Senetas Corporation Limited (SEN) – Update
|Date of Report||ASX||Price||Price Target||Analyst Recommendation|
|Date of Report|
|Sector: Technology||52-Week Range: $0.08 – $0.14|
|Industry: Technology Services||Market Cap: $114 million|
- Senetas has declared first dividend of 0.03699 cents (final and special dividend) unfranked since its comprehensive restructure in 2012. We have assumed a dividend payout ratio of 12% for the next two years.
- Senetas acquires majority shareholding in Votiro, a leader in content and disarm technology for $US8m with an option to acquire the company in the future.
- Following the payment of the dividend and the acquisition, Senetas will remain in a strong financial position.
Strong revenue and earnings growth forecast for FY2019 and FY2020.
- New products such as the 100Gbps encryptor, customised algorithm solutions, virtualised encryption software and cybersecurity awareness across public and private sectors to drive growth.
Senetas is well positioned to participate in the growth of the global hardware encryption market. The US, Asia, European and Middle-East markets represent significant growth opportunities for Senetas with governments, defence departments and commercial organisations becoming increasingly aware of the risks of cyber-attacks and the integrity of data in motion.
The distribution agreement with its partner Gemalto secures access to its global sales, partnering and support locations, enabling Senetas to penetrate new major markets and gain from cross-selling opportunities. With a growing presence in international markets, superior technology, positive industry fundamentals, a robust balance sheet and a number of new products coming to market over the next few years, Senetas remains a strong long-term growth story.
On 30 October 2018, Senetas announced the declaration of a final unfranked dividend of 0.00462 cents per share and a special unfranked dividend of 0.03237 cents per share payable on 4 January 2019. This is in line with previously stated strategy of reviewing its capital management policy with regard to the company’s financial position, capital requirement and outlook for its products.
Senetas also announced a US$8M investment in a leading international provider of content disarm and reconstruction (CDR) technology, Votiro Cybersec Global Ltd. The investment is by way of 3 tranches of convertible notes which will provide Senetas with a majority shareholding on conversion. The initial investment of US$4 million was made on 14 November 2018, with the balance expected to be paid by 30 June 2019 from existing cash reserves. The key terms of the transaction include:
- The instrument is a Convertible Note plus convertible preference share carrying voting rights until converted.
- Interest rate of 8% per annum payable by shares on conversion.
- The conversion date is 30 June 2020 or earlier on certain events.
- Put or call rights over tranches 2 and 3 at the option of either Votiro or Senetas, subject to agreed criteria.
- Senetas will have a majority shareholding on full conversion.
- Senetas has a pre-emptive right over future funding and first right of refusal to acquire Votiro in the future.
- There will be 5 directors with 2 Senetas representatives, one independent agreed by Senetas and 2 nominees from the existing Votiro board. Key decisions require Senetas director approval.
Following the Votiro investment and the recently announced final and special dividends, Senetas will remain in a strong cash position with no debt providing flexibility to further invest in its core products and pursue strategic investment opportunities.
ANALYSIS AND COMMENT
The payment of a dividend for FY2018 follows an extensive review of potential capital management initiatives by the Board. The dividend gives a positive sign to investors on the outlook and we would expect Senetas to continue paying dividends provided that there are no unforeseen events and the company’s financial position remains strong. We have assumed a dividend payout ratio of 12% for the next two years.
The investment in Votiro represents an exciting opportunity for Senetas with substantial upside as new markets are penetrated and scale builds from a relatively low base. Votiro was established in 2010, by Israeli cybersecurity experts Aviv Grafi and Itay Glick who designed and developed the File Disarmer, a patented solution that automatically scans and sanitizes every file sent or shared in an organisation and reconstructs a fully functional file free of any threats in less than a second. Votiro currently has around 400 customers and 1.5m end users largely based in the Asia Pacific region across financial services, critical infrastructure and government departments. The company has strong patent protection for its technology with limited competition and has received leading industry recognition, various Government certifications and industry awards recognising its world leading intellectual property.
CDR is increasingly being recognised as critical for cybersecurity protection with its technology being recognised by Gartner. Content based attacks are on the rise and represent a significant risk where content is exchanged from outside to inside an organisation. The number of users attacked with malicious office documents has risen more than 4x compared with Q1 2017. The most advanced security systems are unable to protect organisations from sophisticated, customised malware attacks against unknown vulnerabilities coming in via infected files. The majority of incoming files are not processed through an effective sanitisation system and can easily bypass the organisation’s cybersecurity defence layers.
