Analyze This: Aladdin Is Healthy

| About: Aladdin Knowledge (ALDN)

Take a look at Aladdin Knowledge Systems (ALDN). In 2003, it had sales of $54.7 million and an operating profit of $2.4 million with underlying profit coming in at $2.7 million. In 2004 it had sales of $69.1 million, a 26.3% increase on the previous year; an operating profit of $9.8 million, a 308% jump on 2003; and a net profit of $8.7 million, 222% higher than the previous year. In 2005 its sales rose 18.3% to $81.8 million, while its operating profit rose to $12.6 million and net profit rose to $12.4 million. Aladdin ended last year with sales of $89 million and net profit of $14 million.

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?

If you look at NICE Systems (NASDAQ:NICE), you will notice that it moved from sales of $224.3 million in 2003 to $416 million in sales in 2006, an 85% increase, while its net profit skyrocketed 704% in the same period. Its stock price rose sevenfold, from $4.4 at the beginning of 2003 to $32.80 today. NICE has risen almost continuously since 2004. So the question is, how is it that NICE has been on a relentless upward climb while Aladdin is constantly getting weaker? Is it because NICE earned or sold more than Aladdin? This would have been correct if, after 2003, Aladdin had risen less than NICE, but Aladdin has fallen and NICE has climbed, even though both companies are moving in the same direction on Main Street.

Could confidence in management be the reason? It apparently has something to do with it but this doesn’t make that much sense, since a study of the companies’ histories starting from the slump in 2002 can only lead to the conclusion that the management teams of both CEOs, Yanki Margalit at Aladdin and Haim Shani at NICE, have done a fantastic job, each in their own respective niches. No index can determine which of the two was better than the other.

This would appear to imply that the “blame” for the behavior of Aladdin’s stock should be laid at the feet of the investors, not the company’s business or management. But this too would be inaccurate, since how can the people who invested in Aladdin be accused of being different from those who invested in NICE? After all, in many cases, we’re talking about the same people. What is the factor that moves an investor to continue buying the stock of one successful company and suddenly sell the stock of another similarly successful one? No, it’s not the investors.

So who then is the force that makes the difference between Main Street and Wall Street? Who could cause such an inflated differential between the valuations of the two companies? The analysts, the investment managers, and the commentators, and I am not being derisive or scornful when I say this. On the contrary, these individuals -- who are investors themselves -- are undergoing the trauma of adapting to the new world that has been created with the revolution in technology and telecommunications. This leaves little time for absorbing information and short-term thinking.

Ehud Eisenstein, the extremely talented analyst at Oscar Gruss & Son, has just published an updated review of Aladdin. He has retained his “Hold” rating, and, on reading what he writes, his reason becomes clear. Eisenstein notes that Aladdin’s growth rate fell from 26.4% in 2004 to 8.9% in 2006, while the management talks in its updated guidance of growth of 6.7-14.6% in 2007. Eisenstein feels this range sheds very little light on the company’s forward expectations, and concludes that it will be some time before the company can be expected to return to a stronger rate of growth. In the same breath, he then praises Aladdin for its Q4 results, in which it again beat his top and bottom line estimates.

Eisenstein has raised his target price for Aladdin to $18 while reiterating his “Hold” rating. His report, and the company’s own announcement, lead me to conclude that its situation in 2007 will be an improvement over 2006. The stock price ranged from $14 to $24 last year, and I don’t think this volatility had anything to do with Main Street.

If you track the movement of Aladdin’s competitors, Check Point (NASDAQ:CHKP), Symantec Corp. (NASDAQ:SYMC), SafeNet Inc. (SFNT) and others, you will find the movement is strikingly similar. The conclusion from this is that in spite of the difference between them on Main Street, this group is moving in a uniform fashion on Wall Street, although Check Point is not selling at the expense of Aladdin, or vice versa.

So the key question, essentially, is not if the company is better or worse than it was in 2004, or whether or not the current low represents a buying opportunity. What people should be asking is, why is this happening at all? I am going with the other recommendation for Aladdin, published by CIBC analysts Shaul Eyal and Manish Hemrajani. They have rated the company “Buy” with a target price of $20.

ALDN 1-year chart:

Published originally by Globes [online], Israel business news -
© Copyright of Globes Publisher Itonut (1983) Ltd. 2007. Republished on Seeking Alpha with full permission.

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