The scariest threat to national security – and how to profit from it

It sounds like something out of a Tom Clancy novel. But ‘cyberwarfare’ is increasingly regarded as one of the biggest threats to national security.

For the past few years, the Chinese military has been hacking into the computer systems of US firms. Everyone from newspapers – the New York Times, for example – to defence contractors has been targeted.

On a more mundane – but for most of us, more consequential level – criminal gangs intent on harvesting credit card and bank details are becoming ever more sophisticated. That means companies are under increasing pressure to ensure their systems are as secure as they can make them.

But this is an ever-evolving arms race. As soon as one loophole is closed, the hackers find another.

This means a lot of money is going to be spent on security over the next few years – and that’s something you can profit from…

This is scary, but it’s no scare story

It’s easy to dismiss the threat of ‘cyberwarfare’ as another scare along the lines of the infamous ‘Y2K’ millennium bug. (Back then, we were warned that planes would drop from the sky and people would be trapped in lift shafts for days because computers couldn’t handle the change of date from 31.12.1999 to 1.1.2000.)

Even experts admit that it’s hard to judge the full scale of the threat. But don’t be lulled into a false sense of security. This isn’t just tech industry propaganda.

Let’s put aside the more lurid fantasies about hacker-terrorists shutting down utility networks and transport systems for the moment. The prospect of something as mundane as having your credit card and bank account details accessed is pretty worrying, and we know how easily it can happen.

One reason it’s hard to judge the scale of the hacking problem is that companies often don’t want to admit that their customers’ data may not be safe. It’s not exactly a big selling point. But increasingly, big companies are coming clean about attacks – mainly because the problem is getting so bad that full disclosure is the only option.

What’s more, these aren’t small companies with a few clunky websites. Cutting-edge technology companies such as Facebook, Twitter, Apple and Google have all been attacked. Indeed, Google’s chairman, Eric Schmidt, claims that Chinese hacking is top of the agenda at most Silicon Valley firms.
 
Perhaps the most high-profile case so far was the hacking of Sony’s PlayStation network two years ago. This caused it to go down for over a week. It also put millions of accounts at risk. Adding up lost sales, legal fees and other costs, the total bill was $170m.

If hackers can cause these types of problems in savvy companies, it stands to reason that the problem must be bigger in less up-to-date firms.

An ever more connected world means more security problems

This threat is only going to grow as the world becomes ever more connected. As Andrew Rose points out in a scary article for Wired, “companies of all kinds… are linking ‘things’ as diverse as smartphones, cars and household appliances to industrial-strength sensors, each other and the internet”.

This promises to offer huge benefits. But it will also “unveil unprecedented security challenges… as technology becomes more intertwined with the physical world, the consequences of security failures escalate”.

When you wrap your head around the idea that in the near future, everything from your thermostat to your fridge could be vulnerable to cyber-attacks, you start to see how the more apocalyptic scenarios could take shape.

The Ponemon Institute, a think-tank, estimates that US firms and government departments will need to raise their spending by 800% to get an acceptable level of security. Given that Britain and Europe are even less prepared, they might have to spend more.

Clearly, there’s a limit to what governments can do. At a time of spending cuts, there isn’t the money to deal with every threat. And if you read the fine print of government plans to deal with hacking, you’ll see that most involve little direct action.

Instead, they’re mostly about encouraging more openness, so that problems and tactics used by hackers are known about more quickly. So while there may be more military and government spending on the threat, we wouldn’t stake big money on it.

However, private firms will have to spend money to protect themselves. They have no choice. The reputational risk is already high, and it will only become greater. If customers start to regard data security as a vital selling point, companies will have to spend what it takes to reassure them.

This is good news for those firms providing support in the area. A PricewaterhouseCoopers (PwC) report just over a year ago estimated that the global industry is already worth $60bn, with spending estimated to grow by at least 10% a year for the next five years.

PwC also notes the growing interest in the sector from big defence and technology players who are buying up security specialists, rather than set up in-house teams. For example, chipmaker Intel has bought antivirus company McAfee, while defence groups BAe and QinetiQ have also bought security firms.

This suggests that other companies in the sector are all potential targets, which should be good for share prices. One of the better value options is F5 Networks Inc (Nasdaq: FFIV). F5 provides support services to networked applications, including security. One of its flagship products is a next-generation firewall which, as well as blocking threats, monitors the application’s data at the same time.

F5 is set to launch a range of new products and upgrades in the next few months. These will further increase the protection its systems provide. The company also claims to be in the process of closing a number of deals with government bodies. It is also in talks with web-filtering company Websense (which blocks dodgy websites, essentially) about a strategic partnership.

Even without these deals, sales are already growing fast at 13% year-on-year. The firm also has a healthy return on equity of over 20%, and is debt-free, which should enable it to expand more quickly if it chooses. The price/earnings ratio of 17 times forward earnings is higher than the US average, but much cheaper than other firms in the sector. Given its strong growth prospects, it looks good value.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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One Response

  1. 28/02/2013, @SMSFs wrote

    Or alternatively trading on say 10X earnings you could look at Microsoft…. a company that is a pretty contrarian pick anyway if you like that sort of thing.

    It’s worth perhaps asking where the security problem is. Is it at the firewall or the application/operating system level. If the way you get in is by social engineering (say sending someone an email that encourages them to visit an external website etc) then perhaps it’s more the application/OS vendors (including the desktop security vendors) that are more likely to benefit.

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