Increase in Cyber Security Spending

Spending on Cyber Security Will Increase 50% This Year… Boosting Profits for This Little-Known Technology Firm

A Taipan Publishing Group Strategy Report
By Michael Robinson, Editor, BreakAway Investor

Buy now and lock in a potential 80% return on your money

Who would have thought a little friendly computer file sharing would send shockwaves through the federal government?

After all, peer-to-peer file sharing became a standard part of the Internet a decade ago when Napster made stealing music a popular college hobby.

This time, however, someone blasted national secrets across the Internet to Iran. Officials say an unidentified “malicious” source at an IP address in Tehran viewed blueprints and other sensitive data about one of President Obama’s helicopters.The February incident underscores an escalating trend of cyber attacks on U.S. military and intelligence computers. The Pentagon is like a shirtless man in a swamp, constantly buzzed by angry mosquitoes — reported attacks rose from about 800 in 1996 to more than 150,000 today, nearly a 15,000% increase.

Not even Defense Secretary Robert Gates seems immune. In June 2007, a hacker penetrated a Pentagon e-mail system, forcing 1,500 accounts off line. Gates, the former head of the CIA, had to shut down his computer for cleaning.

In the case of Marine One, the president’s Sikorsky-built helicopter appears to have fallen victim to a mistake by a defense worker who didn’t realize the outside world could view the information.

No wonder the Obama administration wants to spend billions on cyber security. He can’t even trust the good guys.

Demand for Federal Technology Services Soars

Indeed, the administration listed cyber security as an important part of its $787 billion stimulus plan, which in turn leans heavily on Information Technology (IT) upgrades.

Stanley Associates, Inc. (SXE:NYSE) offers a chance to profit not just from cyber security, but also from the overall increase in federal IT spending.

With fast-growing revenues and earnings layered on top of stable cash flow, the company will outperform the market during President Obama’s first term.

The administration’s stimulus plan and proposed budgets target spending on federal information technology infrastructure across the board. From the Pentagon to field offices for the FDA, the government will spend heavily to improve computer networks — and their security.

Thus, Stanley represents a pure play on U.S. government IT services. The company has no commercial customers and no overseas exposure.

Keep these factors in mind because the commercial IT market will barely keep pace with inflation this year. And the global economic meltdown will retard overseas growth.

With a $2.1 billion backlog of funded orders, Stanley garnered nearly $1 billion in contracts related to travel and immigration. This comes at a time of increased immigration concern and when Americans must have passports to leave the U.S.

Merger Targets $10 Billion Cyber Security Market

Last year, Stanley made an astute acquisition that will give it a leg up in the Obama administration. Stanley picked up Oberon Associates, Inc. for $170 million net of cash acquired in the deal.

Oberon’s core competencies relate directly to protecting federal computer networks. Hackers might try to steal sensitive data, such as military secrets, or destroy mission-critical information before an attack on the U.S.

Thus, Oberon’s biometrics systems engineering, integration and deployment will come in handy. They can protect the Pentagon and the intelligence communities from computer breaches.

The value proposition here remains simple. Think of fingerprints. They not only help catch criminals, but they offer a biometric lock that prevents unauthorized users from accessing individual computers and related networks.

Of course, no system guarantees foolproof operations. But security experts say biometric locks work much better than passwords or security cards, which can easily be lost or stolen.

The Army says biometrics also help protect soldiers. Last November, Stanley said it was part of a team that received a Defense Department biometrics contract worth up to $38 million.

Stanley will maintain the current configuration for the Biometrics Automated Toolset-Army (BAT-A) system and its peripheral devices. Among other things, BAT-A collects and compares fingerprints, iris images and facial photos.

Developed to identify foreign nationals brought to military detention centers, it has became so valuable military units around the world depend on the technology. Stanley expects to work in Iraq, Afghanistan, Kuwait, Horn of Africa, Belgium, Germany and Korea.

At this writing the early Obama administration defense budgets remained in a state of flux. Defense Secretary Robert Gates needs to balance the surge in Afghanistan with troop redeployment from Iraq.

Simultaneously, a weak economy and looming budget battles apply pressure to rein in spending. My best forecast calls for cyber security spending increases of close to 50% in five years from about $7 billion today.

Even without cyber security capabilities, Oberon represented a big win. The purchase yielded a five-year contract for U.S. Army intelligence worth up to $300 million. Oberon could generate about $85 million in revenue for the 2009 fiscal year ended March 31 and about $100 million in fiscal 2010.

Recently Issued Stock Outperforms Market

In March 2008, Stanley received a $570 million order to process passports for the State Department, its oldest customer. In the last year, the State Department produced more than 18 million passports. With the new travel restrictions, that figure will climb.

Known for its ability to up sell clients, Stanley had already received a $164 million passport contract back in 2006. The next year it received a $225 million order from a unit of Homeland Security responsible for immigration and citizenship services.

