Keyw: Cyber Security Inferiority And Looming Dilutive Equity Raise, Reiterate Strong Sell

| About: KEYW Holding (KEYW)


Channel checks with cyber security competitors reveals credible competitors have never even heard of KEYW.

KEYW needs to raise equity to remain solvent, up to 36% dilution coming according to SEC registration filings.

KEYW commentary implies weak 2Q, dilution will probably occur before the end of July to avoid further stock price declines on weak revenue trends.

Highly credible competitors have strong venture backing and partnerships that KEYW lacks.

Recent attempts to pump the stock have fallen flat and large institutions are aggressively selling KEYW shares.

Keyw Corp. (NASDAQ:KEYW) likes to tout its alleged "cyber superiority" in press releases. I set out to evaluate these claims by discussing KEYW's products with competitors already established in the cyber security business. I found that KEYW is far behind its competitors in every relevant category: R&D spending, partnerships, functionality, and most importantly, revenue.

As a reminder, KEYW has virtually no cyber revenue - this is in contrast to FireEye (NASDAQ:FEYE), which has over $200mm in last 12 month revenue, a number that has grown rapidly, unlike KEYW's declining cyber revenue. In fact, KEYW's cyber revenue only accounts for approximately 3% of its total revenue, roughly 1/20th that of FEYE.

This lack of meaningful revenue and unimpressive growth might not be too concerning for a startup company under other circumstances - what makes it a problem for KEYW is the company is late to the party and faces an uphill battle against entrenched competitors with more resources.

KEYW likes the comparisons some have drawn between it and FEYE, comparisons that I have explained are completely nonsensical (see my prior report on KEYW here). In fact, FEYE doesn't even mention KEYW as a competitor in its 10-K - apparently KEYW is not even on the radar for FEYE. Furthermore, FEYE will have 2014 R&D spending of 40-43% of its estimated ~$410 million 2014 revenue - this is in the neighborhood of $170mm of R&D for next year alone while KEYW is teetering on the edge of violating debt covenants and possible bankruptcy.

How does KEYW stack up? Quoting from the KEYW 10-K:

In 2013, we spent approximately $7.5 million, or 2.5% of revenue on R&D. For 2014 we are budgeting 2.5% - 3.0% of revenue for R&D. R&D spending increased in 2013 and we expect it to be flat or increase slightly in 2014."

I estimate this to be roughly $7.5mm again - 3% of my $250mm sales forecast for 2014 (remember, based on Q1 and Q2 guidance, KEYW's revenue is declining). So FEYE will likely outspend KEYW in 2014 by a factor of ~23x on R&D. Regardless of where KEYW is today (and it seems quite clear to me they are not even on the map yet), there is simply no way for KEYW to compete with FEYE long-term with that kind of R&D spending differential.

Furthermore, it's clear after even a cursory look that FEYE has a substantially better management team than KEYW. Let's look, for example, at FEYE CEO David DeWalt's biography (pulled directly from CapIQ):

Background: Mr. David G. DeWalt, also known as Dave, has been the Chief Executive Officer at FireEye, Inc. since November 28, 2012. Mr. DeWalt serves as a Senior Advisor of Silver Lake Partners. He is based out of the Menlo Park office of Silver Lake Partners. He has more than 25 years of experience building innovative, industry-leading technology companies. He has a strong record of driving revenue growth at startups, midsize, and large companies, and has helped create more than $10 Billion in shareholder value thru a series of CEO-led industry changing major acquisitions.

In 2008, he was named one of the top five CEOs of publicly traded software companies by Institutional Investor magazine. A recognized authority on cybersecurity, he appears regularly on nationally televised news programs, has spoken numerous times at the World Economic Forum in Davos, participated in panel discussions alongside world leaders, and serves as an Advisor to the critical government agencies amongst others. In May 2011, He was appointed by President Obama to serve on the National Security and Technology Advisory Council.

This is not even close, KEYW is simply out matched competing against FEYE. But I kept digging anyway and was surprised by what I found.

NetCitadel: Unaware HawkEye Even Exists while Beating KEYW at its Own Game

KEYW likes to talk about its Hawkeye G product, which supposedly has automatic threat detection capabilities. What the Street has missed, and which KEYW doesn't like to talk about as far as I can tell, is that another company beat Hawkeye G to the punch with automatic threat detection products. This company is NetCitadel.

