As we become an increasingly digital society, identity theft becomes an increasingly prevalent crime. In fact, nearly one in twenty American adults has been the victim of identity thieves.
It's the kind of thing that no one thinks can happen to them. Until it does. And unfortunately, the process of recovering from identity theft is a long and arduous one filled with proving to banks and creditors that you are who you say you are and that you didn't take out a loan on an RV on the other side of the country.
That's why the best way to deal with identity theft is simply to avoid it all together. And to do that, you need a product that provides comprehensive, proactive, and guaranteed protection. You need LifeLock (NYSE:LOCK).
LifeLock is still a new player in the stock market, having only gone public in October of last year. The IPO was priced at $9, and it had a rough first few months in the secondary markets. However, the new year has breathed new life into the stock, and it rallied to $12 before starting its recent pullback.
This provides a nice entry point for new investors, as it's currently priced less than a dollar above its IPO. Tuesday's action was over-exaggerated and technically motivated since no news broke about the company, yet it dropped over 5% regardless. However, it found intraday support at $9.50 and quickly rebounded from the lows of the session.
What this means for those interested in initiating positions is that it's oversold and likely to reverse as soon as tomorrow. And since - as I'll demonstrate below - it's priced so attractively now, the time to pounce is as soon as possible.
If you want to limit your risk, I'd recommend putting in a stop order just below the IPO price of $9. If it breaks below that point it's likely to continue lower and present an even more attractive entry later down the road. However, a $9 stop would present a favorable risk/reward ratio with only $0.76 of downside compared with at least $2.24 of upside should the stock continue its uptrend beyond $12.
And even though I'd advise taking some profits around the $12 mark, I'd still want to keep most of my position; LifeLock isn't just a vehicle for a quick trade, but a stock with the potential to leave $12 per share in the dust as it becomes one of the great growth stories of the next decade.
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The biggest factor working in LifeLock's favor right now is that it provides a wholly unique product. There are other services that can help consumers monitor their credit to detect identity theft, but only LifeLock works proactively to prevent it.
This effectively means that the company has no competition, and that if other companies were to try to offer similar services in the future - as they almost certainly will at some point - they'd have to compete with LifeLock's established and growing brand recognition. But until other players enter the space, LifeLock is free to grow into a largely untapped market as fast as it can acquire new customers.
In order to serve this end, LifeLock has hired Rudy Guilliani as a sort of company spokesman and tasked him with educating the public about the dangers and prevalence of identity theft. And in the company's most recent earnings conference call, CEO Todd Davis mentioned that they sponsored the movie Identity Thief - starring Jason Bateman - in a sort of backdoor attempt to boost awareness of the problem they hope to address. Having not seen it, I can't speak to the quality of the film, but if nothing else, it's an innovative marketing technique.
Whether it's the movie or the company's ever present TV spots is debatable, but something must be working because LifeLock's done a good job of both acquiring new customers and retaining old ones, finishing FY 2012 with roughly 2.5 million "members" - a 20% increase year over year. And with an 87% retention rate, most of those customers seem satisfied enough with the company to continue generating revenue into the foreseeable future, a key point to consider because LifeLock's entire business model hinges on member retention.
All that marketing LifeLock puts out means it spends $150 on average to acquire each new member, yet only receives an average of $9.28 per member per month in revenue. If you do the math, you'll find that LifeLock needs to hold onto a member for at least 17 months before the company can start booking profits.
But as both identity theft and LifeLock become increasingly common phrases in the household, the acquisition cost of each customer should gradually decrease. And with an over 70 million customer market to address, LifeLock has a lot of potential to grow, both in terms membership and profit.
But Is The Company Profitable?
The short answer to that question is "barely", with the company reporting basic earnings of $0.18 per share and diluted earnings of $0.09 per share. That's quite a discrepancy, and in all honesty if I hadn't taken a closer look at LifeLock's 10-K, I never would have realized the true potential of the company. But I was curious about the reason for the excessive amount of dilution, and in the process of combing the annual report I found some interesting factors affecting the profitability of LifeLock both for the fiscal year past and for the years looking forward.
At the core of the problem is the fact that before it went public in October, LifeLock issued seven different types of convertible preferred stock, all of which were forcibly converted on the date of the IPO. Because that conversion occurred in the final quarter of the fiscal year, the "weighted average shares outstanding" - the metric the company uses to calculate its diluted and basic earnings - isn't exactly the most accurate denominator to use for those calculations.
However, the dilution process is still ongoing owing to a sizeable amount of unexercised pre-IPO warrants and options outstanding, and for the purposes of my own research and demonstrations I chose to recalculate the company's earnings using 99 million shares of common stock - the number of shares of common stock that will exist once the diluting warrants and options are exercised, and the number the company used when issuing its FY 2013 guidance. But we'll get to that later.
Using the more accurate denominator of 99 million shares, LifeLock actually posted earnings of $0.06 per share, a 30% reduction from the GAAP figures calculated using the "weighted average" method. With its current price of $9.76, that gives it a P/E ratio of 162 and makes it an expensive stock by any measure.
And if you read my last article, you'd know that I'm no fan of expensive stocks. So what makes LifeLock the exception to my rule?
This is one of those rare cases where the GAAP figures grossly misrepresent the true value of a business, and where a little digging in a company's financial reports can pay dividends.
My $0.06 per share figure above was calculated using just $6.17 million in earnings attributable to common stock. But the company actually booked net profits of $23.5 million for FY 2012. So what happened to the $17.3 million in missing profits?
Remember those seven types of preferred convertible stock LifeLock issued before going public?
For the first three quarters of the fiscal year the company had to make payments to those preferred shareholders. The cost of those payments, plus the costs associated with creating the new shares of common stock after the preferred shares were forcibly converted on the date of the IPO adds up to just about $17 million.
And although those costs were undeniably real and should be accounted for in the company's books, there are no longer any preferred shares of LifeLock in existence, meaning that from now on all of the company's earnings will be attributable to the shares of common stock.
Further more, since the $17 million will not recur next year and had no bearing on the company's operations or net profits, it's precisely the kind of expense that could truly be classified as "extraordinary".
And excluding the "extraordinary" item above, LifeLock actually booked earnings of roughly $0.24 per share using the 99 million shares of fully diluted common stock, giving it an earnings multiple of 40 using the most recent closing price.
So Where Do We Go From Here?
LifeLock issued FY 2013 guidance with earnings of $0.30 - $0.35 per share using the fully diluted amount of 99 million shares. But here's why I'm quickly warming to this company's management: they issue their guidance assuming no acceleration of the company's growth. The numbers are calculated using their historical rates of new member acquisition and current member retention, and not by assuming that they'll grow any faster in the next fiscal year.
That's a big part of why the company finished FY 2012 above the high-range of its guided figures, and why I suspect LifeLock may repeat the performance this year.
Because any acceleration in their business will cause them to surprise to the upside of their guidance, LifeLock's management is adhering to the dogma of under promising and over delivering - an approach that has historically fared better with the markets than its alternative.
Now to be fair, even on the high end of the FY 2013 guidance LifeLock would still trade at 27 times next year's earnings. But 27 times earnings isn't terribly expensive for a solid growth play, and with the rash of "hack attacks" exposing just how vulnerable we all are to having our information compromised and our identities stolen, my thesis is that LifeLock will experience the sort of acceleration in growth that will cause its profits - and stock price - to continue increasing.
With zero debt, no competition, a strong brand, and a still underserved market for potential customers, LifeLock's recent slide from its $12 high presents the perfect buying opportunity for investors to get in on what could be one of the great growth stories of the next decade.