Despite the recession, demand for legal immigration remains high. In the technology industry, employers frequently need to import workers with unique skills.

Founded 42 years ago by a retired U.S. Navy admiral, Stanley went public in October 2006. With an initial price of $13 a share, Stanley recently closed at about $31 — a gain of nearly 140% in 30 months.

The stock price reflects the company’s continued growth. It trades at 27 times 2008 earnings per share. Consider it pricey but safe.

Among others, Stanley works for the Commerce, Justice and Treasury Departments, and the Pentagon. The company helps the DoD with biometrics, systems engineering, weapons systems simulations, and logistics command and control.

Even with the wind down in Iraq, the military must have this technology. In high-tech modern warfare the computer becomes as powerful as a missile.

Profits More Than Triple in Three Years

I have weeds in my garden that don’t grow as fast as Stanley. Or think of it this way: As an office building, Stanley’s revenues rose to a single story in 1999. Today, that structure would stand 12 stories tall.

Over the past decade, revenue grew by an average 32% a year to close fiscal 2008 at $604.3 million. Stanley expects fiscal 2009 revenues of up to $780 million. I project Stanley will become a $1 billion enterprise three years later.

Though Stanley keeps a sharp eye out for possible acquisitions, it focuses heavily on internal growth, seeking a rate of 10% to 15% per year. By contrast, the federal government’s internal IT growth rate will remain at about 4% annually. Last fiscal year Stanley’s organic growth jumped to 37%.

Furthermore, the company wants to continue improving profit margins. Stanley had a yield of 2.9% in fiscal 2006. Last fiscal year, the margin rose to 4.3%, a 48% improvement.

Stanley also seeks to get more bucks for the bang. Several years ago more than two-thirds of contracts covered operating costs and paid a flat fee for services. Recently that figure fell to about one-half.

The remaining awards pay either a fixed price or cover time and materials. Both of these latter contracts make more money for Stanley.

No wonder profits more than tripled in the past three years from $8.2 million in fiscal 2006 to $26.2 million last fiscal year. They’ve already beaten that amount for the first nine months of fiscal 2008. Net income for the nine months ended Dec. 26 rose 44% from the comparable period to $26.7 million.

Series of Acquisitions Keeps M&A Team Busy

Meantime, the Oberon purchase underscores another important point. It represented the sixth acquisition Stanley made in the last eight years. Don’t underestimate the importance of these purchases.

Acquisitions fill in the franchise with new customers, contracts and revenues. They also improve profit margins. That explains the major drive toward consolidation in the federal IT space in what is expected to be an era of new technology opportunities amid tightening federal budgets.

For many companies, acquisitions can offer mixed results. At first there’s great fanfare, but after a year or two, disappointment surfaces. Many acquired employees simply don’t fit in, and the supposed benefits never fully materialize.

Stanley intends to avoid those pitfalls. As part of its formal acquisitions program, Stanley has a team of executives responsible for smoothly combining the companies.

It’s more than just a feel-good exercise. Stanley also wants to make sure it properly integrates finance, accounting and business development.

Furthermore, the firm keeps a clear strategy for finding targets. The companies must maintain a deep portfolio of federal contracts with strong internal growth and a compatible culture.

In early 2006, Stanley added Morgan Research Corporation to the lineup and got NASA as a new customer. Morgan also gave Stanley a strong presence in Huntsville, Ala. The area remains home to the Redstone Arsenal, where the Army develops and tests missiles.

Last December, Stanley announced it is part of a team awarded up to $31 million for weapons systems simulation at Redstone. Stanley will develop and modify software as well as provide analyses of weapons successes against a wide range of targets. These include armored personnel vehicles, unmanned aerial vehicles, helicopters and tanks.

In April 2007, Stanley acquired Techrizon LLC, a premier provider of software, training, simulation and information security solutions. Like Morgan, Techrizon also was strategically located at a military center that will expand under the Pentagon’s baseconsolidation program.

Located in Lawton, Okla., Techrizon began serving the Army at Fort Still in 1976. Pentagon leaders have announced plans to merge the Air Defense Artillery Center at Fort Sill into the Field Artillery Center. The resulting Fires Center of Excellence will remain at Fort Sill.

A Business With Hundreds of Barriers to Entry

Still not convinced the federal IT services market is lucrative? Consider this: None other than technology powerhouse Hewlett Packard recently invested nearly $14 billion in the space.

That’s roughly how much the storied Silicon Valley powerhouse paid to acquire EDS, the company former presidential candidate Ross Perot founded. EDS ranks 10th on the list of the top 100 federal contractors as compiled by the trade journal Washington Technology.

Without EDS, Hewlett Packard ranks 39th. With less than 1% of HP’s $100 billion in revenues, Stanley is close on its heels. Stanley ranked 48th, up from 50th place in 2007.