Let's look at a few facts about NetCitadel:

NetCitadel has valuable partnerships with some of the leading cyber security companies:

From the company's own website we can see that NetCitadel is plug and play ready with some of the best security providers in the world:

Threat Response accepts security event information from existing detection solutions like Security Incident and Event Management (SIEM), Advanced Malware Detection (AMD) and Intrusion Detection Systems (IDS) and, based on the information in the security event, updates existing security devices to react to those security events in real-time. Examples of detection devices that already communicate with Threat Response with no additional coding include: FireEye, Palo Alto Networks, HP ArcSight, and QRadar.

(Notice KEYW, Hawkeye or Hexis are not mentioned…)

This partnership has been covered in press releases and is mentioned in FEYE's S-1.

The fact that NetCitadel and FEYE (among others) are partnered up begs a host of questions for KEYW investors:

  • Why wasn't KEYW chosen to partner with NetCitadel?
  • Does this negate the entire advantage KEYW claims to have over FEYE (R&D disparity aside)?
  • Can KEYW really be considered a revolutionary product if NetCitadel was founded in 2011, apparently beating KEYW to market by ~3 years?
  • Are these partnerships the reason KEYW has had difficulty ramping its Hawkeye G product?

Interestingly, even though NetCitadel appears obviously superior to "Hawkeye", NetCitadel was recently acquired by ProofPoint (NASDAQ:PFPT) for $24 million. PFPT has LTM revenue of $150m and spent $39m on R&D (26%). Although we don't know how much revenue NetCitadel had, it probably wasn't much for this price. The apparently low acquisition price raises substantial additional questions for KEYW shareholders:

  • Why is KEYW being valued like a cyber security business when it, too, has very little cyber security revenue? Apparently the acquisition market isn't awarding high valuations to such companies.
  • Would KEYW likely be worth even less than NetCitadel because it lacks these key partnerships?
  • Why did ProofPoint acquire NetCitadel instead of KEYW's cyber business?
  • Either NetCitadel has a low revenue base or trades at a low multiple of revenue - this is bad for the KEYW bull case, which is largely predicated on a high multiple of cyber security revenue.

Common sense would dictate none of these answers end well for KEYW shareholders, but I wanted to be sure so I called employees from NetCitadel to get their take. I was surprised to learn that the NetCitadel employees I spoke with had never even heard of KEYW, Hexis, or Hawkeye G. This tells you what little penetration KEYW has made into the cyber security market - not only is NetCitadel not even remotely concerned with KEYW, they don't even know who KEYW is!

Who exactly is backing NetCitadel? This is where it gets really interesting. NetCitadel was originally backed by New Enterprise Associates, a prominent venture capital fund with $13 billion of committed capital.

Furthermore, FEYE was originally backed by In-Q-Tel. In-Q-Tel is a not-for-profit venture capital firm that invests in high-tech companies for the sole purpose of keeping the Central Intelligence Agency, and other intelligence agencies, equipped with the latest in information technology in support of United States intelligence capability.

My recommendation is that anyone who owns or is thinking about buying KEYW stock owes it to themselves to get on the phones and talk to competitors - you're likely to get a much different view than what Wall Street's biased investment banks are telling you about KEYW stock.

This means that not only is the combined FEYE / NetCitadel partnership vastly larger with a much higher R&D budget than KEYW, it is also backed by the smart money with deep ties to the CIA. Given these facts, and other issues KEYW faces, what reason does anyone have to believe that KEYW could possibly compete with the FEYE / NetCitadel partnership?

I think after all of the above it's quite clear that KEYW shareholders are in for a rude awakening if they think this cyber business is worth much but let's keep going.

History of KEYW's "Cyber" business: What exactly is Hawkeye?

As I discussed in my prior report, KEYW was the buyer of last resort of Sensage, an asset that was sold at a loss by its initial VC backers and which was dropped before that by HP. Sensage now makes up a key part of the Hawkeye suite and has apparently been rebranded Hawkeye AP. Hawkeye AP claims to aggregate and prioritize threats and then Hawkeye G claims to try and eliminates them. Sensage "serves enterprises who use the software to capture and store event data so that it can be consolidated, searched and analyzed to generate reports that detect fraud." Sensage is what's known as a SIEM software product - Security Information and Event Management.

What is the history of Sensage? It used to be a key service provide to Hewlett Packard until HP acquired ArcSight and dropped Sensage. This was a real slap in the face for Sensage as Sensage was already integrated with some HP products and HP would have been highly familiar with Sensage's capabilities. So basically this acquisition can only be interpreted one way: According to HP, Sensage is not as effective as ArcSight.

