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ADDRESSING CYBER VALUE

18 May


     A few weeks ago I attended the InfoSec World Expo in Orlando, Florida where I had the privilege of listening to and learning from some of the smartest people in the information security industry.  Among an overabundance of financial service professionals were hackers, government intelligence officials, private sector security consultants, researchers, and authors.

I was surprised by both the number of financial service professionals in attendance and the spectrum of their employers.  The Federal Reserve, bulge bracket banks, regional banks, and online and full service broker dealers.   Yet there was a noticeable lack of industry representation from software and technology vendors that support financial service firms (FinTech).  Nowhere could I find anyone from a capital market technology vendor, or a security exchange, or a clearing house.  I struggled to understand why these providers of strategic services so vital to the financial community were so startlingly absent from this event.  Are these FinTech providers insulated from the threats that the financial service providers and the government in general have succumbed to over the past few years?

There was a similar dearth of CEO’s, President’s, CIO’s or CTO’s.  Most of the attendees were direct reports of the technology leadership and almost no strategic or client focused representation was noticeable.   This brought me to my second question – Are security issues in today’s world not important enough for the most important?

I hope to answer both of these questions within this brief article.

Roger Cressey, a well-known terrorism analyst, gave a rather animated keynote.  His argument, similar to many others at the show, was that the United States Government is ill equipped to deal with the growing threat of cybercrime.  Moreover, the private sector may be even more poorly equipped.  Most of the cyber crime is not coming from kids in a basement or a lone wolf, said Cressey, but rather from foreign governments, even those considered close US allies.  Highlighting cyber attacks such as the Navy’s F-35, Google’s breach in 2009, Operation Trident Breach in 2010, Nasdaq and London Stock Exchanges breaches in 2010,  and the European Union headquarters attack in 2011 cemented his argument that no one is really ready for growing threat of cyber terrorism.

Others at the conference discussed the cloud and its ramifications on security, particularly the highly sensitive information possessed by financial related services.  Many security professionals argue that moving information and services to the cloud to cut costs is a bad idea, with most of the companies not having a contingency plan for major breach.  Furthermore, once companies move information to the cloud, bringing information back to their own local data centers is a problem few executives can answer.  Overall, most argued that expense related technology changes that impact security should be done on a very select and very diligent basis.

My third take away from the conference was that many of the cyber attack are not direct attacks on corporate infrastructure, but typically well placed “phishing” attempts where corporations are infiltrated from an employee’s computer through file sharing or social media related sites.  In this situation with limited security infrastructure to help neutralize these types of cyber attacks, diligence is your best weapon.  My discussions with industry professionals informed me that these attacks are becoming more complex and harder to detect, to the point that they are almost impossible to prevent.

In the month since the conference I have had time to reflect and speak with many colleagues, clients, and friends about security and the issues addressed above.  Most agreed that cyber security is becoming a major challenge and most also agreed that nothing will get done until there is a major attack, whether it be a breach where substantial information is stolen or a freezing of highly sensitive and important infrastructure.  Most also agreed that these issues are not on the agenda for most C-level executives because they have not been important enough.

This is where I would like to make an argument on value.

Many companies are occupied with thinking through strategy, planning product initiatives, executing on top line growth and eliminating unnecessary costs, all with the intent of driving increased shareholder value, and rightly so.  Up until most recently, the major concern for FinTech companies, the goal that would facilitate all of the preceding goals mentioned, was simply ensuring uninterrupted service.  However, today the operational risks, although perhaps not well identified by most, are game changing and demand attention.

Imagine that a major FinTech company that archives client information, including family holdings, and brokerage commissions, is breached and the securities stolen.  You can imagine the destruction in value, lost clients, major shakeup in C-level management, negative media exposure, and the quickly deteriorating share price.  The more important question is not related to the individual firm, but rather the industry in general.  What would happen to the sector’s value?  Would everyone experience a decline in capitalization?  Would the smaller more nimble entrepreneurial company experience an even greater decline in value – a flight to quality?

