KEYW Holding - Highly Overvalued, Risky, And A Rating To Sell

| About: KEYW Holding (KEYW)


Highly speculative, KEYW is an incredibly risky investment.

Extended short-term debt and a second public offering to pay down long-term debts.

John Kabrath, the chief financial officer of KEYW, chose to abruptly resign effective April 25, 2013.

KEYW does not have the ability to pay down its debts, if made necessary.


KEYW Holding Corporation provides cyber-security solutions to the United States government, national security agencies and commercial enterprises. KEYW focuses primarily on defense and analytics, and the corporation is segmented into two parts, government solutions and commercial cyber solutions. However, the KEYW's commercial cyber solutions arm only makes up approximately 3% of its revenue, and the rest lies solely in government contracts.

The company completed its initial public offering on October 1st, 2010. KEYW began trading on the Nasdaq. 2010 onwards, KEYW focused itself on making tactical acquisitions to break into geospatial intelligence, cyber security, cloud computing and other technology-based industries. KEYW's major acquisitions include Sycamore, Everest Technology and JKA Technologies. In 2012, KEYW heavily shifted its focus on cyber security solutions, and as a result, Sensage, Rsignia and Dilijent joined to further expand the realms of KEYW's cyber security solutions. Hexis Cyber Solutions was formed in July of 2013 to facilitate business IT infrastructure and provide a stronger defense against cyber threats.

Overview of KEYW Balance Sheet

The balance sheet for KEYW appears to be very weak. The total assets decreased within the last year by $14.82 million. The decrease is a result of a decline in cash, receivables and intangibles. If the total assets had stayed the same and the intangibles had decreased, that would have been a good sign for the company; unfortunately for KEYW, this is not the case. An alarming sign on the balance sheet is the high goodwill, at $297.48 million, however, this can be linked to the cost of intellectual property, as its acquisitions have all been technology firms. This goodwill can be traced to the major acquisitions of Sycamore, Everest Technology, JKA Technologies, Poole, Sensage, Rsignia and Dilijient. Furthermore, there is negative tangible equity. The tangible net worth of the company at the end of 2013 is negative, at $-26.59 million. Another alarming figure would be the incredibly low amount of cash KEYW is holding relative to its other assets, liabilities and shareholder equity. KEYW holds only $2.48 million in cash, and this appears to be insufficient to pay off any long-term debt.

In 2012, KEYW issued common stock worth $95 million in its second public offering. This diluted shares and led to a decrease in EPS. Share dilution leads to a decline in the value of the stock. The result for end of 2013 was a diluted earnings per share of -$0.29. The reasons behind KEYW's second public offering were to pay down long-term debt and acquisition costs of Poole & Associates Incorporated.

Income Statement Analysis

An analysis of the income statement shows strong revenue growth. KEYW had revenues of $288.91 million from government solutions and $9.82 million from commercial cyber solutions in 2013. The total revenue was $298.73 million, and an increase of $55.21 million from 2012. KEYW holds positive gross profits that have been increasing on a year-to-year basis. As the business of KEYW has grown, it is normal to expect an increase in operating expenses. In 2013, the operating expenses outweighed the gross profit and resulted in an operating income of -$9.85 million. The gross profit margin appears to be at 33.3%. The cause of the increase in operating expenses is due to a higher number of employees and office costs, which in turn, can be somewhat linked to KEYW's major acquisitions, such as Sensage and Poole in 2012.

The net income for 2013 is a loss, at -$10.63 million. This could be the result of major acquisitions, however, it appears KEYW's growth appears to be unstable and will continually lead to net losses in income.

Statement of Cash Flows

In the statement of cash flows, there is an increase in net cash provided by operating activities. In this criterion, we always look for an increased level of inflow. KEYW had a slight increase in 2013 of $1.1 million since 2012, but a solid increase of $4.8 million since 2011. The total cash flow from operating activities at the end of 2013 was an inflow of $15.1 million. This can be linked to a positive account receivable total in 2013, which implies that customers have paid more than the cost of the services they received. This increased cost of operating activities is concerning, at -$7.3 million, which is significantly higher than previous years. As of December 31, 2013, with amounts expressed in millions, KEYW Holding had net cash provided by operating activities of $15.1 (cash flow statement) and net sales of $298,732 (income statement). We can divide this, and the equation gives us an operating cash flow/sales ratio of 5.1%, or approximately 5 cents of operating cash flow for every sales dollar. This is incredibly low, and as a general rule of thumb, we want to have as high a ratio as possible.

