Ability's Achilles' Heel

| About: Ability Inc. (ABIL)

Summary

We are sharing the results of our in-depth investigative report on Ability Inc. and our opinion on the company.

The marketability of ULIN may be severely challenged by major (undisclosed) shortcomings of the product.

Sales of legacy products appear to be collapsing and serious legal liabilities may be looming.

Based on our findings, shares are overvalued and not worth above book value, implying 84%+ downside.

Our Investigative Research Team has conducted an in-depth inquiry into the prospects of Ability Inc. with particular focus on ULIN, its would-be "game changer." Our research uncovered a number of critical issues that, in our opinion, doom the success of the product from the start as well as the future viability of the company.

Disclaimer

This publication represents the current opinions of the author concerning Ability Inc. Funds and accounts managed by the author currently have short positions in Ability Inc. Although the author does not expect to announce in the future any changes in either its opinion concerning or economic interest in Ability Inc., both are subject to change. This investigation research is for informational purposes only and does not constitute investment advice or a recommendation to purchase or sell any particular security or to pursue any particular investment or trading strategy. The author cannot guarantee that any projection or opinion expressed in this publication will be realized. The author's opinions are based on the sources cited in this article, but the author cannot and does not provide any representations or warranties with respect to the accuracy of those materials.

ULIN's Conspicuous Fingerprints

We have performed an in-depth due diligence on Ability Inc. (NASDAQ:ABIL), a public Israeli company selling mainly security and surveillance equipment to various government entities around the world. The stock has recently dropped 60% in a few days following a major accounting restatement and the withdrawal of 2016 guidance only a few month after the company went public.

The result of our analysis suggests that Ability's so-called legacy products may be undergoing a rapid decline due to decreasing demand and commoditization. Moreover, despite the company's enthusiasm, its latest addition to the product pipeline, a tool to intercept mobile calls anywhere from anywhere in the world named ULIN, seems to have a number of critical flaws that, in our view, make it unlikely to be a commercial success. In our opinion, the company has failed to disclose adequately these flaws to investors.

Finally, ABIL recently announced that a class action lawsuit has been filed against it for making false and misleading statements to investors and there are potential risks deriving from its conduct vis-à-vis the Israeli export regulations mandated by the Ministry of Defense.

Despite the recent price drop, shares are still trading at 6.5x book value; a multiple, that in our opinion, is unjustified given the uncertain prospects of the company.

Methodology

We have been investigating Ability Inc. for approximately two months. Our analysis consisted in comprehensive "desktop" research - information that has already been published - as well as a thorough field investigation. We have examined a considerable amount of non-confidential material on Ability, its industry and the technology it claims to use. We have also approached and interviewed a significant number of parties especially within the Israeli security & surveillance industry, including consultants, competitors, end users (e.g. former intelligence officers and analysts), electronic engineers and even well known "good" hackers and privacy activists.

We have conducted our investigation in full compliance with the law and have therefore refrained from approaching any personnel related to the company, its advisors or any person whose status or function with the company gives him access to 'inside information'. Please note that we succeeded in obtaining information from a wide array of sources and that most sources provided their contribution for free.

As a result of our investigation, we assume that we have gained a very accurate understanding of the company and its underlying market potential, as the information we compiled from our sources almost always collimated to the same conclusion.

Company Description

Ability Inc. is an Israeli defense company providing security, control, surveillance and detection equipment, it is headquartered in Tel Aviv and counts 19 employees. It went public in December 2015 by SPAC deal and is headed by Mr. Anatoly Hurgin, a naturalized Israeli citizen of Ukrainian origins with an extensive background in military intelligence. Mr. Ari Levin and Alexander Aurovsky serve as CFO and CTO (Chief Technology Officer) respectively.

Ability's main product lines include equipment to intercept and decipher cellular communication as well as to perform geolocation i.e. determining the geographical position of a target at any given time. The company markets its products to government entities around the world, including police forces and intelligence agencies.

Ability trades on both NASDAQ and the Tel Aviv Stock Exchange under the symbol "ABIL" and has a market capitalization of approximately $112m.

ABIL past and consensus sales: note the massive increase projected by analysts for 2016 & 2017

Recent Events

Following its SPAC deal, Ability was floated for around $9.5 per share giving it a market cap of approximately $240m, which raised many eyebrows within the industry as many found it not reflective of economic reality (1).

