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Cyber-Security Stocks Bubbling

January 23, 2024

Demand for cyber-security is growing strongly and further out years are unlikely to see any change in that pattern.

Increasing adoption of Artificial Intelligence AI in day-to-day activities of businesses poses great benefits to operations by increasing efficiency but at the same time making companies more vulnerable to cyber attacks.

As businesses increasingly transition their operations online, the threat of disruptions posed by malware attacks and ransomware becomes increasingly evident, highlighting the growing importance of cybersecurity.In today’s landscape, cybersecurity serves a dual purpose: protecting organizations from cyber threats while helping them seamlessly transition to a wider online presence.

As digitalization grows globally and businesses use innovation to expand their technical capabilities, cybersecurity will remain a wise investment for both companies and investors in the long run.

Companies Increase Expenditure on Cybersecurity

According to Matthew Ball, Chief Analyst at Canalys the number of publicly reported ransomware attacks has surged by over 50pc, with breached data records more than doubling in the first eight months of this year, indicating that 2023 is the worst documented year, ahead of 2021.

Per Gartner, according to Investor’s Business Daily, corporate expenditure on cybersecurity is forecast to reach a valuation of $215bn by 2024, witnessing a 14pc rise. Earlier, the research firm had estimated 11pc growth but revised its forecast upward, driven by increasing ransomware attacks by developments in generative AI.

Zacks, 24 August 2023

This is good news for ETFs specialising in the sector.

The Strongest ETF in the Sector

Below I show a chart of the strongest ETF in the sector. It looks explosive with a golden cross buy signal and a chart breakout close to a new all-time high.

It is instructive to look at the fund’s largest holdings.

The list includes my top three picks in the sector, Crowdstrike, Palo Alto Networks and Zscaler. It also includes Broadcom which is best known as a semiconductor business.

Just in passing Broadcom has had an amazing record of dividend growth since it began paying dividends in 2016.

It is in every way an exciting company.

Broadcom, which went from being a hardware company to a semiconductor company and is now transitioning to being half software and half semiconductor/hardware, has a large portfolio of many small electronic parts that we use every day without even realizing it. Just the fact that 99.9pc of all Internet traffic passes through at least one Broadcom chip is crazy when you think about it. That sounds like a big moat to me.

Broadcom has built a strong ecosystem and deep industry expertise. The combination of storage, Ethernet, PCIe, and Fiber Channel means that many customers are dependent on Broadcom. Broadcom is the market leader in Wi-Fi, with nearly 80pc of the infrastructure relying on Broadcom, 1bn Broadcom DSL connections installed worldwide, and Broadcom server storage is used by a very large portion of enterprise server customers.

And thanks to high reliability, which is very important for mission-critical tasks, low latency, and high power efficiency in the desired areas, Broadcom is very popular with its customers. And the focus on software and especially data centers should pay off in the coming years.

The most significant change is the increase in net debt from $25bn to $70bn to $80bn as a result of the VMware deal. But as we can see in the picture above, this is part of Broadcom’s strategy. They buy strong companies with debt, then improve their margins, and then deleverage the balance sheet. And historically they have been very successful with this strategy.

Tangerine Capital, 3 January 2024

This is a classic serial acquirer strategy, to make acquisitions, build up debt in the process and then manage their own and the acquired companies ruthlessly to generate cash to pay down the debt and build a war chest for more acquisitions. The company has so far made 39 acquisitions costing over $130bn.

The chart shows how effective they have been in creating shareholder value. Since 2009 the shares are up 87 times without including dividends reinvested. The man who has presided over this extraordinary progress, Malaysian-born, Chinese American, Hock Tan, is another classic US CEO. He was educated at Harvard, Massachusetts Institute of Technology (MIT), and Harvard Business School. He is 71 but may not be in any rush to step down.

AVGO is an impressive company and the VMWare deal is a big one.

And since 2020, even though we have not made an acquisition, we have shown a robust trajectory of growth, driven by semiconductor growing at an 18pc CAGR over the past three years. In fiscal 2023, operating profit grew by 9pc year on year, and our free cash flow grew 8pc year on year to $17.6bn, or 49pc of revenue. We returned $13.5bn in cash to our shareholders through dividends and stock buybacks. We just closed the acquisition of VMware on November 22nd, just about four weeks into Broadcom’s fiscal 2024.

We are now refocusing VMware on its core business of creating private and hybrid cloud environments among large enterprises globally and divesting noncore assets. Reflecting the consolidation of a restructured VMware into our 2024 outlook, we forecast our fiscal year ’24 consolidated revenue to be $50bn. We expect the integration to take about a year and will require close to $1bn in transition spending, which will largely be done as we exit fiscal ’24. Regardless, we expect our fiscal year 2024 adjusted EBITDA to be approximately 60pc of revenue.

Hok Tan, CEO, Broadcom, Q4 2023, 7 December 2023

The company is ideally placed for everything that is happening in AI.

Revenue from generative AI in fiscal ’23 reached 15pc of semiconductor revenue, in line with our expectation. And moving on to fiscal ’24, we forecast semiconductor solutions revenue to be up mid to high single-digit percent year on year. We expect revenue from generative AI to represent more than 25pc of the semiconductor revenue, consistent with prior guidance, which more than offset the lack of growth from non-AI semiconductor revenue. With the consolidation of VMware bringing our infrastructure software segment revenue to $20bn and the semiconductor segment holding a high single-digit growth year on year, we are therefore guiding our fiscal ’24 revenue to be $50bn, which represents 40pc year-on-year growth from fiscal ’23.

Hok Tan, CEO, Broadcom, Q4 2023, 7 December 2023

If it is true, as I believe, that you need to be big to compete in the generative AI space then Broadcom is doing all the right things and may become a member of the $1 trillion club before too long. In answer to a question about AI accelerators Hok Tan had this to say.

So, that’s — to answer the question, yeah, I fully concur with AMD [Advanced Micro Devices] when they indicate that it looks like demand appears to be accelerating rather than staying stable or decelerating.

Hok Tan, CEO, Broadcom, Q4 2023, 7 December 2023

Below is a definition of AI accelerators provided by Synopsys, a company active in the sector.

An AI accelerator is a high-performance parallel computation machine that is specifically designed for the efficient processing of AI workloads like neural networks.

Synopsys, 2023

None the wiser; there you go. In his question, the analyst spoke about this market as being worth $400bn.

Strategy – Make Sure to Have Exposure to Cyber Security in Your Portfolio

Cyber security feels to me like an arms race being waged by governments, enterprises and individuals. The leading companies in the space look set to become very large and existing giants, like Microsoft are also big players.

Share Recommendations

First Trust Nasdaq CyberSecurity. CIBR. Buy @ $56.31

Palo Alto Networks. PANW. Buy @ $345.65

Crowdstrike. CRWD. Buy @ $298.66

Zscaler. ZS. Buy @ $240.85

Broadcom AVGO. Buy @ $1211

Strong Growth Trend in Cyber Security Spending

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