For their part, senior managers at Stanley don’t just view federal contracts as a source of stable cash flow. They openly tell interested investors that contracts provide barriers to entry that protect profits.

After all, the federal government rarely breaks a contract. Furthermore, these are not simple products like copy machines. Sales people for a competitor can’t phone up an official at the Army or NASA and say they’d like to drop by to demonstrate they can do the same job faster, better and cheaper.

The federal IT market would make Darwin proud. The strong get stronger — federal officials consider past performance when awarding new contracts.

And initial programs often get bigger over time. Once a contractor gets inside an agency, it can win new contracts from other departments that need technology upgrades.

A Broad Portfolio of Contracts Brings Stability

Though heavily focused on serving the federal government, Stanley likes to maintain a diversified portfolio. The company boasts more than 300 contracts with some 50 federal agencies.

Except for its work on passports, no single contract constitutes more than 4% of income. Defense accounts for 70% of customers. Civilian agencies make up the rest.

Phil Nolan, who serves as chairman, president and chief executive, understands the defense and civilian IT markets as well as anyone. Nolan began with a Bachelor of Science degree from the U.S. Naval Academy at Annapolis.

While on active duty, he served as deputy program manager for weapons integration on the Submarine Launched Tomahawk Program. He has a master’s degree in engineering management as well as a law degree, an invaluable asset in a contract-driven business.

This year Nolan chairs the Professional Services Council, a trade group for government vendors. His expertise runs deep.

Nolan boasts a tight senior management team. Most have worked together for more than a decade. Nolan joined the company in 1989 and certainly understands its financials. Before obtaining the top three lots, he logged time as Stanley’s treasurer as well as vice president for operations.

A Motivated Top-Secret Workforce

Since it is in the services business, Stanley considers its work force of nearly 5,000 a major competitive advantage. For that reason, the company emphasizes its designation as one of Fortune magazine’s “100 Best Companies to Work For” in each of the past three years.

This is much more than a public relations ploy. Except for presidential appointees at civilian agencies, a majority of federal workers seek stable long-term employment. They want to know that consultants servicing their contracts maintain a similar profile, that building long-term relationships will reap benefits.

The more a contractor understands an agency’s needs, the more that company can find new programs that further improve operations. If, on the other hand, turnover remains high, it is difficult for the agency to gain any real synergies.

In plain terms, once Stanley gets its hooks in, it can catch more fish. But happy high-tech workers don’t just improve sales and morale. They emerge as an essential part of daily operations. Nearly three-fourths of Stanley’s employees work at the client’s location.

At the Pentagon, officials must plan several fiscal years in advance. This is becoming ever more imperative as the military services continue their drive to modernize at every step of the way in what is called “force transformation.”

America’s fighting forces remain the most formidable in the world in large part because the Pentagon embraces high-tech warfare. For this reason computer networks and other IT components remain critically important.

Secrecy also is paramount. Remember the phrase, “loose lips sink ships”? More than 70% of Stanley worker’s have Secret or Top Secret clearances.

$254 Million in New Defense, Intelligence Contracts

Stanley kept up its torrid pace of new contracts throughout the third quarter. Last November, Stanley said it will provide a broad range of technical and management services to support the Marine Corps with its efforts to consolidate computer networks and IT infrastructure.

Valued at $119 million over five years, the program will help create a more effective web-based environment capable of supporting highly distributed operations across the Marine Corps. That means commanders and other authorized users will gain access to timesensitive information crucial for making battlefield and other assessments.

The company received a $112 million order for tactical field biometrics work for a communications and electronics unit of the Army. Another Army directorate also contracted with Stanley for $29.5 million to support software that helps control weapons

Taken together, Stanley’s contract wins, motivated workers and financial performance help it stand out from the crowd. Last October, Stanley made its debut on Forbes’ list of “America’s 200 Best Small Companies,” entering at seventh place for 2008.

For eligibility, a company must have sales between $5 million and $750 million and a stock price of at least $5. Forbes examines return on equity, sales and profit growth. The magazine also compares a company’s stock performance with that of industry peers.

Consider Stanley (SXE:NYSE) for your portfolio at up to $42 a share, a price justified by the low end of its growth range. A broad technology sell-off that ignores Stanley’s strong fundamentals remains the main threat to appreciation. At the upper end of its growth forecasts and current multiples, Stanley could hit $56 in the next three years.

Here's another way to profit from technology. This report outlines a life-saving transformational technology that a disastrous occurrence helped to bring about. The situation may shock you, but the potential gains could blow you away. Take the next five minutes to read your FREE report on this tragic event turned important opportunity…

Originally published June 04, 2009.

Other Related Topics: BreakAway Investor , Information Technology Investm , Michael Robinson , Obama , Spending Habits , Stimulus Plan

Other Articles Related To This Topic:

Comments (1)