The stock price declined slightly during the subsequent five months, but then collapsed suddenly when the company reported its 2015 4th quarter earnings on May 2nd, losing as much as 57% in just a couple of days with a low of $2.8. There were two reasons we identified for the fall: first, the company announced a set of material accounting restatements for the previous two years (2). Second, the company withdrew their 2016 guidance citing uncertainty with the pricing and revenue model of a new product named "ULIN"(3).

In the subsequent quarter (1Q 2016) revenue decreased as much as 68% from a year earlier, with Ability reporting a net loss. During its earnings conference call, and in response to a question from one of the participants, the company admitted that even the little reported revenue in the quarter actually originated from a 2015 contract. To our understanding, that means that, so far, in 2016 ABIL failed to generate any new sources of revenue.

Perhaps surprisingly, the stock reacted positively to the news and appreciated significantly during the earnings release day and in the subsequent few weeks. We believe this renewed investor enthusiasm is a direct result of the narrative spin that management has given to the entire situation as well as to the prospects for its latest product: ULIN.

Ability price chart. Notice the sharp drop in my following restatements

Management's Version

As far as the accounting restatement is concerned, we got the impression that the management has downplayed the event and attributed the issue to bona fide accounting mistakes. The company has initiated an internal investigation and it will be interesting to see what their findings will be eventually.

As far as the steep fall in sales and profit in the first quarter of 2016, we feel that ABIL has been vague. From its statements, management seems to imply that sales of legacy products have slowed down as a result of the introduction of their new product ULIN:

As our strategy evolves and focuses more on ULIN sales, we believe our growth and revenue in 2016 will be more dependent on ULIN than we previously expected, we expect this solution, deployed using a SaaS model, will benefit Ability and its shareholders in the long-term, reducing quarter-to-quarter volatility in our revenues and profits by increasing recurring revenue and helping expand overall margins. However, in the near term, this accelerating shift to a new solution is significantly reducing our revenue visibility.

More importantly, management seems to imply that ABIL is on the verge of a critical positive transformation, thanks to the introduction of a new, game-changing product: ULIN, a real breakthroug,h if we are to believe recent statements on press releases and conference calls:

"a disruptive game changer"

"a solution that we believe no other provider in our industry can match"

"generating client interest beyond expectations"

"adoption faster than expected and accelerating"

In other words, the recent slowdown in sales could be just a temporary consequence of the shift from legacy product to ULIN, which is expected to succeed beyond all expectations.

But what is ULIN? According to management, ULIN (Ultimate Interception) is a revolutionary system to intercept mobile communications with the following distinctive characteristics:

  • Can intercept GSM calls anywhere, with no need of proximity to the target.
  • No need of consent of mobile operator.
  • Target's phone number is the only input required.
  • Can intercept encrypted calls.
  • It operates by hacking into the SS7, a protocol used by mobile networks to communicate with each other.

Perhaps given the sensitive nature of the product, ABIL does not disclose much else about the system. It is important to understand how ULIN would differ from ABIL's legacy products. The latter essentially consist in suitcase-sized devices connected to a laptop that allows direct interception of mobile communication. However, these systems require proximity to the target, at a distance of a few hundred meters at most. On the other hand, ULIN would differ as it can be deployed from anywhere and does not require any physical proximity at all, arguably a powerful advantage over legacy systems.

On Secrecy And Lack Of Transparency

According to some of the people we approached in our inquiry, going public is a bad idea for companies in this field. The electronic security & surveillance industry is inherently secret and, in our opinion too, it is incompatible with the level of scrutiny and transparency required of a public company.

In fact, clients are typically secret as they are often law enforcement or intelligence agencies. Product technology is secret, since disclosing it might tip off targets or their infrastructure on any weaknesses in their defense. In addition to this, companies are typically wary of disclosing details about their employees, competitors and the legal environment in which they operate. Due to the above, most companies in the sector choose to remain private.

