Stay With VDSI, Compelling Upside Potential For Patience

| About: VASCO Data (VDSI)
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Management remains conservative and somewhat opaque in its 2016 guidance.

Improving gross margins support our bullish outlook.

Strong Balance sheet and cash generation provide ability to growth with strategic acquisitions.



12- Month Target Price


VASCO Data Security International (NASDAQ:VDSI)

VASCO reported 19% lower year-over-year sales in the fourth quarter ending December 2015, but sales for the full year still represented a 20% annual increase as the Company completed its large order of authentication devices and software for the international financial institution, RaboBank. We reiterate our BUY rating on VDSI and set a new price target at $25.00.

52-Week Range

$13.00 - $35.00

Long-Term Debt


Shares Outstanding

39.8 million


0.0 %


26.3% / 50.0%



Public Float


Book Value/Share


Market Capitalization

$562.8 million

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Quarter highlights

Company Description

VASCO Data Security International, Inc. designs and markets hardware and software used to secure access to the information assets of banking, retail and other enterprises. The Company operates in fourteen countries in North America, Europe, Asia, the Middle East and South America. Revenue is generated through the sale of hardware, licenses of software and the provision of design and maintenance services.

Sales mix

Non-hardware products increased to 28% in the fourth quarter 2015 compared to 23% in the same quarter last year as card reader shipments to Rabobank wound down.

Improved gross margin

Gross profit margin in the quarter ending December 2015 improved to 66.1% compared to 56.6% in the same quarter last year, as the sales mix shifted to higher margin software products.

Acquisition integration

Leadership from recently acquired Silanis joined the earnings conference call to describe the lubricating effect VASCO with its strong balance sheet has had on Silanis prospects and contract negotiations.

Muted guidance

Management released guidance for 2016 sales and profit margins that implied low-single-digit growth in the authentication segment. Guidance appeared to conflict with simultaneous claims of record backlog and strong business pipeline.


We continue to look favorably at VASCO based on a consensus for double-digit digital security sector growth and positive developments for authentication technology.

Fourth-quarter and Year-end 2015 Financial Results

VASCO reported $50.9 million in total sales in the quarter ending December 2015, providing $3.5 million in net income or $0.09 per share. Sales declined 18.5% compared to the same quarter last year as a major contract to supply authentication devices and software to Rabobank came to a close. The strong U.S. dollar continued to impact reported sales, as the Euro and other foreign currencies accounted for 26% of total sales. The Company disclosed that in constant dollars, sales would have been $1.9 million higher than reported, a level nearer our estimate for sales in the fourth quarter.

Gross margin in the quarter was 66.1%, a significant improvement over previous quarters when lower-margin hardware products represented a larger portion of the sales mix. Operating expenses totaled $28.5 million, including certain one-time expenses associated with the acquisition of Silanis Technologies, which closed in November 2015 and an internal investigation into sales of certain of the Company's products to end-customers in a government-restricted market. Operating expenses were 56.0% of total sales in the fourth quarter compared to 38% in the previous quarter and 36.3% in the same quarter last year.

Performance in the quarter brought total sales for the year 2015 to $241.4 million. While the quarter comparison was unfavorable, sales for the full year grew 19.8% compared to the prior year when sales totaled $201.5 million. The boost in sales was primarily the result of the large order for authentication devices and software from Rabobank, which represented 12% and 30% of sales in the years 2014 and 2015, respectively. We estimate revenue attributed to Rabobank over the last two years totaled approximately $96.6 million. We note that while sales in the U.S. represented only 5% of total sales in FY15, as much as 78% of total sales were denominated in the U.S. dollar. Nonetheless, foreign currency rates related to the balance of VASCO's revenue trimmed $9.6 million from VASCO's reported sales for the full year 2015.

The gross profit margin for the full year 2015 was 60.5% compared to 63.4% in the full year 2014. The profit margin declined on the increase in lower-margin card readers as a percentage of the sales mix in the recent year. Card readers garner profit margins that are 25% to 35% lower than average non-hardware products. Card readers represented 36% of total sales in 2015, as the Company delivered on the order for upgraded devices to Rabobank. This compares to 25% of total sales for card readers in FY14.

Balance Sheet and Cash Flows

The Company did not provide a cash flow statement with the fourth-quarter earnings announcement. However, during the earnings conference call, management indicated operations generated approximately $69 million in cash during the year. The Company ended the December 2015 quarter with $78.5 million in total cash and an additional $45.0 million in marketable securities. We estimate the Company used approximately $85 million in cash to acquire Silanis Technology in November 2015.

At the end of December 2015, equity increased to $248 million, compared to $205.9 million one year earlier. The increase in shareholder's equity can be attributed primarily to the addition of the Silanis operation and the incremental cash flows generated during in the year. VASCO is capitalized exclusively with equity and has no debt. Return on equity was 17.4% in the year 2015.