From the blog link above, let's recap who the winners and losers were of this transaction:


  • ArcSight, of course.
  • Kleiner Perkins with about 20x on the investment; even CIA made some money (via In-Q-Tel)
  • SIEM players close to the top of the totem pole. All will now claim "ah, we are the leader now!"


  • Whoever was on the shortlist with ArcSight to be acquired by HP. Oops!
  • Current HP "SIEM" partner - this vendor now gets to add their own name to the list of failed SIEM vendors :-) Bummer! [Author's note: He doesn't even know Sensage's name! Oops indeed]
  • SIEM players close to the bottom of the totem pole. Even fewer people will buy your wares now, especially if HP discounts Express aggressively.

So naturally, the next logical step for Sensage was to sell itself to KEYW so its VC backers could exit at a loss - this makes sense for KEYW given their history of awful capital allocation, something I covered in my last report.

So for all of you who believe that Hawkeye is a revolutionary product, this is simply not true - Hawkeye is largely based around Sensage, a failed SIEM provider that was dropped by HP.

More concerning than that though, FireEye has partnered with ArcSight to offer an integrated product. FireEye wins again! And remember In-Q-Tel, the CIA VC fund? They were one of the original backers of ArcSight.

If we stop and put this all together:

  • FireEye is much bigger than KEYW and is growing rapidly
  • NetCitadel has a better threat protection system than KEYW according to FEYE (implied with the partnership)
  • ArcSight has a better SIEM product than KEYW (implied by HP's acquisition and FEYE partnership)
  • These companies are backed by leading VC firms and directly connected to the CIA venture fund

Not looking too good for KEYW. No wonder NetCitadel has never even heard of Hawkeye - why would anyone possibly pick Hawkeye in a head-to-head competition against NetCitadel / FireEye / ArcSight? Is this the cyber superiority that KEYW constantly touts? To me it is very clear that this is cyber inferiority.

So where does that leave us today?

KEYW needs equity badly and this capital raise, if even possible, will be highly dilutive

Those following the KEYW story closely know KEYW filed an S-3 on April 23rd to sell up to $150m in equity and this registration went effective on May 14th. In a prior report I covered in detail how badly KEYW needs equity in order to avoid bankruptcy. KEYW's urgent desperation to complete this filing along with the recent effectiveness of the S-3 means that KEYW could issue highly dilutive equity any day now, and in my experience companies typically do this as soon as possible after the effectiveness is approved by the SEC. The registration is a proposed maximum offering of $150,000,000 and if issued in full, would result in ~13.6 million shares at today's price, which would amount to a whopping 37% dilution for shareholders if you exclude potential warrant coverage.

Given the huge amount of dilution that is likely for KEYW shareholders, the stock would very likely get crushed on the announcement of this equity offering. I believe much of this capital would go to simply keeping the company solvent as KEYW needs to pay off its debt, so there is little upside for shareholders except avoiding bankruptcy (no reason to own this stock now).

KEYW will likely report 2Q earnings toward the end of July (last year it was July 31st). On the last conference call, KEYW's CFO guided for weak revenue in 2Q (recall that this conference took place on May 1st, which means KEYW would have had good visibility in 2Q results already) - 2Q is likely to be down 20% yoy in my estimation. I believe KEYW will do everything in its power to close the secondary before this conference call when the stock will likely be even lower than it is now.

KEYW is doing everything it can to try to keep its stock up before the dilutive secondary comes:

  • Chardan apparently attempted, but failed, to promote KEYW stock
  • Insiders are apparently trying to gain support by buying stock
  • The company issued a promotional, but ultimately empty, press release yesterday

Let's go through each of these one by one

In my opinion, Chardan is one of the lowest quality investment banks on Wall Street

Some of the questionable practices Chardan has engaged in have been written about extensively:

One author alleges fraud in some of the reverse merger China shells that Chardan helped support

One buy rated stock that Chardan supported was later delisted by NASDAQ

Various Chardan stocks have been written on extensively by credible short sellers here and here

These are just a few examples of alarming Chardan actions that can be found on the internet in just a few minutes - a more thorough discussion of Chardan's transgressions or alleged transgressions would likely take days or weeks to compile.