In light of this, we were quite surprised to see a recent article published on Forbes (4) featuring an interview with ABIL's CEO Anatoly Hurgin and providing significant insights and details about ULIN and the network flaws that would allow it to operate. In our opinion, the information contained in the article might well alert the networks to the vulnerabilities of their infrastructure and prompt to accelerate their efforts to secure them. As one of our sources put it:

"in this domain there is such thing as bad publicity: the article was complimentary, but it did detail the problem with ABIL. This will create a lot of pressure from privacy activists, raising the awareness on the pipes through which ABIL is acting. So, the problem is that now those pipes can be either narrowed down or completely shut down. As long as nobody is aware of this issue or as long as they don't have their nose "pushed into it" people tend to ignore it because of inertia. If you take a look around, you will see that other vendors in the market tend to shut up in order not to attract attention. The more you talk about your product the more your targets understand how you have been using them and the more technology vendors understand how you operate through them and they tend to close you down. The Forbes article essentially explains enough on the product to serve as a blueprint on how to close down the security loophole." - Security consultant interviewed by our research team

Perhaps, management was so desperate to support ABIL's stock price in the short term that it was ready to jeopardize the long-term success of its product by contributing to this piece by Forbes.

On The History of ULIN

Management has been vague as to the origins of ULIN technology. Based on official statements and conference call, we were unable to determine how old was this technology, whether it was developed in-house, whether it originates in Israel or abroad and who were the people/entities responsible for its development. Fortunately, we believe we found satisfactory answers to these questions thanks to our deep due diligence.

According to our findings (5), the core components of ULIN technology were indeed developed in Israel, not by ABIL, but rather by one of its competitors, a company named ****. Essentially, they found a way to hack into the SS7 protocol using one of its vulnerabilities and developed an infrastructure to do it consistently. Initially they were interested only in Geolocation (6), but then noticed that they could use the system to capture call content as well. After testing the system, the developing company decided that while Geolocation was apparently safe and viable, intercepting calls using this system was dangerous (for the reasons we shall see later), so they set the project aside. According to our sources, Mr. Anatoly Hurgin approached the **** partner and offered him a large sum of money in order to resign and deliver the newly-developed technology to Ability: the partner agreed and now Ability is attempting to commercialize the product, apparently encountering some difficulties due to ULIN's inherent vulnerabilities.

ULIN Achilles' Heel: Fingerprints

This is arguably the most important part of our report: while on the face of it, ULIN looks like a valid product with excellent market potential, according to our sources, it has potential issues that seriously question its viability and on which Ability has been remarkably silent: ULIN can be easily prevented, detected, and leaves permanent traces.

ULIN works by hacking into the SS7 protocol, a kind of shared language that mobile networks use to communicate with each other and allow mobile calls across networks. After hacking into the system, ULIN directs it to invite a third-party number into a conference call, which is then used to listen surreptitiously to the call. The system sounds brilliant in its simplicity, but unfortunately, it seems to have a number of major drawbacks.

First, most modern networks are able to detect the kind of intrusion used by ULIN to operate. Interestingly, we learned that many networks are primed against this kind of attacks not only out of concern for the privacy of their subscribers, but also because to the network operators the SS7 hack looks like an attempt to steal phone calls, thereby affecting their bottom line.

Second, ULIN leaves "massive traces that remain forever" (7). As far as we understand, because ULIN works essentially by directing a conference call to a third party number, the existence of the call is recorded forever into the network's logs, probably including sensitive information such as the listener's location, etc. This information, when reviewed, can easily prompt the network to shut down the flaw, report the intrusion to the authorities and finally take countermeasures. This leads us to the third issue: networks installing an SS7-firewall can easily prevent the ULIN hack. These solutions are readily available on the market and we learned that 20% of networks have already installed them, with another 30/50% expected to do so in the near future. So, networks appear to be well aware of the issue and the trend is for them to quickly close the gap.

"I can tell you that the list of products that already prevent this [SS7 hacks] is pretty competitive and there are at least 15 solutions right now all of which can prevent this and they are fiercely competing for network attention." (8)

ULIN's Market Potential

As we saw in the earlier sections of the report, ABIL's management sounded very enthusiastic about the market prospects for ULIN. Based on the shortcomings of the product identified in the prior section, we were more skeptical and tried to come up with what could be a more realistic assessment of ULIN's marketability. Without exceptions, every single source we interviewed on this subject assumes that ULIN's market potential is very limited at best.

According to our sources, due to its conspicuousness and the traces it leaves behind, ULIN (as it currently operates) is effectively unusable in most countries except for conflict zones and, perhaps, very under-developed geographical areas. In conflict zones, due to the inherent turbulence of war, networks might be essentially "too busy" to detect SS7 intrusions, allowing maybe ULIN to work. In all other areas, especially in Western countries, the product would be virtually unusable. (9)

Anybody remotely familiar with how intelligence agencies operate will understand their reluctance to use a system that can be easily detected and whose traces might not only lead back to you, but also alert your target of an ongoing surveillance.