Recent Competitive Developments

There are a number of players in the digital authentication sector. The group has shown considerable resilience against negative global economic forces, given the imperative to protect against cyber attacks and fraud. Demand conditions have encouraged new product introductions and service innovations. The sector has also continued to consolidate as the larger players like VASCO use acquisitions to expand product lines and capture market share.

One of the largest authentication market participants, Gemalto (GTO: Euronext) recently announced a new customer for its LinqUs Mobile ID platform. Nigeria's primary mobile communications network, MTN Nigeria, will be using the platform to give its mobile subscribers authentication options from their mobile phones. The system provides a universal digital identification code to use for secure web access, payments and other financial transactions. MTN Nigeria expects the platform to provide its customers with protection against identify theft and cybercrime.

Mobile security is the single focus of Telesign. The Gemalto LinqUs Mobile ID platform appears to compete directly with Telesign's Mobile Identity, which uses attributes of the mobile phone number, device identification and communications behavior to verify mobile transactions and online activity. In November 2015, Telesign announced a partnership with Swisscom, Switzerland's largest telecom service provider, for the purposes of helping Swisscom launch an identity service for their customers.

CA Technologies remains focused on the enterprise. In November 2015, the company introduced a new product group called CA Privileged Access aimed at businesses with multiple environments from cloud, to distributed computing to mobile to mainframe. The offering helps control user access to sensitive data and to protect against security breaches. CA Technology used the occasion of the new product announcement to make note of its Identity Suite and Advanced Authentication technology that can be used to two-factor authentication for end-customer access. This had been the most recent public news from CA regarding its authentication products since April 2015, when the company announced the adoption of CA's authentication technology by Grupo Financiero Banorte SAB de CV in Mexico.

neXus staked a new claim on the northern European, Scandinavian and UK market territories with the appointment of new sales leadership for the region. neXus offers a broad portfolio of IT security solutions, including identification solutions. In June 2015, neXus landed RobinsonsBank in the Philippines as a new customer for its PortWise Authentication Server, which provides two-factor authentication for application and service access. Demonstrating its market versatility, the same month neXus also announced the adoption of the same PortWise Authentication Server by L&T Construction, India's largest construction company.

Symantec (NASDAQ:SYMC) started out the year newly focused on cyber security. In January 2016, Symantec finally closed on the sale of its data storage subsidiary, Veritas, to private equity investor Carlyle Group. Symantec offers a multi-factor authentication solution, but its strength is in network security and cyber attacks. In June 2015, Symantec released the 14th Data Loss Prevention suite for data security in the cloud. The solution uses content-aware security technology to help corporations identify where their most sensitive corporate information is located.

We also note that several other players have achieved higher visibility in the authentication solution market, including DuoSecurity, Okta, Authentic8 and OneLogin, among others. We believe these companies have been attracted to the sector by developments in business and technology that are opening doors of opportunity for new innovations. For example, the work environment is becoming more flexible and there is increased use of mobile devices by employees as well as members of the supply chain. There are new digital business models such as on demand businesses that require customer and data protection through authentication. Perhaps most importantly there appears to be increasing awareness by the public of network security risks. This latter development bodes well for adoption of multi-factor authentication solutions that are welcomed by consumers.

In our view, the addition of new players in a growing and dynamic market should not present undue competitive challenge for a well-established player such as VASCO. The Company also has the benefit of a strong balance sheet that supports opportunistic and aggressive market strategies. We believe VASCO has the financial ability to address competitive challenge with new products or more aggressive marketing tactics.

Updated Earnings Model


Management provided guidance for the year 2016 along with the disclosure of year-end financial results. Sales in range of $205 million to $215 million for the full year 2016.

Potential follow-on orders from Rabobank near 20% of total original purchases of $96 million in 2014 and 2015, implying an incremental $19 million in sales in 2016. Gross profit margin in the mid-to-upper 60s and in line with gross profit margin recorded in 4QFY15. Operating profit margin excluding amortization expenses in a range of 10% to 12%, implying operating income near $26 million at the top-end of the sales guidance range.

During the conference call, chief operating officer Jan Valcke indicated in opening remarks that the Company is starting the current year with a "strong business pipeline." This appears to conflict with the guided sales range.

Sales guidance also appears to conflict with management's claims that VASCO ended the year with the second highest backlog in the Company's history. During the earnings conference call, management declined to provide the backlog figure and deferred to the future filing of the annual report for disclosure of the actual figure. We note that backlog at the end of 2014 was $113 million, which included significant orders from Rabobank for its authentication solution upgrade. The next highest backlog in the last five years was $56 million at the end of 2010. Thus, it appears 2015 backlog is between $56 million and $113 million.

