How to profit from the cyber-threat

This Aussie small cap is poised to profit from the rise of cyber security

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Cyber security is the first-world challenge of our age. Every other day we seem to be hearing about a new multinational company that has been hacked. Those data breaches are costly, which also means that companies are willing to spend up big to prevent them happening. One small Australian company is helping them do that, and its industry leading technology means that it is poised to profit.

Senetas (ASX: SEN) is a world leading developer and manufacturer of high-speed network data encryption hardware, based in Melbourne. Senetas customers trust the company to securely transport vast volumes of highly sensitive information quickly. Its customers include global multinationals, government departments, banks, financial systems providers, even national defence forces (the data is so sensitive that specific customers cannot be named).

Growing demand

For the past three years Senetas has reported compound revenue growth of 53% per year, following a key new distribution deal. That growth isn’t showing any signs of slowing down either. In the most recent half year Senetas clocked up revenue growth of an incredible 68%.

Even better, in recent years Senetas has shifted its pricing structure to generate more of its revenue from ongoing maintenance fees rather than one-off sales. These maintenance fees are typically set at around 20% of the up-front cost of the hardware. That structure means that every new sale not only gives Senetas a one-off revenue boost, but also provides reliable recurring revenue for several years to come.

High added-value

Australia is often criticised for the low added value of our exports. We are said to import flat screen televisions and export lumps of rock. Senetas puts the lie to that myth. The precision engineering required for security at Senetas’ world-class level means that a single Senetas encryptor – about the size of a Sony Playstation – can sell for tens, or even hundreds of thousands of dollars.

The company isn’t resting on its laurels either. Senetas is constantly re-investing in research and development to push the technological envelope forward. The current project is to develop a high-speed encryptor capable of operating at 100 gigabits per second which the company expects to release to the market within the next twelve months. That is an order of magnitude faster than the best of the current technology, and the company expects strong customer demand.

This constant technological evolution is a boon for Senetas. By staying on the cutting edge, they are able to regularly sell to the same clients over and over again, as they upgrade to the latest and fastest technology. The rise of cloud computing is also providing a tailwind, as companies need to secure the huge volumes of traffic between their monolithic data centres.

Concentration risk

The biggest risk that investors in Senetas needs to be aware of is distributor concentration. Although Senetas products are ultimately used by leaders in multiple different industries (not to mention government departments), the path to reaching those customers is controlled by one key distribution partner – Gemalto.

In exchange for the improved pricing terms that have helped turn around Senetas fortunes, the company agreed to an exclusive distribution deal with SafeNet (later acquired by Gemalto) a few years back. If Gemalto decided to renegotiate terms, or worse, walk from the deal entirely, it would be a devastating (though, likely not fatal) blow for Senetas.

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Matt Joass is a Motley Fool analyst. He owns shares of Senetas. You can follow Matt on Twitter @TMFMattJoass. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson

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