So, leaving out Western countries, who else could be interested in using this system?

Local police forces: we doubt these could be significant customers for ULIN. Police forces virtually in any country have legal access to telecom networks (provided they have a warrant) and typically do not need to hack into any system.

Intelligence agencies: serious intelligence agencies often have their own gear and should be reluctant to use a system with the technical limits discussed above.

Private entities: based on our conversations with privacy activists, we are of the opinion that call interception systems may not be legally sold to private entities (corporations, individuals, etc.) so they should be off limit. (10)

Ability's Piper Dream: Sales To The United States

ABIL has frequently expressed its intention and expectation to sell its products to the United States. Without exception, we have been told by our sources that this is highly unlikely, if not utterly impossible. Again, selling to private entities would be illegal, so ABIL could target only federal or local law enforcement agencies.

The first problem is that US agencies (as well as those from most other Western countries) are barred from acquiring foreign intelligence technology, if they can develop or acquire it within their own borders. Clearly, using foreign technology for a spy agency can be unacceptably risky. Now, as much as ULIN might look to an outsider like state-of-the-art technology, our sources tell us that Western agencies have at their disposals technology that is far superior to ULIN in terms of scale, capabilities, conspicuousness, reliability, etc. and that these technologies are strictly developed in-house. The odds of say, CIA or FBI or MI6 acquiring ULIN or ULIN-like products are, in our opinion, effectively zero.

This leaves local law enforcement agencies like, say, NYPD or LAPD or similar. Again, these entities would give priority to US technology. Furthermore, police departments across the US have legal and effective access to the networks without needing any hacking devices.

Based on the above, we are of the opinion, that ABIL's stated intention to eventually market its product in the United States might stem more from a desire to support its stock price rather than by commercial reality.

Pricing Model And Pricing Power

According to our sources, ABIL initially tried to sell ULIN "on premise" rather than "SaaS" to borrow some cloud terminology. In other words, they tried selling the entire infrastructure for a price ranging between $5m and $20m per unit (11). Competitors claim that ABIL has encountered some difficulty persuading clients to pay as much as $20m for a product with the inherent weaknesses listed above (12). Therefore, the company started offering a pricing model based on usage intensity, presumably billing per number intercepted or similar drivers.

We have yet to receive any indication that this pricing model is gaining traction, in any case, we wonder how can ABIL's sales, currently at a yearly rate of $38m, be expected to increase to $104m (13) within 18 months by selling to a few developing countries and charging a small amount per call. For example, we heard that Geolocation services today might sell for as little as $30 per query (14).

Legacy Products

So far, as far as we understand from recent press releases, ABIL is yet to conclude a single sale of ULIN. That means that all the revenue generated derives not from ULIN, but from its legacy products. These include, among others, suitcase-based systems for tactical interception that requires proximity to the target to function adequately. The latest quarterly reports show legacy sales decreasing a jaw-dropping 68% year-on-year, but why is that exactly? In our opinion, ABIL did not sufficiently address this question in its conference calls and press releases, but it has been more specific in its annual report:

"Since the introduction of ULIN, while we have continued to offer our existing cellular interception solutions and products, we have experienced a significant decline in sales of our existing portfolio of products within the cellular interception category, in part due to customers electing to put a hold on any potential purchase orders for similar products to wait for the fully developed products based on a newer technology." [2015 20-F, page 8]

While it is indeed possible that some existing clients are indeed postponing their purchases of legacy products due to ULIN, we are skeptical that this explains the bulk of the drop because ULIN and legacy products should appeal to different end users. The way we interpret it, ULIN's advantage (if any) would be the ability to intercept calls remotely. While legacy products would be preferable to ULIN because they don't leave the same "massive" traces that ULIN does. In other words, a logistic advantage vs. a security advantage. It follows that the two products should answer differ operational needs and should not cannibalize each other excessively.

If we are right and that is the case, the massive drop in legacy sales must have other reasons. Our sources tell us that the culprit is a known phenomenon in any hardware-producing industry: commoditization. As far as we have been able to understand, ABIL's legacy products are widely available from several other suppliers and do not have any special reputation for quality or reliability. Indeed, one of our sources referred to such products as "clunky." (15)

We understand that the deciphering ability of these products is instead more appealing, but even that is becoming rapidly commoditized.

Competition

In its official communications to investors, ABIL has been consistently emphasizing the uniqueness of ULIN technology:

"We offer the innovative ULIN solution, which we believe no other provider in our industry can match, giving us increasing confidence that we are on a path to a solid 2016"(16)

We have thoroughly investigated these claims with our industry sources and are of the opinion that they are highly dubious. Here is a summary of our findings:

  • There is nothing new with exploiting the SS7 protocol in itself: intelligence agencies and other companies have been doing it for years.
  • There are several competing companies providing Geolocation services leveraging the SS7 protocol (17).
  • It is less clear whether there any are commercially available products supplying voice call interception through SS7.

The last point is remarkable and, on the face of it might corroborate ABIL's claim of uniqueness. However, we believe that the true story is more complex than that. Based on our conversations with industry experts, the technology used by ULIN for its SS7 hack and voice interception is actually quite simple, not patent protected and readily available to a number of competitors. In our opinion, and based on our research, it seems that the reason why there are no competing products advertised yet, is not because of difficulty in developing the technology, but rather because the system might be dangerous and cannot be used reliably due to the traces it leaves behind.

Other people we contacted are quite confident that competing companies in fact do sell SS7 voice interception products, but they are simply not as bold as ABIL, which has the guts to advertise it overtly. (18)

We have also found several sites and blogs on the web confirming that companies other than ABIL are indeed marketing SS7 hacks, probably including voice interception. (19)

The technology is readily available and nothing special, we just decided not to use it because it's very dangerous […]. So far only ABIL have the system, but it's not a problem, anybody who knows SS7 can easily develop the same capability to listen to voice calls. (20)

I would definitely discredit them [ABIL] on the fact that [ULIN] is very valuable. nobody is going to pay $20m for it. i paid my guys $100k and they recreated this entire system [for network testing purposes]. you are not going to pay so much money for something that is so easy to duplicate. (21)

As far as development costs, I agree that it's about $100k to develop home-made and maybe $3/400k for development by a serious company for commercial use. The critical thing is the ability to hack into the networks, which is not so simple, but it's doable. So, there are some barriers, but all the companies mentioned (Circles, Rayzone, Verint, etc.) have the capability to do exactly the same. (22)

Bottom line: ULIN technology might be easily replicable, cheap to produce and might already be sold commercially by a few competitors.

Legal Issues

As if the serious doubts we have raised so far on the commercial viability of this company were not enough, we believe there are a number of legal liabilities pending over this company, some of which are, in our view, potentially very serious.

  • Ongoing class action lawsuit for issuing false and misleading statements to investors and weak internal control which was filed on 25 May 2016.
  • Possible trouble with the Israeli Ministry of Defense and the API regulations regulating the distribution of sensitive Israeli technology.
  • Possible repealing of the so-called"Brokers Law," allowing Israeli companies to sell technology to third parties.
  • Possible lawsuits for failing to disclose the shortcomings of the ULIN product hypothesized in this report.

Let us review each of the above issues a little closer:

Class Action: It is sufficient to check the newsfeed of ABIL stock to notice how most of the latest news are crowded out by countless announcements of a pending class action lawsuit. This is the result of ABIL's recent accounts restatement and a number of alleged misleading statements to investors. It is hard to assess how long or how painful the legal process will be for ABIL, but if history is any guide, we are of the opinion that you are likely to see this issue casting a shadow on the company for years and the threat of sizeable damages.

MoD and API regulations: Given Israel's delicate position as both a country under constant security threat and a fine producer of sensitive military technology, it is not surprising that the government is careful in regulating the sale and transfer of such technology from the private sector to third parties. According to our understanding of the law, if you are an Israeli seller of Israeli sensitive technology, you must receive a license from the MoD before you are allowed to export. The MoD has the power, inter alia, to decline the application for license or to approve each individual sale down to the single end user and to scale down the technical specifications of the product being sold. Now it is unclear to us whether ABIL's legacy products are considered Israeli technology and are therefore subject to the export licensing requirements. What is clear, is that from the company's own statements it can be inferred that there was some ambiguity as to whether ULIN was considered Israeli technology or not from the start:

