospect.

BUSINESS OVERVIEW

Aladdin is an information security company specializing in authentication, software digital rights management (DRM) and content security. It operates in two segments:

Software Security DRM provides software and hardware that helps software publishers manage licensing and distribution of their software to prevent theft and piracy.

Enterprise Security provides USB-based hardware and one-time-password devices for user authentication and content security solutions that protect computers against intrusion.

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INVESTMENT HIGHLIGHTS

  • Leading software rights management products, used by software publishers to protect their IP and reduce piracy losses. Software DRM is a ~$200 million market globally, growing in the low teens.*
  • eToken is leader in USB authentication, a $150 million market growing at 30%+. Aladdin also competes in the one-time-password authentication, a $450 million market growing at roughly 20%.*
  • eSafe secure Web gateway competes in $650 million market growing at 20%+.* eSafe provides advanced protection against Web-based threats.
  • CEO Jacob Margalit (45) founded company in 1985. CFO Shemer (38) joined Aladdin in 2007.
  • Active M&A strategy, including 39% investment in Athena Smartcard, €10 million purchase of Eutronsec, and $65 million acquisition of SafeWord product line from Secure Computing (SCUR). SafeWord offers one-time-password authentication.
  • Guiding for revenue growth of 15-25% and EPS decline from $1.02 in 2007 to $0.04-0.10 in 2008; non-GAAP EPS to decline from $1.20 in 2007 to $0.74-0.84 in 2008. The guidance includes the SafeWord acquisition. A slowdown in revenue growth, M&A expenses and the strengthening of the Israeli shekel are behind the likely decline in EPS.
  • Received $14.50 per share acquisition proposal from Vector Capital in October, following rejection of $13 per share Vector proposal in August. The company also rejected a proposal by Vector to buy Aladdin’s DRM business for $125-135 million. Vector owns 14% of Aladdin shares.

INVESTMENT RISKS & CONCERNS

  • M&A strategy with “focus on market share.” Second criterion is “technology,” with value creation apparently in third place.
  • Competitors include SafeNet, Macrovision and Wibu in software DRM; RSA in authentication; Trend Micro in content security for gateways; as well as McAfee, Symantec, Blue Coat, Secure Computing, IronPort, Websense, and SurfControl.

MAJOR HOLDERS

CEO Margalit 13% │ Other insiders 7% │ Vector 14% │ Galleon 12% │ Manning & Napier 9% │ RenTech 5%

* Source: Frost & Sullivan, Company, The Manual of Ideas.

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