When it comes to the burgeoning Internet of Things ((IoT)) - whereby companies are equipping everyday objects with internet connectivity - security is an afterthought. Or as Trend Micro's (OTCPK:TMICY) Christopher Budd says, "Lurking behind some of the most exciting products being showcased this year are serious privacy and security concerns."
That's downright frightening news for consumers. I mean, China could already be assembling a cyber weapon of mass destruction to exploit these vulnerabilities. Yet, at the same time, it's unbelievably positive news for investors. Here's why…
Another Avenue for Attack
Almost every expert agrees that cyber threats aren't going away anytime soon. What's more, a brand-new frontier of devices is opening up for cyber criminals to target.
Literally billions upon billions of new devices are about to come online - with the ability to send and receive data, no less. And some teenager in Hungary will be able to turn these devices against us, forcing them to bombard the internet with insane amounts of data traffic - grinding vital global websites to a halt. Or worse. Our sworn enemies could literally kill us by hacking into our medical implants.
Don't believe me? Then you obviously didn't see the 60 Minutes piece with former vice president, Dick Cheney, where he revealed that his doctor insisted on disabling the wireless functionality of his heart implant. He feared that terrorists might hack it in an assassination attempt. And you must have definitely missed my article last week, when I revealed how an unsuspecting refrigerator was commandeered to participate in a 750,000-message spam attack.
Obviously, we can't stand around defenseless. Our daily lives, our economic security - even our national security - are on the line. So the investment implication for us is obvious… Go "long" leading cyber-security companies. Because demand for their services can only go one way from here - up! In fact, the uptick is already underway. Cyber-security firms are reporting double-digit quarterly sales growth - almost without exception. But here's the $64,000 question: What cyber-security stocks hold the most upside potential?
Let's Make a Deal
Understandably, we've witnessed a spate of mergers and acquisitions in the cyber-security space, as big players like Cisco (NASDAQ:CSCO) jockey for position. In the last year alone, the number of cyber-security deals in the United States doubled, according to Dealogic. So if we want to maximize our profit potential, we'd be wise to identify not only a leading cyber-security firm, but also one that's a prime takeover target. That means focusing on small-cap players. After all, they're the most affordable in dollar terms.
With that in mind, the recent deal between FireEye, Inc. (NASDAQ:FEYE) and privately held Mandiant proves most instructive. On January 2, FireEye paid $1.05 billion in a cash-and-stock deal for Mandiant, which works out to roughly 10 times revenue. Rest assured, the valuation isn't an outlier. Not when we consider that Cisco paid 12 times revenue for Sourcefire back in July 2013. If we apply the same multiple for the Mandiant purchase to the remaining independent cyber-security firms, an obvious investment choice emerges for us: The KEYW Holding Corporation (KEYW).
It's important to note that the company boasts similarly impressive growth rates as its peers. So the fact that it's trading at a discount to the industry on a price-to-sales basis isn't based on inferior fundamentals. Could the upside potential really be that significant, though? Yes, indeed! And don't just take my word for it.
Wall Street Analyst Goes Rogue
On the heels of FireEye's deal for Mandiant, SunTrust Robinson Humphrey analyst, Tobey Sommer, wrote in a note to investors that KEYW would be worth over $80 per share in a buyout. At the time, shares were only trading hands for about $15. So his estimate implies an upside of more than 400%, too. Never in my career have I witnessed such a bold call from a mainstream Wall Street analyst. It's not in their nature. They're herd animals. Accordingly, I admire Sommer's willingness to break rank. And, of course, I wholeheartedly agree with his analysis.
Bottom line: With cyber attacks on the rise, don't be foolish and leave your portfolio vulnerable, too. Load up on shares of KEYW before one of the titans of the industry - like Cisco, IBM (NYSE:IBM), Juniper (NYSE:JNPR), Symantec (NASDAQ:SYMC), or EMC (EMC) - goes on a buying spree and beats you to it.
Disclosure: No positions