The Aladdin Knowledge Systems (ALDN)/Vector Capital deal continues to pose one of the more frustrating research and analytical projects in recent memory. While there appears to be a very mild sense within the industry and among some analysts that this transaction may be problematic from a competition standpoint, there does not appear to be a single source for decent market share data for the relevant U.S. or European markets. Furthermore, despite numerous attempts to contact competitors and industry analysts, no source seems willing, or able, to provide an assessment that we consider useful in projecting this deal's regulatory timing.

Therefore, it can only be stated yet again that the evidence available to this point clearly shows a direct overlap and exceedingly high combined market share (the specific market share remains a mystery) in the Software DRM niche, both in the United States and various European markets. Until this publication is able to obtain information from a reliable source that this proposed combination is insignificant in terms of competition, it must be assumed that the FTC/DOJ and the European Commission will conduct lengthy reviews.

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:

Q3 2008 Earnings Call

October 16 2008 9:00 am ET

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Internet

• China Finance Online Co. Limited, a Chinese online financial information and corporate data provider, will deploy Aladdin eToken PRO USB smartcard devices. The devices provided by Aladdin (ALDN) are enabling secure customer access to China Finance Online's StockStar investment analysis tools and services. Aladdin eToken USB smartcard devices will provide an initial 20,000 VIP users with strong, two-factor authentication for secure online access to StockStar accounts and could potentially reach over 500,000 StockStar users. China Finance Online's customers will gain enhanced security against fraud and identity theft while receiving proprietary financial information through a secure network connection.

Small Cap Stock Pick #1: Aladdin Knowledge Systems (ALDN)

ALDN broke out from the horizontal resistance mark around $10/share Monday on heavy volume in the face of a collapsing market. This breakout suggests a possible move to fill the gap in the low 13 area which implies a possible 30%+ potential gain here. Looking at ALDN's numbers, the company expects some very strong earnings growth, nearly 75%, in 2009, which is quite significant as we don't see these kind of estimates very often in this weak economy. Analysts are expecting $0.68EPS in 2009, which gives ALDN a future fair value among its industry peers of $16.10/share compared to its closing price of $10.17 on Monday. I'm long at $10.06.

Aladdin Knowledge Systems Ltd. (ALDN)

Q2 2008 Earnings Call

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• Gold: M3, a broad measure of U.S. money supply (see graphic), is growing at almost 15%/year (vs. a typical 5%), driving the dollar down. While some cite gold's already-high prices, McNay notes that at its peaks, gold has traded at the same price as the DJIA; right now it sells for 1/14 of the Dow. He recommends gold ETFs streetTRACKS Gold Trust ETF (GLD) and Market Vectors Gold Miners ETF (GDX). He also suggests owning Chinese yuan rather than U.S. dollars. As the yuan revalues upwards, it will offer protection against purchasing-power erosion.

The Ugly:

Aladdin’s stock started 2004 at $8.73, and then rose to $20 following the publication of its annual results for 2003. In November 2004, following the publication of its figures for the first nine months of the year, it reached a high of $32 and even edged slightly higher. It started 2005 at $25 and 2006 at $17.30. It now stands at $17.50, following the publication of its report for 2006. So despite a 62% increase in sales and a 420% jump in net profit from 2003 through 2006, the stock is currently 45% lower than its value following the results for 2003-04. Naturally, I have made the breakdown of its figures a tad simpler, but they still show that the correlation between performance on Main Street and share price on Wall Street is bent out of shape.

Something is wrong here. A company that has sales of $89 million and earns $14 million ought to be worth more than a company that has sales of $69.1 million and earns $8.7 million, no? But a company’s value lies in the market value of its shares, and in this case they indicate a 55% drop in company value. As Aladdin shareholders, you could raise your grievances about this with the CEO and management and tell them, “Guys, something is wrong here. You’re doing great work at the company, but what do we, the owners, get out of all this?

TWST: What's at the top of your favorite list at this point?

Upgrades:

If that is the case, what is it that sent Aladdin climbing above $30 a share in 2004, and then back down to its current price of $16? Moreover, what was it that lifted the share from $1 to more than $30 in the two years before the peak? True, this week’s sharp fall arose from investors' disappointment at the fact that the company missed its own guidance for the second quarter of 2006, but what has happened to the company that so animated the imagination two years ago?

One such example is Aladdin Knowledge Systems (Nasdaq: ALDN), which warned and then plummeted more than 20% in two days. It has already claimed that it did not have good sales in Germany because of the World Cup.

I see three possible reasons for Check Point’s sharp fall on Friday. The most logical of the three is the fear of a warning. Another reason could perhaps be the disappointment at the news that security company RSA Security Inc. (Nasdaq: RSAS) was snapped up by storage systems solutions giant EMC Corporation (NYSE: EMC), which may also be setting its sights on Check Point’s market. A third (somewhat weak) reason is the fact that Check Point was thrown out of the portfolio on the final day of the first half of 2006 by managers of large portfolios and funds who did not want it to appear in the semiannual reports that they will soon be circulating to investors. This possibility is remote, since Symantec Corp. (Nasdaq: SYMC) is another security company that has been a great disappointment this year and I didn’t see anyone dump it in a similar manner.

Morgan Stanley analyst Serhan Cevik discussed the rise of the Hamas and the upcoming election in Israel: