These days, few problems have as much potential to keep a business executive awake at night as does the threat of an IT security failure. Cyber-attacks cost businesses billions of dollars each year and expose them to a multitude of operational, financial, and legal risks. Just ask Equifax.
Thus, it should come as no surprise that the global cyber security industry is growing by leaps and bounds. Analysts see the IT security market growing at an annualized rate of 9.5% through 2021.
South Africa’s Johannesburg Stock Exchange (JSE) is home to just one pure play in this burgeoning industry, and the market is offering its shares at what we believe to be a bargain price. We recently bought a batch for our Africa strategy.
When Information Security Architects (ISA) Holdings was founded in 1998, it didn’t do much more than resell anti-virus and firewall software to local companies keen to protect themselves from the emergent threats of doing business online. But in the intervening years, the company has broadened its repertoire to include managed services that help its clients to keep their data secure without sacrificing operational efficiency.
Today, the company still distributes a full suite of IT security software sourced from a range of global developers, but its focus is on building up a stream of recurring revenue from managed service agreements and selling security monitoring and backup software – dubbed MSS Pulse – that the company developed in-house.
The strategy appears to be gaining traction. In the most recent financial year, which ended in February, the company saw subscription revenue climb 27% while sales of MSS Pulse software jumped 36%.
While we like the fact that ISA operates in an industry with significant potential for revenue growth, it’s the fundamentals of the business that first drew us to the stock. Over the past ten years, CEO Clifford Katz and Chief Technical Officer Philip Green (who own a combined 25% stake in the business) have nearly quadrupled ISA’s revenue while growing earnings per share at an annualized rate of 12.5%.
And, unlike many listed technology companies, ISA’s growth has been almost entirely organic. Rather than splashing out cash on acquisitions in a bid to juice earnings growth, the company instead returns excess capital back to shareholders in the form of buybacks and dividends. ISA has cut its total share count by 19.0% since the end of 2008, and it has issued a special dividend in five out of the past ten years. The company declared a R0.10 dividend for the 2017 fiscal year, giving the stock a dividend yield of 6.3% – an unusually high payout for a fast-growing technology company.
And thanks to management’s focus on cost control and the development of subscription-based services, ISA remains solidly profitable. Operating earnings have climbed at an average rate of 18.9% over the past five years, and a healthy 18 cents of every rand’s worth of revenue collected filters down to the company’s bottom line. ISA’s 30.2% return on assets ranks among the highest of all JSE-listed firms. Remarkably, the stock presently trades at a price-to-earnings ratio of just 8.0.
The company’s balance sheet hasn’t had a speck of interest-bearing debt since 2015. And despite ISA’s frequent share repurchases and generous dividends, the company’s pile of cash continues to grow. Cash and equivalents surpass current liabilities by a substantial margin, giving the stock a positive net cash position and a robust quick ratio of 2.2. Given the company’s strategy of prioritizing organic growth, the liquid balance sheet hints that another big share buyback or special payout may be in the offing.
Of course, the company does have a few weaknesses. A weakening rand can hurt ISA’s profitability because much of its software inventory is imported. And it has been an ongoing challenge for management to hire employees with the requisite skills, and then to keep them on staff. Thus, we are on the lookout for rapidly escalating employee expenses.
But we view these risks as modest in relation to the company’s potential upside. With a clean balance sheet and a heavily-invested management team that devotes its energy toward organic expansion instead of playing the risky acquisition game, we believe ISA is a fine way to lock in exposure to the growth of the IT security industry.
Disclosure: We own shares of ISA Holdings in our Africa strategy.
Africa Capital Group LLC
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