It seems more than possible that a major breach to one FinTech company can have a systemic effect upon the entire industry.  The only way a firm can be protected from this value erosion is to ensure that they have well documented and strategically aligned security program, with full C-level participation.

Although the threat of a flight to quality is ever present, it seems that entrepreneurial companies have an advantage in ensuring a well thought out and strategically aligned security program.  Unlike most of the large FinTech providers, these smaller FinTech companies are more nimble, with fewer infrastructure needs, allowing the instillation of a viable program that addresses cyber security issues in the manner above.

Cybersecurity and cybercrime are game changers for FinTech companies, yet many C-level executives are currently unaware of the real risks they pose and some will unfortunately fall into their grasps.

Bankers typically discuss how to assist companies with increasing shareholder value through growth, but in this case it seems important to discuss how you may save value, or even create value, in a way that may have been previously overlooked.  It’s my advice that you reconsider your security strategy, re-analyze your needs, re-consider the ideas from the IT staff, and, most of all, engage the entire organization in your plans.

Kroll Ratings – A new disruptive entrant?

21 Jan

 

As I have been arguing over the past 6 months, the oligopoly of the credit ratings agencies will probably not be sustained in the long term.  Today, we have a new and welcomed competitor, Kroll Bond Ratings Agency Inc.  Founded by Jules Kroll, who has a background in corporate investigations, Kroll expects to dig deeper in credit ratings, moving beyond issuer information.  Kroll expects to lever his son’s security firm K2 Global to assist in uncovering anomalies or areas of risk that lie off the balance sheet.  Kroll is not a new company but rather the business evolution of Lace Ratings, which the company acquired in the summer 2010.

Over the past few months we have seen one new entrant and two acquisitions in the ratings marketplace:

New entrant: Meredith Whitney’s Advisory Group

Acquisitions: Morningstar acquisition of RealPoint LLC and Kroll’s acquisition of Lace Ratings.

These seem like three moves in an industry that is ripe for change, both organizationally and technologically.  The anticipation is that change will continue to happen, with ratings agencies acquiring more analytically sound and advanced mathematical ratings capabilities and many of the investor research firms which have such capabilities moving into the ratings agencies marketplace.

It seems like the only barrier to entry standing in the way of new product innovation  is related to the selection process for a new Nationally Recognized Statistical Rating Organization. Today, the SEC provides unclear information related to the application and selection process.  Once the SEC gets out of its own way and clears the path for more competition, we should feel confident that this marketplace will erupt in many different areas, creating quantitative qualitative, industry specific and many other different types of ratings.

Only time will tell but the trend is showing a positive move in the right direction.

Articles of Interest:

http://professional.wsj.com/article/SB10001424052748703951704576091683201498122.html?mg=reno-secaucus-wsj

http://www.bloomberg.com/news/2010-12-08/credit-ratings-can-t-claim-free-speech-in-law-bringing-risks-to-companies.html

http://professional.wsj.com/article/TPPRN0000020110119e71j004so.html

http://corporate.morningstar.com/us/asp/subject.aspx?xmlfile=174.xml&filter=PR4482

Is M&A an Impediment or a Catalyst?

20 Sep

By:  Luigi D’Onorio DeMeo

Your name does not have to be Nouriel Roubini, Paul Krugman or Ben Bernanke to understand that the United States economy is not faring so well these days. Still recovering from the most severe financial crisis since The Great Depression, the economy is plagued with uncertainty related to costs associated with regulatory reform, a consumer that prefers to save rather than spend, and potentially higher income, dividend, and capital gains taxes.

The “headwinds” for the market and ultimately, a CEO are blistering. These executives are struggling to enhance shareholder value as costs have been slashed and final consumer demand remains weak. With historically high cash balances and a limited appetite to pursue new ventures, some CEO’s are turning to mergers and acquisitions (M&A) as a means to acquire new technologies and services that will enhance their footprint in the market, yet at the same time provide the opportunity to realize further cost synergies and enhanced distribution opportunities.