By scanning and deconstructing, validating file attributes against specifications and blocking threats before they become widespread within an organisations systems cybersecurity threats are effectively eliminated. Votiro provides an advanced API that organisations can integrate into content and various applications providing protection against content-based threats from all communication channels (mail, Disarmer API, content collaboration platforms, removable devices, file transfers and the web). This technology can also prevent a ransomware attack, rather than trying to fix the content once the damage is done. There are few products on the market able to do this in sharing platforms like Box and Dropbox. This provides for significant synergies with SureDrop with an opportunity to integrate with CDR technology to enhance capabilities taking Votiro from a defensive product to a broader business tool.
With global regulatory changes being introduced and the increasing frequency and sophistication of cyber- attacks, there is a need for new technology to combat the useability/security constraints of sandbox software. Votiro can provide protection across multiple end user markets (Web Gateway, Identity and Access management, Content Services, Email Gateway and CASB).
With Senetas having strong global distribution capability and globally recognised security credentials, we expect new markets will open up for Votiro particularly in the US and EMEA, where it currently has limited exposure. Funds provided by Senetas will finance ongoing investment in sales and marketing as the business builds scale. Votiro is expected to generate revenue of US$3.5m-4.0m in CY19 with cash breakeven anticipated in 1HCY20. The company will move from an upfront license to more subscription based revenues in the future. Senetas is expected to initially equity account the investment in Votiro.
While Votiro will not contribute significantly to revenue and earnings in the short-term, we are very positive on the investment and believe it can significantly boost earnings in the longer-term as Votiro is operating in a high growth market with minimal competition and strong patent protection. Senetas’ product suite has now been further expanded from ‘down the wire’ protection to content protection with the range comprising its CN series (high assurance hardware encryption), CV series (virtualised encryption), SureDrop (secure file sharing and synchronisation) and Votiro (content disarm and reconstruction technology).
We remain positive on the outlook for Senetas with the significant pipeline of new products being released to the market and with the increased cybersecurity awareness across governments and the private sector. The continued growth in data flows across Layer 2 networks and the requirement for software based encryption solutions for Layer 3 and 4 networks provide substantial growth opportunities for Senetas’s products. Larger scale virtual encryption with Layer 3 compatibility and new opportunities in Europe with further certification will also drive growth.
Despite having lowered our forecast slightly for FY2019, we are still expecting strong revenue growth over the next few years. For FY2019, net profit after tax is forecast to increase 36% to $4.5m (excluding impact of impairment charge in FY2018) on revenue growth of 16% and for FY2020, we expect net profit after tax to increase 44% to $6.5m on revenue growth of 15.5%. Revenue will be underpinned by increasing new product sales and ongoing sales of existing encryption products. While estimating the revenue impact of new products is difficult at such an early stage, we expect to see strong contributions in FY2019 and FY2020 as virtualised encryption, the 100Gbps encryptor, custom algorithm products build revenue with increasing sales momentum. We also expect increased contributions from investments in particular SureDrop and Votiro over the longer-term as they build scale. A larger portion of overall revenue in the future will be derived from software based solutions which are delivered as a service (SaaS). This will increase annuity style income which is far more predictable.
With the stock selling on EBITDA multiples for FY2019 and FY2020 of 14.0x and 10.1x respectively, based on our forecasts, we believe the current valuation does not fully reflect the potential of Senetas’ new products, many of which, will open up significant new growth markets.
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The core business of Senetas is the design and manufacture (under contract) of high performance encryption hardware. The product range known as CypherNet is capable of encrypting nearly any LAN/WAN infrastructure with no loss of performance. Senetas’s layer 2 technology encrypts voice, video, or data streams at a wire speed up to 100Gbps, significantly reducing the complexity and importantly the cost in meeting data protection and privacy requirements. They are purpose built to satisfy security requirements from small branch locations to high speed corporate and data centre environments.
Senetas CN is a complete family of high-performance purpose built encryptors for ETHERNET, SONET, FIBRE CHANNEL, LINK and ATM networks. Products include: CN4000 series 10Mbps to 1Gbps encryptor – compact and versatile ideal for SME’s; CN6000 series 1Gbps to 10Gbps encryptor rack mounted and carrier grade true end to end network encryption; and the CN8000 10 by 10Gbps multi-link/multi-port which are efficient hub and spoke encryptors.
Product enhancements and new developments have included: the CN4010 low cost encryptor, the CN6010 cost reduced 1Gb rackmount encryptor and more recently the CN9000 ultra-high speed high assurance encryptor designed to secure data at 100Gbps. The CN9000 supports complex, ultra-fast network topologies; enabling 100% security for Cloud Computing, Big Data and data centre services. Senetas has FIPS approval allowing sales of its new 100Gbps encryptor to US government agencies and other organisations that provide services to the government.
Senetas has also developed a customised algorithm product for customers and virtualised encryption products (CV1000 released June 2018) which have opened up Layers 3, 4 and more Layer 2 markets. The CV series virtualised encryptor enables rapid scalability, flexibility and cost-effective data protection to the virtual edge. The successful development of this product reinforces Senetas’s capability to deliver cost effective encryption solutions with global applications. It has opened up significant new market opportunities for Senetas as data networks continue to grow in size enabling new business efficiencies. With the continued increase in cyber threats and stronger data protection laws, the case for strong encryption solutions is growing. The CV1000 enables customers to encrypt their large sale and extended virtualised network links that otherwise may not be protected. The market potential for these products is significant. Senetas is continuing to explore opportunities to work with technology partners to address the potential opportunities in large scale networks in order to further expand its customer reach, having recently entered into a technology partnership and distribution agreement with ADVA.
Senetas has the most certifications and is the only global player in Layer 2 high assurance encryption: Common Criteria EAL4+, FIPS 140-2 Level 3, Communications-Electronics Security Group (CAPS) for its Ethernet IG product in the UK and NATO (North Atlantic Treaty Organisation) information security product certification covering NATO member states. This gives Senetas a distinct advantage over its major competitors ATmedia, Certes Networks and InfoGuard, when selling to the government sector and major commercial organisations as it provides assurance that its products conform to the highest quality and technical standards. Senetas is currently progressing additional certifications in Europe and in Eastern Europe for its custom algorithm encryptor.
Senetas operates a ‘go to market’ model whereby Gemalto is currently its distributor in global markets (excl. Australia and NZ) under its SafeNet Identity and Data Protection Solutions brand. Gemalto has substantial global market reach with a sales force located across 45 countries servicing their global customer base. Senetas shares in revenue from product sales as well as maintenance sales and also provides customer support services.
For Senetas’ virtualised encryption technologies, ADVA also represents a route to market through its technology partnership and distribution agreement. This enables Senetas to embed its high-speed networking encryption technology into ADVA’s industry-leading virtualisation technology, Ensemble Connector. ADVA is a leading provider of network solutions for the delivery of cloud and mobile services. By combining ADVA’s Ensemble suite with Senetas’ virtual encryption engine will provide a disruptive solution for site-to-site and site-cloud encrypted VPN’s resulting in substantial cost savings to users and a significant new market opportunity for Senetas.
The ADVA agreement complements the distribution agreement with Gemalto with Senetas now having two independent routes to the market for its two different virtualised encryption technologies.
In Australia and NZ, Senetas sells and distributes its products through a number of channel partners including UXC Ltd, Nextgen and HP.
BUSINESS DRIVERS AND GROWTH PROFILE
Senetas has a sustainable business model and having the most product certifications with access to a global distribution channel through its partner Gemalto, is well positioned to exploit the large growth opportunities existing in the high speed data encryption market.
In a globally interconnected environment, organisations are experiencing unprecedented growth in valuable digital assets in the form of intellectual property, scientific data, business information and government privacy and secrets. Market Analyst Data Corporation (IDC) is forecasting exponential growth in data volumes and valuable digital assets. The digital universe size is expected to increase by 40% per annum to 2020, which requires high speed data throughput. It is estimated that only around 50% of this growth rate is being protected.
To cater for this growth, enterprises, carriers, and content delivery networks are upgrading their networks to ensure that this information can be shared at very high speed. With data now flowing at up to 100Gbps across hundreds of millions of kilometres of optical fibre cable, there is plenty at stake if data interception occurs.
While vast amounts of money are invested in securing data at rest (intrusion detection systems, email and malware security and firewall protection), organisations often underestimate the magnitude of risk to critical data while it is in transit across private or public networks. Cyber intrusions are clearly the largest threat to these digital assets while they are stored, moved and shared. Cyber criminals are increasingly targeting high volume/high value data and unsecured networks and the breach landscape is continuing to evolve. Approximately 1.4 billion data records were compromised in 2016, 1,792 breach incidents were reported and 59% of the breaches were motivated by theft. In 2016, only 4% of the breaches involved encrypted data with the stolen data rendered useless.
The Australian government has highlighted the risks of not protecting data in recent papers. The new Australia Cyber Security Centre (ACSC) became operational in late 2014 and brings cyber security capabilities from across government into one location. It is a hub where the private and public sector can collaborate and share information to combat serious cyber security threats. The Defence Signals Directorate (DSD) reported a 30% increase in the average number of serious online attacks against the government in 2013 that required a heightened response and the ACSC in its 2015 Threat Report warned that the number of state and cyber criminals with capability will continue to increase. Senior intelligence officials remain concerned about the vulnerabilities across “hardened” areas including the major banks, telecommunications, Governments and infrastructure utilities. Corporations globally are now recognising the need to protect valuable data that is being transported at very high speeds across sophisticated IT networks. New data privacy and protection regulations have been introduced by governments with heavy penalties for breaches.
Data privacy and protection regulations have been introduced by governments with heavy penalties for breaches. Australia’s new federal data breach notification laws came into effect in February 2018 which requires businesses to report cyber incidents to the Australian Information Commissioner and individuals impacted by data breaches which are likely to result in serious harm. With Europe’s new data privacy and security laws now in effect, businesses conducting business in Europe will be subject to significantly tighter data privacy requirements. This includes businesses based in the European Union as well as businesses based elsewhere but dealing with European Union businesses. In the US, all but two states have laws requiring consumer notification of security breaches involving personal information. This will increase the importance of encrypting data and potentially will be positive for Senetas who now have the ability to provide encryption products across various protocols.
The key growth markets for Senetas’ products remain the US, where the encryption hardware market is forecast to reach US$65b by 2020 and in the UK where the Government has estimated the cost of cyber-crime to be at least £27b per year across corporations, government and private individuals. Other potential growth markets include Asia, Eastern Europe and the Middle-East.
The majority of global networks are still Layer 3 IP/TCP routed networks (80%). With the substantial growth in network traffic (volume and reach), the high-bandwidth applications such as data-centre connectivity, disaster recovery/business continuity measures and data storage replication, organisations and network providers are increasingly embracing the benefits of layer 2 Ethernet services. Layer 2 encryption is designed to be transparent to end users with little or no impact on network performance and the cost per gigabyte is the lowest.
With the growth in data volumes, driving greater adoption of Layer 2 networks and the increased awareness of the need to protect valuable data travelling around networks at very high speeds, Senetas being the market leader in Layer 2 encryption technology and with its proven range of certified encryption protection solutions for governments, defence departments and the commercial market is a major beneficiary of this trend.
Senetas is actively pursuing new technology partnerships with vendors specialising in Layer 2 networking and CCTV Technologies. In January 2015, Senetas completed a technology partner agreement with Avaya a major international data network provider. Avaya’s standards based SPB fabric Connect solution is based on Layer 2 Ethernet technology as a foundation for building virtualised data networks for the Datacentres, Campus LANs, MANs and WANs. This provides Gemalto/Senetas access to Avaya’s network technology and its customer base.
Senetas’s highly innovative and responsive R&D program remains the key focus and will be the major growth driver in the future. During FY2017, there were a number of milestones reached with the commercialisation of development of the 100Gbps encryptor, the customised algorithm products and the virtual encryption product.
Senetas’s ultra-high speed 100Gbps ethernet encryptors having received FIPS certification with Common Criteria pending and successfully completing trials is now available for sale. This product was developed to satisfy the requirement of large customers who are upgrading their networks from 10Gbps to 100Gbps. This represents a natural progression for many organisations that move a lot of sensitive information at fast speeds. Early sales have been encouraging and while it is difficult to accurately estimate the full potential of this product, the market for 100Gbps is growing strongly and is expected to account for at least 50% of data centre activity by 2019. Senetas is well positioned to capitalise on this significant growth opportunity.
Senetas has developed its ‘custom algorithm’ encryptors for new and growing markets particularly in Eastern Europe, which allows customers to select their own algorithm giving them security control as a result. Sales will commence when the certification process is complete (expected early FY2019). This represents a new and large market for Senetas and there are no competing products that match its product capabilities.
Senetas’s virtual encryption product was released ahead of schedule and represents the first virtualised encryptor to provide strong encryption for large scale multi-layer (layers 2, 3, and 4) networks carrying sensitive data across thousands of end-points. This has opened up large scale market opportunities for Senetas well beyond its current core customers and provides for significant revenue growth opportunities over the next few years and beyond. Also, being a subscription based model will help to offset the lumpiness of product sales aiding predictability and cash flow.
Senetas’ technical skills enable it to re-engineer encryptors using its core technology – hardware and virtual to suit the requirements of the customer. This was behind the recent successful technology and distribution agreement with ADVA, the leading provider of open networking solutions for the delivery of cloud and mobile services. With Senetas’s high speed networking encryption technology being embedded into ADVA’s virtualisation technology, significant new market opportunities across service provider customers and enterprise-focussed resellers as well as the large public cloud providers have been created by the provision of a solution for site-to-site and site-cloud encrypted VPN’s. While it is too early to predict the potential financial impact on Senetas, revenue is expected to commence in FY2019 and should continue to accelerate as product volumes build.
Senetas is also investing in non-core technologies which are aligned with its competencies; leveraging encryption, security and networking skills. The capital cost of these investments is modest and they expand Senetas’s product suite in global markets potentially accelerating growth and adding value for shareholders over the longer-term. Current investments include:
- A 6% equity interest in Smart Antenna Technologies (SAT) a pioneering international smart antenna technology company based in the UK. SAT has designed, developed and patented a pioneering smart antenna technology which enables smartphone and tablet device manufacturers to replace several antennas with a single multi-band antenna, the performance of which, will match that of separate antennas at their specified frequencies. Senetas has board representation. The investment has a carrying value of $1.89m and is performing to expectations.
- Acquired SureDrop on an earnout basis with no upfront capital outlay. SureDrop provides a Drop Box file sharing capability incorporating the best security based on the same technologies used in Senetas’ multi-certified high-speed encryptors. The target markets of SureDrop are large commercial enterprises and governments. It is in the early stages of release to the market but there has already been significant interest in the product with trials being undertaken by customers in conjunction with a large Australian telecommunications company. Sales are expected to build in FY2019. The revenue model is based on user subscription and will add a source of recurring revenue.
- Senetas has made an US$8M investment in a leading international provider of content disarm and reconstruction (CDR) technology, Votiro Cybersec Global Ltd. The investment is by way of 3 tranches of convertible notes which will provide Senetas with a majority shareholding on conversion. The initial investment of US$4 million was made on 14 November 2018, with the balance expected to be paid by 30 June 2019 from existing cash reserves. Votiro was established in 2010, by Israeli cybersecurity experts Aviv Grafi and Itay Glick who designed and developed the File Disarmer a patented solution that automatically scans and sanitizes every file sent or shared in an organisation and reconstructs a fully functional file free of any threats in less than a second. Votiro currently has around 400 customers and 1.5m end users largely based in the Asia Pacific region across financial services, critical infrastructure and government departments. The company has strong patent protection for its technology with limited competition and has received leading industry recognition, various Government certifications and industry awards recognising its world leading intellectual property.
- Invested US$1m in DeepRadiology Inc., a medical learning and artificial intelligence company. It has developed the first autonomous radiology scan interpretation and reporting system and provides the technology base for Senetas and DeepRadiology to research and develop machine learning solutions for analysing and protecting data in transit. Senetas has board representation. FDA approval for the technology has not yet been received and the value of this investment has been written down to nil due to uncertainty over the carrying value.
- EON Reality Inc. is a world leader in Augmented and Virtual Reality based knowledge transfer for industry and education based in California. Senetas made a US$2m investment (preferred stock with cumulative dividend) in 2000 which has a carrying value of zero on the balance sheet. EON is planning to list on the NASDAQ having formed an IPO committee, which will create some value for Senetas when listing takes place. The timing of an IPO and potential value of the investment remains unclear. Senetas has board representation.
Please note that Gordon Capital has been retained by SENETAS CORPORATION LIMITED to provide this report for a fixed fee. Gordon Capital does not provide specific investment recommendations and does not receive any additional benefit for the provision of this report. Gordon Capital aims to provide a balanced and objective analysis in this report. At the time of writing the report we do not hold shares in SENETAS CORPORATION LIMITED. They do not receive any indirect benefits or assistance from SENETAS CORPORATION LIMITED. Their remuneration is not linked to the views expressed in this report. At the time of writing the report they do not hold shares in SENETAS CORPORATION LIMITED.
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Recommendation Rating Guide
|Recommendation Rating Guide||Total Return Expectations on a 12-mth view|
|Speculative Buy||Greater than +30%|
|Buy||Greater than +10%|
|Neutral||Greater than 0%|
|Sell||Less than -10%|
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