I believe it's very likely Chardan initiated coverage on KEYW to help support KEYW's stock price in hopes of winning the underwriting business that KEYW offers. We also know that investment banking fees for secondary equity offerings are fairly standard across the Street at roughly 7% of equity raised. This is not a price sensitive decision, it is a reputation decision. So for KEYW to have to go Chardan for help, that likely means none of the white shoe firms on Wall Street are interested in putting any of their clients into KEYW, even for a flat fee (and there's nothing investment bankers love more than fees!).

Remember, an investment bank plays both sides of a capital raise, both raising money for the company, and also finding buyers for the company's stock. A name-brand investment bank is incentivized from doing low quality deals because it means the top-tier clients that use the name-brand investment bank will be less likely to do repeat business.

Where are BofA and Morgan Stanley? After all, these are the companies that helped take KEYW public, according to KEYW's 2010 S-1 filing. The fact that these bulge bracket firms have fled the scene is very telling - this is known as the trade down effect, and it's representative of an equity declining in quality.

In fact, only some of the lowest quality "bucket shops" (in my opinion) cover KEYW stock now:

  • Drexel Hamilton
  • Noble Financial
  • Chardan
  • Suntrust Robinson
  • Sterne Agee
  • FBR Capital

As I discussed in a prior report, most of these underwriters have benefited from the $11 million in fees KEYW has paid Wall Street for the capital it has raised so far. These firms are hardly objective - and investors know this: the market shrugged off both recent upgrades from Chardan and Drexel. This is probably because the market knows how hard it has been for KEYW to raise equity in the past. Why the difficulty? KEYW has been a terrible steward of capital in the past and the market knows that.

KEYW insider buying is still below the level where insiders have traditionally sold stock

In a prior report I discussed how KEYW insiders have historically been sellers at this price level despite recent purchases

I checked KEYW's historic open market acquisitions vs. open market dispositions, per CapIQ data, in the $10-12 price range. As they say, "the numbers don't lie" - KEYW insiders, including Moodispaw, have purchased a total 35,000 shares in this price range and sold 195,400 shares. This is a staggering divide in dollar terms: I estimate, based on CapIQ data, that KEYW execs have purchased $396,823 and sold $2,233,622 in a similar price range over time, a startling 5.6-fold difference. Clearly, insiders would rather take profits at this level, historically speaking.

With the recent insider buys, these figures have closed slightly, but not enough to be meaningful and the market remains skeptical of KEYW's valuation - the stock has failed to convincingly hold $11 in recent weeks despite these purchases. Insiders have now purchased 67,000 shares according to current CapIQ data and sold 195,400 shares, or 3x as many insider sales in this range. This is no comfort to people who own the stock at this level.

In my opinion, yesterday's press release is another empty attempt to promote the stock in front of the equity offering

Yesterday's press release is long on hype and short on substance, saying virtually nothing. Here are the questions investors should be asking:

  • Which government agency? What does "initial delivery" mean? Is this a revenue generating contract or instead bookings with distant promises of possible revenue?
  • If it's a revenue generating contract, how much?
  • Is this a trial or a full blown contract? If it's a contract, how long will it last?
  • Why was this press release with such limited information issued now? If the contract is so material couldn't it wait until KEYW released more details?

In light of the impending secondary, I caution investors that empty press releases provide no downside protection in front of the avalanche of dilution coming to KEYW shares very soon. If this were a material contract, KEYW would have been required to file an 8-K with the details, something it has apparently not done.

Large shareholders have been selling stock

According to CapIQ data based on the March quarter (most recently available data), several large shareholders have been selling stock. I think it's likely some or perhaps even all of these shareholders have sold more stock since March 31st 2014 - this view is based on the KEYW stock chart, which has clearly been under pressure as lots of supply has come to market.

It can't be good when BlackRock, AllianceBernstein, Columbia Management and UBS are selling shares. These shareholders collectively have enough shares remaining (as of the last official 13F filing for each shareholder) to significantly impact the shares if they decide to completely exit KEYW stock.

I tried to contact management by email and phone for their comment but unfortunately did not receive a response.


  • KEYW remains a busted rollup that has mediocre returns on capital
  • The company desperately needs equity and the only solution is heavy dilution
  • Cyber revenue remains ~3% of total revenue: KEYW is NOT a cyber company
  • KEYW's "cyber" business is unlikely to ever amount to much in my opinion given superior competition
  • Large shareholders are losing faith and have been liquidating shares of KEYW

Reiterate STRONG SELL and $3.80 price target. Don't get caught in KEYW's hype and imminent avalanche of dilution or bankruptcy.

(Photo source)

Disclosure: The author is short KEYW. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. See website for full disclaimer