Most recently we have seen M&A activity increase with BHP Billiton’s hostile bid for Potash, Intel’s acquisition of McAfee, First Niagara merging with NewAlliance Bancshares (biggest US bank takeover since 2008), HP and Dell’s bidding war for 3PAR, and HSBC’s stake in South-Africa based Nedbank. According to Bloomberg data, deals in August will total $285 billion, close to the $297 billion of deals in August of 2007.

There seems plausible four main reasons for the recent M&A flurry:

  1. Anemic economic growth in developing countries, limiting revenue expansion and potentially bottom line growth after expenses have been aggressively cut. The limited growth is attributed to an apprehensive consumer and unforeseeable regulatory future created by policy leaders.
  1. Excessive cash on corporate balance sheets are due to lack of demand or confidence, leading to hesitancy to hire additional workers or increase capital expenditures. Shareholders demand that cash be invested in current or future businesses, not remain as reserves.
  1. Low borrowing costs coupled with low earnings rates on corporate cash lead to low cost of capital and inefficient interest gains on cash.
  1. Executives are not expecting a double-dip recession, but instead a slow growing economy that forces them to diversify or grow revenues and margins through M&A efficiencies.

Underlying these deals, there seems to be a consistent pattern developing. BHP Billiton, the world’s largest mining company is attempting to buy Potash to enhance its emerging market presence with Potash’s investments in China, Chile, and India. Intel’s acquisition reflects a chip maker acquiring a security company to supposedly enhance its top and bottom line while growing margins through synergies. HSBCs acquisition of Nedbank is just another attempt of an established company searching for growth in emerging markets.

While M&A activity is normally bullish for stocks and the economy in general, many experts believe as though these deals are not for the right reasons. Most of the acquisitions reflect an attempt to grow in other countries. This reiterates executives’ view of the weak US economy and the need to diversify away from a sluggish revenue stream. In August of 2007, an extraordinary amount of deals were done correlating closely with a stock market and economic high or top.

Many market commentators will use the M&A flurry to describe a negative catalyst where CEOs and executives tend to be late in timing markets and can invest capital at the height of the market rather than prior to a boom. I take a slightly different view and see the deals completed as a mixed revelation of confidence in the strong emerging market growth versus tepid growth for developed economies. While companies are admitting that domestic growth is fragile, they are confident enough to finally deploy capital with confidence that they will receive a higher yield on their investment than current interest rates on cash balances.

Corporations are also in disagreement with the market regarding the battle of bonds versus stocks. Companies believe stocks are too cheap and this is reflected in their hesitance to use stock to finance deals. Normally, businesses issuing equity for financing usually relates to a management’s belief that their stock is either overvalued or at fair value. Debt and cash are inexpensive avenues to raise capital and this phenomenon was most recently exacerbated in IBM’s ability to sell 3 year paper for just 1%.

I believe that the “headwinds” for the market and the economy that caused the near 20% decline in equities and recent soft economic data are suddenly becoming “tailwinds” that can rejuvenate stronger and more sustainable growth. Since the equity market decline and fixed income rally that started in late April, many economic and market variables have changed. The 10-year treasury yield that was pressing above 4% currently yields close to a record low of 2.40%, The Fed that was previously readying to withdraw liquidity in the market, is now on the cusp of further Quantitative Easing. Also, the dollar strength that was experienced months ago has started to fade as the greenback has erased half of its gains against the Euro, and finally, Crude Oil that traded around $85-$90 per barrel, currently rests around $73 lowering gasoline prices and allowing more disposable income for consumers. The variables are stimulating in nature for the consumer and businesses and it possible that CEO’s are taking note of that and investing in M&A.

Ultimately there is no debating that US economic data has been soft but I feel as though the scale has tipped far enough where the variables that drove economic growth in 2009 have corrected themselves to a currently favorable position. CEO’s are starting to invest in future business rather than continue to hoard cash. This allows me presume that the recent M&A buzz reflects that companies believe in a recovery rather than a recession and therefore to be cautiously optimistic with regards to previous impediments now becoming catalysts for growth.

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