The cash flow from investing activities has a decreased outflow from the previous year, which, in regards to technology firms, is not good sign. This was mainly due to decreased amount of money spent on acquisitions. This is generally a bad sign for investors, because high outflows of cash is required in investing activities to ensure competitiveness, maintenance of the company and need for tangible assets. In 2013, the outflow of cash was $15.7 million, whilst in 2012, there was an outflow of $142 million. Outflow in 2013 can be linked to investing activities, such as the formation of Hexis Cyber Solutions, which cannot match the level of 2012's cost of acquisitions considering Sensage, Poole and others. KEYW has made 13 acquisitions, and to this date, these have integrated poorly into the company. Aggressive growth is apparent in its assets, however, in that same time period, the operating income has declined, with an increase in operating expenses. Thus, the outflow of money into investing activities appears to be lost money.

The cash flows from financing activities had an outflow in 2013 of $2.6 million, which contrasts heavily with the inflow of $132 million in 2012. In 2013, KEYW used proceeds of $60 million from a revolving credit facility, proceeds from options and warrant exercise of $1.8 million to pay off debt of $64.6 million. Looking into the financials of 2012, KEYW used the second public offering and proceeds of $95 million to assist in paying off debt and fund further acquisitions, which resulted in an increased inflow of cash flow of $132 million. While in the most recent year, it is good that KEYW continues to pay down its debt, it appears to be funding the pay-down from proceeds from a revolving credit facility. If the markets become less liquid, this would cause severe problems for KEYW and its ability to pay off its short-term and long-term debts.

The overall net cash flow considering all activities was an outflow of -$3.1 million, as compared to the previous year's positive cash flow of $4.3 million

Liquidity analyzed through ratios

The average current ratio for KEYW's industry is 2.32; for KEYW to be a considered a financially strong company, it should be above the average. KEYW is far below the average, with a current ratio of 1.25. The ratio is used to assess KEYW's ability to pay back its short-term liabilities with short-term assets such as cash, inventory and receivables. KEYW's ratio is very low, but it is enough to pay off its short-term obligations, if necessary.

KEYW return on equity is -3.54%, versus that of the top 1500 large cap stocks, which is 10.3%

This negative return on equity shows that KEYW's unprofitable, because it does not generate a positive profit in regards to the amount of money shareholders have invested. A low debt/equity ratio would indicate a healthy balance sheet. We should compare the debt/equity of KEYW to the industry. The 28.31 total debt/equity that KEYW holds is considered acceptable when you consider the technology industry average of 125.41.

Overall Summary and Recommendation

KEYW Holding is not a transparent company, and appears to withhold critical financial data in regards to valuing the firm correctly. This can be exemplified by the lack of financials provided for major projects within Hexis Cyber Solutions, such as HawkEye. KEYW holds almost no cash and incredibly high goodwill, which shows that KEYW is in a difficult position to pay down its long-term debt and fund future necessary acquisitions to stay competitive. KEYW held a second public offering in 2012 for exactly these reasons, as it looked to pay down debt and acquire Poole & Associates Inc. While the revenue growth for KEYW has continued to impress, the overall net income was at a loss of -$10.63, which shows that the company's growth is unstable and the costs of running the businesses are beginning to outweigh the profits from the revenue. The cash flow statements of KEYW Holding show that the cash provided by the operating activities continues to be stable, with a positive inflow of $15,120. The cash flow had a decreased outflow of cash of -$15.7 million compared to the previous year, that is -$142 million. The change in outflow of investing activities shows that the company is not investing as much as it previously had in order to maintain its competitive edge, but this may be due to the change of focus on developing the in-house Hexis Cyber Solution projects, such as HawkEye. In 2013, the absence of any issuances of common stock or proceeds from term notes (short-term debt) resulted in an outflow of cash at -$2.6 million, compared to the previous year's inflow of $5.6 million. It is alarming to see that the company extended short-term debt and a second public offering to pay down long-term debts.

When analyzing the financial statements for KEYW Holding, it is clear that any investment would be purely speculative. There are no financials to support KEYW's current value, which somehow continues to increase. It is not surprising to see that John Kabrath, the chief financial officer of KEYW, chose to abruptly resign effective April 25, 2013. KEYW Holding is mostly likely benefiting from macroeconomic conditions with a need for higher cyber security with scandals regarding the NSA, recent commercial security faults with Facebook, Twitter, Evernote, NBC and Microsoft. KEYW Holding is unable to maintain positive stability with its net income, and by assessing the financials, it is clear that KEYW does not have the ability to pay down its debts, if made necessary; thus, KEYW is an incredibly risky investment. KEYW should receive a rating to sell, and anyone who chooses to invest in this stock should be bearish.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.