Friday, May 25, 2012

Two Overlooked Stocks in Big Data and Security

Nice Systems $NICE and its competitor, Verint Systems $VRNT are stocks that benefit from increasing security and regulatory compliance within financial services. They make the kind of surveillance and monitoring systems that banks like UBS would have needed to make sure that rogue trader Kewku Adoboli might have been picked up early on in his activities. As such, their primary profit drivers are increasing regulation and, the growth of ever more complex needs to gather information from multiple sources, both internally and externally.

Nice and Verint set for Growth

With the implementation of Dodd-Frank and the increasing needs for firms to manage security and work flow optimization, these firms look set to grow strongly. They help companies to extract insight from interactions, transactions, and surveillance. The information is gathered from a wide range of different sources, from emails and phone calls to video surveillance.
Nice and Verint should see good growth as financial firms start to spend again in order to support expansion and deal with mounting compliance and regulatory issues. Furthermore, financial firms and Governments are under increasing pressure to protect themselves and the company from internal and external security threats as well as ensure that work flow is being properly managed. These words sound abstract, but consider criminals like Nick Leeson and Jerome Kerviel, both of whom benefitted from lax monitoring and compliance controls.

Nice Systems and Verint Systems Recession Proof?

The odd thing about these two stocks is that they both increased net income and cash flow through the recession. This is to be understood, as their revenue drivers are relatively secular. However, with Nice Systems, there was a drop in revenues of 6.5% from 08-09 and gross profit fell by 10%. However, Nice managed to only lose 7% in EBIT due to reduced SG&A  expenses.
This suggests that they are relatively recession proof but the problem is that a large amount of the company’s revenue comes from the financial services vertical. Unfortunately, if there is a Sovereign Debt Crisis induced slowdown then it is this sector and its suppliers, that will get hit the hardest. Nice Systems will not be immune from any negative sentiment.

Focussing on Nice Systems

I want to focus on Nice as I view it as the stronger of the two.
Essentially, Nice Systems is positioned at the high end of the Work Flow Optimization (WFO) market. As such, Nice tends to offer relatively expensive large scale solutions to the enterprise market. This leaves them exposed to cheaper competitors chasing Nice's installed base when they come to upgrade or renew. However, it also ensures that Nice offers a comprehensive best in class solution.

One area of possible concern is public sector end demand, but it is probable that this is an area of spending that Governments will be highly reticent to cut. Security is not the sort of area they should be cutting back on. Work Flow Optimization gives a tangible return on investment and much of Nice's end demand is regulatory and compliance led. Another cause of worry could be an increase in the demand from organizations for their WFO solutions to be sold by their contact center infrastructure provider. Although, Nice is focused on the high end so this trend is unlikely to have a great affect.

Nice Systems Q4 Results

In the previous quarter a number of questions were raised by analysts regarding current growth prospects. I’ve summarized them here.
  • Slower customer bookings in the third quarter, some of which were closed in the ongoing fourth quarter
  • Book to bill forecast to be much higher in the fourth quarter
  • Weakness in Q3 not seen in any product line or geography
  • Management explained that the book to bill also had a pattern of being weaker in the third quarter in previous years, and that this was partly due to the increase in maintenance revenues and the way that business was conducted
Fortunately, when Nice gave its Q4 numbers, all of these issues were resolved in the manner that the company suggested. The book to bill went over one, Nice reported record revenues and the pipeline was strong. There is nothing to suggest that current orders for Nice (and Verint) are not in good shape. The market reacted by marking the stock up. Verint reported later and confirmed that the industry is in good shape.

Should you buy Nice and Verint?

I prefer Nice because it generates more free cash flow and has better growth prospects than Verint. In fact Nice has generated over $380m in free cash flow over the last three years. That is not bad for a company with an Enterprise Value (EV) of $2.21bn. Furthermore, earnings estimates are for mid teens growth in earnings and revenues, for the next two years.
In summary, Nice Systems is currently generating over 6% of its EV in free cash, has strong growth prospects, and is in a favorable long term industry with plenty of upside given increasing corporate awareness of security issues and workflow optimization.

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