Aladdin is a leading vendor of hardware authentication tokens. The company is No. 1 in the software license authentication token market and No. 2 in the rapidly growing USB token authentication market. Aladdin also offers a digital rights management product for secure software distribution. Investment Thesis
Best way to play software piracy protection: Software providers continue to show great concern regarding piracy of their products. In June 2004, market research firm IDC reported that the global software industry’s losses due to the illegal use and duplication of business software reached $29 billion in 2003. Aladdin holds almost 40% market share in the digital rights management (DRM) market and about 60-70% of its revenue is derived from this market. Aladdin’s recently released software DRM has less than 10% marketshare, so any traction seen in this market is really leverageable. Like many analysts, we believe this steady grower feeds the growth in the sexier token business (see below).
Tokens, Identified as a leader in Identity Management: The sexy part of Aladdin’s business, Aladdin also maintains a leadership position in the identity management market via its eToken, a multifunction USB token. As identity theft garners more visibility via phishing and pharming scams and government, this market has been getting a lot of buzz. Governments globally are attending to similar issues and recent financial scandals, like the one that occurred at Societe Generale, will also bring added attention to the identity management market. EMC’s purchase of RSA a couple of years ago (for $2 billion) has also put the industry on investors’ radar screens. Seeing robust demand in its end markets, the company is pursuing a lot of high-profile, large deals on this front.
Healthy balance sheet: Aladdin has about $95 million in cash and investments as of the December quarter, 2007. The company continues to generate cash from operations. ALDN had announced a couple of share buybacks over the past year but hasn’t really aggressively begun purchasing stock.
New token deals: Revenues are beginning to trickle in from a recent major deal Aladdin struck with CIITE-India (Consortium for Indian Information Technology Education) which covers 28,000 campuses and 4 million students with eTokens. Analysts expect this deal to harbinge others like it and start providing meaningful revenues for the eToken business. Aladdin has done a good job stretching pricing on these deals as well. In the fourth quarter, the company announced deals with Thailand’s government, Continental Airlines (NYSE: CAL), and South Korea’s largest online bank.
Weakening shekel: The Israeli shekel has been one of the best performing currencies in the world over the past year and especially over the past couple of months. For a company like Aladdin, which does its R&D in Israel denominated in shekel and reports earnings in dollars, the shekel has caused some trouble over the past year. Bank of Israel Stanley Fischer just lowered interest rates in Israel in deference to calls from exporters to weaken Israel’s currency. A softer shekel should propel earnings and better margins for the company over the next few months.
New product introduction: ALDN recently introduced the HASP SRM, the first DRM product that offers both a software and hardware based security solution. The company is very positive for the potential uptake of this hybrid product.
Societe Generale fallout: As the after-effects of a rogue trader triggered massive losses for the bank, financial institutions around the world are currently strategizing about enterprise security. Private and public institutions continue to allocate larger budgets for identity management and enterprise security.
Threats to Thesis
Highly competitive markets: ALDN faces intense competition in the security markets. Larger companies with deeper pockets and broader distribution are direct and less direct competitors. Companies like Symantec (Nasdaq: SYMC ),Trend Micro (Pink Sheets: TMICY), SafeNet and RSA Security (NYSE: EMC). Highly competitive markets in identity management have typically created a downward spiral on pricing, creating commodity pricing across the industry. As Aladdin focuses on driving emerging market business, margins may be further pressured.
Supply risk: Certain key components are purchased from sole-source suppliers. ALDN obtains the ASIC and microcontrollers included in its HASP products, as well as the microcontroller and the smart card, including its operating system, for its eToken products from sole-source suppliers. Disruptions in the supply chain or demand greatly outstripping supply could cause delivery problems for Aladdin.
Weak dollar: Like many Israeli companies who conduct R&D in Israel and sell products worldwide, Aladdin has seen their margins crimped by the strength of the Israeli shekel vis-a-vis the U.S. dollar. If the shekel continues its historic run against the dollar, Aladdin may see its margins further compressed.
Poor cash management: Aladdin enjoys a very strong balance sheet. If the company decides to put this money to use by making a dilutive acquisition, this could hurt the overall prospects for the firm in the short-term.
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Disclosure: Author’s fund holds a position in ALDN. He has no position in any other stock mentioned as of 3/3/08.
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