"After a lot of consideration, we decided this [licensing from a foreign entity] infrastructure. If we had decided to keep ULIN an in-house product, the export restrictions would have been unpredictable and we could have ended up with Ability to be able to sell only to 3 or 4 countries around the world. During the latest trade show [last September] it was not decided yet how we were going to introduce ULIN […]. Everything could have been done under the umbrella of Ability in Israel." (23)

- Anatoly Hurgin

What is Mr. Hurgin talking about exactly? Basically ABIL declared on multiple occasions that ULIN technology is licensed from a third party abroad with an exclusivity agreement expiring in 2018. (24)

Apparently, ABIL decided to choose a licensing structure rather than keeping the product in-house, because the former would allow them to avoid the heavy MoD limitations on exporting the technology. This raises two important points: first, because the technology is licensed and not proprietary, ABIL would be at risk to lose its supposedly premier product if this license is not renewed by the foreign entity as soon as 2018. Second, and more worryingly, if ABIL had the choice to keep the technology in-house, could it be that the MoD might decide at some future date that ULIN is Israeli enough to fall under MoD export rules? By the company's own admission, this would be catastrophic as "we could have ended up with Ability to be able to sell only to 3 or 4 countries around the world."

Brokerage Law (25): According to our understanding of Israeli law, Israeli companies are exempted from certain export regulations if they are selling non-Israeli technology to third countries, just as ABIL seems to be doing with ULIN. Most of the sources we approached told us that the law might be on the verge of being modified in a way that would allow the Ministry of Defense to regulate sales or broker foreign technology the same way that it regulates Israeli technology. Again, if that were to happen, it would be fair to assume that ULIN's market would be severely restricted.

Shortcomings of ULIN: We believe we have made a rather convincing case on some important technological, marketing and legal weaknesses of ABIL that, in our view, have not been disclosed adequately by ABIL. If ULIN sales were indeed to prove below expectations and these weaknesses were to come to light, we would not be surprised to see further class action lawsuits for misleading investors.

Finally, we feel it is important to point out that some of our sources believe that ABIL has a reputation for being quite "aggressive" with its choice of clients and may have sold its products to unauthorized entities, including non-government ones. However, it should be emphasized that we have failed to uncover any hard evidence in this respect and do not have enough data to form an opinion on this particular claim.

Corporate Governance

Ability Inc. has only 3 executives apparently, Mr. Anatoly Hurgin (CEO), Mr. Avi Levin (CFO) and Mr. Alexander Aurovsky (CTO). Mr. Levin is the only one of the three who shares some information on his biography. We understand that Ability is his first CFO position and that he has covered various positions at Credit Suisse, PWC and at another US-traded company called Broadridge.

There is very little information on either Mr. Hurgin or Mr. Aurovsky. According to a recent article published on Forbes, both have significant experience in the IDF, apparently as electronic engineers. The sources we contacted, in general, speak well of Mr. Hurgin, who has been described as smart and impressive. These same sources, however, speculate that Mr. Hurgin might be seeking to exit the industry and therefore, the merger might constitute, in our opinion, a convenient way out. It is important to point out that, as we understand it from the ABIL official reports, Mr. Hurgin and Mr. Aurovsky have cashed out approximately $18m upon the SPAC deal that brought ABIL public. They still retain a significant ownership in the company controlling some 68% of shares and will be able to dispose of their stock at the end of 2017, after a 2-year lock-up.

Valuation

In our opinion, valuing ABIL certainly poses a challenge for many reasons. It is hard to trust the accounting given the recent restatements, earnings tend to be volatile due to the project nature of ABIL's revenue and clients tend to be concentrated. In addition to this, as we saw, revenue originating from legacy products seems to be in the middle of a ruinous collapse, with a recent drop of 68% year on year. Future revenue, by the company's own admission, depends largely on the success of ULIN, on which we have serious doubts given what has been uncovered in this report.

Even if ABIL were successful marketing the product, something we strongly doubt, we struggle to see how the company is to meet analysts' sales expectations, which forecast $104m of sales by the next 18 months. ABIL says they have clients in about 50 countries. Assuming legacy sales become negligible (as it sure looks like), then ABIL would need to sell on average as much as $2m worth of ULIN to every single client on its list every year (50 countries X $2m) to meet expectations. In our opinion, this is close to impossible.