We believe management's guidance implies loss of market share. Industry research firm Market and Markets released revised estimates for the multi-factor authentication market, pegging industry growth at 17.7% compound annual growth through 2020. Certain segments, such as mobile authentication and biometric identification, are expected to grow at slightly faster rates than the segment average. In our view, to maintain market share VASCO should be able to grow near the average industry rate. Excluding Rabobank from the mix in 2015, sales were approximately $169 million to all other customers. At a 17.7% growth rate, sales would be expected to reach $199 million if the Company is to retain its market share. However, assuming the top-end of the guided sales range of $215 million and excluding guidance for sales to Rabobank near $19 million as well as a contribution of $15 million from Silanis, the implied organic sales to all other customers are near $180 million. This dissection of management's guidance implies 6.5% growth in organic sales in 2016, excluding the Rabobank relationship.

Alternative Scenario

Investors might be frustrated by the apparent friction in management's commentary on the current pace of business and sales and earnings prospects. To provide an alternative view on VASCO's prospects, we are attempting an adjustment to our earnings model to reflect management's claims for "record backlog" and "strong business pipeline" rather than the guided range of $205 million to $215 million. Accordingly, we assume VASCO's authentication business grows at least at the average industry growth rate of 17.7% and apply this growth rate to 2015 sales excluding Rabobank, which were as noted above approximately $169 million. We note this growth rate is lower than the historic compound annual growth rate of 21% cited by management during the earnings conference call. Along with incremental sales from Rabobank and Silanis, we reach a revised sales estimate for 2016 of $234.0 million (from $249.0 million).

Management's guidance for operating profits in a range of 10% to 12% implies operating profits near $26 million at the high-end of the sales guidance range. This excludes amortization expense related to the Silanis acquisition. Assuming sales totaling $215 million and a gross profit margin of 65%, operating expenses would have to increase to approximately $114 million from $95.7 million in 2015. Of course, the addition of Silanis to the mix will add to operating expenses. Based on the first nine months of 2015, the Silanis operations spending is near $21 million per year at the recent revenue run rate. At this level for Silanis spending, the implied operating expenses excluding amortization of intangible assets would be approximately $114 million as guided by management.

Accordingly, we have also adjusted assumptions for cost of sales and operating expenses, to reflect recent operating performance and management's updated guidance for operating spending. Our gross profit margin is increased to 65% (from 60.0%) in 2016 and 2017. We also made adjustments to our sales and marketing and general and administrative expense assumptions. Based on VASCO's year-end balance sheet we estimate new intangible assets associated with Silanis were approximately $30 million, which may result in incremental amortization near $3.0 million per year over the next ten years. Excluding all amortization expenses our estimated operating profit margin is 18%, which is significantly higher than management's guided range for 10% to 12%. The higher estimated profits accrue from our higher estimated revenue level and the assumption of operating leverage on the elevated sales.

The combined results of the revised sales, cost and expense assumptions is net income of $28.0 million or $0.70 per share in 2016. Excluding certain non-cash expenses such as depreciation and amortization, non-GAAP net income is estimated at $36.0 million or $0.90 per share.

We have introduced for the first time our estimates for the four quarters of 2016. In the current quarter ending March 2016, we expect sales near $54.8 million, including a contribution from Silanis for the full three months. Sales are expected to provide approximately $6.4 million in net income or $0.16 per share. On a non-GAAP basis, adjusted net income is expected to be $8.4 million or $0.21 per share. Estimates for sales, costs and expenses for the full-year 2017 have also been introduced for the first time. We have estimated 15% top-line growth to $269.4 million, providing net income of $36.8 million or $0.91 per share.

Valuation and Outlook

Our price target of $25.00 implies a forward price-earnings multiple of 35.7 times our revised GAAP earnings estimate of $0.70. While our price target might appear unjustifiably aggressive based on the implied earnings multiple, we note that a discounted cash flow valuation approach results in an even more aggressive valuation target near $43.00.

Unfavorable year-over-year comparisons are likely to weigh on VDSI for several months as investors adjust their views on VASCO without the heady revenue from Rabobank. Management's sales guidance is also a damper on sentiment, as even the upper-end of the guided sales range suggests that the Company is struggling to maintain market share. We expect a period of price weakness in the wake of the earnings report while investors digest 2016 guidance. Management's conservative prognosis notwithstanding, the opportunity in authentication sector appears significant and VASCO has historically been able to capture a growing portion of the pie.

VASCO management's credibility might have been burnished somewhat by the unexpected testimony by a senior officer of Silanis during the earnings conference call. Silanis recently won a significant contract for its digital signature solution with one of the world's top banks. Although the proposal had been submitted prior to the acquisition announcement, the eventual association with VASCO facilitated the contracting process. Silanis was able to use VASCO's strong balance sheet with ample cash and no debt to demonstrate its ability perform. The bank also happens to be an established VASCO customer, giving Silanis a strong reference.

The ability of VASCO to facilitate market penetration by Silanis was one of the selling points for the Silanis acquisition. VASCO management did not disclose the value of the transaction in terms of revenue or profits. However, the example appears to prove out the acquisition strategy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.