Finally, there are potential legal liabilities looming, the extent of which is impossible to quantify. In light of this, and considering we are talking about a company without any significant IP assets or significant proprietary know-how, in our opinion, it is hard to assign to ABIL more than a book value valuation, i.e. $0.69 per share (implying 84% downside) or less, if legal liabilities turn out to be material.

Is there anything valuable within the company? According to our sources yes, the company's main valuable assets are its clients. In this industry, the trust deriving from repeated business is paramount, as sensitive government clients clearly prefer to do business with a known and trusted entity, due to potential security risks inherent in this industry. It follows that ABIL's network of trusted clients is worth money, but whether the $100m+ valuation is justified based on this is highly doubtful, especially if the senior management (who holds the key to such clients), is indeed on his way out.

Conclusion

Based on the analysis above, we are of the opinion that ABIL shares are risky business. ABIL's product portfolio essentially includes two main product lines: legacy and ULIN. The first one appears to be in ruinous decline, the second has yet to receive commercial validation, but its future success seems highly dubious given the alleged product flaws, its limited market potential and the likely competition. Moreover, we perceive ABIL to be subject to serious legal liabilities given its outstanding lawsuits and its possible conduct vis-à-vis the Israeli export regulations. Finally, absence of any significant IP or other intangible assets makes it hard to justify the current valuation of 6.5x book value. Therefore, we would not be surprised to see a major price collapse as the market reassesses the future potential of the company.

Appendixes

Exhibit 1: A Google search for "SS7 firewall" returns almost 2000 results!

Exhibit 2: Recent Forbes article on Ability

Exhibit 3: Recent investigative blog that appears to suggest that Ability's competitor Circles Bulgaria is also engaging in SS7 activity possibly involving voice calls.

  1. Several industry sources interviewed by our research team.
  2. [...] "restated to reflect corrections of errors with respect to previously unrecognized commissions due to a vendor […] improper allocation and timing of revenue recognition […] and previously unrecognized commissions due to a third party on cost of revenues". Source: ABIL official press release.

  3. "this accelerating shift to a new solution is significantly reducing our revenue visibility. Until we have clarity on the sales cycle, and a better understanding of the timing and implementation for a relatively small number of larger deals on an entirely new solution, we cannot provide a forecast for 2016 and we are not reaffirming the forecast for 2016 previously provided in connection with the business combination". Source: ABIL official press release.
  4. Yahoo Finance
  5. Interviews with industry players, who does not relate to Ability nor has an access to an 'inside information'.
  6. The ability to detect the geographical location of a target through his mobile device.
  7. Source: well-known hacker and privacy activist interviewed by our research team.
  8. Source: well-known hacker and privacy activist interviewed by our research team.
  9. Source: security consultant.
  10. In most or all Western countries, private entities are forbidden from any kind of eavesdropping or access to public networks of communication (mostly because of protection from privacy laws).
  11. The pricing range has been confirmed by ABIL in its conference call to investors on May 2
  12. Source: competitor - "
  13. Consensus estimates.
  14. Source: competitor: "nobody pays $20m for interception [equipment] anymore".
  15. Source: former intelligence analyst.
  16. 4th Quarter 2015 Press Release
  17. For the sake of example, the companies Rayzone, Verint and Circles Bulgaria are believe to supply such services. We heard that a number of other companies do so as well.
  18. Source: network security consultant.
  19. Bivol.BG
  20. Source: competitor.
  21. Source: network security consultant.
  22. Source: surveillance & detection consultant
  23. ABIL conference call, 6/6/2016.
  24. ABIL 2015 20-F, page 36.
  25. "Certain of our activities are exempt from Israeli export control under the current export control regime as these activities do not involve the export of Israeli-controlled items from Israel, but rather the sale by us of items of non-Israeli origin (as such term and items are defined by the Israeli Defense Export Control Law, 5766-2007 (the "2007 Law"), to non-Israeli entities, which activities are referred to as "Brokerage" under the 2007 Law. This exemption is due to the fact that the chapter of the 2007 Law relating to Brokerage transactions has not entered into force to date. If such Chapter were to enter into force and apply to Brokerage transactions (even if such Brokerage does not involve the export of controlled goods from Israel), we may be required to obtain additional licenses or modify our method of doing business in the future". Ability 2015, 10-F, page 20

Disclosure: I am/we are short ABIL.

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.

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