Why Vasco Data (NASDAQ: VDSI) is a buy

By Kunal Jaggi (References from Business Week)
Attached below is my research on this stock that I have been watching and trading (on paper i.e fake money) for the past 2 months.

<<VDSI Research Package >>

Contents

1. Detailed analysis of annual financial statements for past 5 years & past 5 quarters.

2. Price & volume history for past 6 years.

VDSI - Year to Date up 193.08%, past 6 mths up 118%, past 3 months up 48.93%.

Vasco Data Security International, NASDAQ (VDSI) designs, develops, markets and supports patented user authentication products for major financial institutions, enterprise security (for secure remote access), e-business and e-commerce. Their user authentication software is delivered via its Digipass line of hardware and software security products. They operate in a niche that is increasingly being considered essential to business operations rather than luxury - ensuring security through networks and online commerce. In simple words, according to Business Week - "To safeguard Internet transactions, banks in the U.S. often ask customers a "life question," such as the name of a favorite pet or the street they grew up on. In Europe, though, many financial institutions rely on Vasco's Digipass, a handheld gizmo that uses a microprocessor to generate a random number every time a customer types in his name and password. The sequence in that mobile-phone-sized device matches a number that's synchronously generated by the bank's computer. No match, no transaction"

1. Management & Industry

The company was founded with a specific focus on the banking industry, which is still one of their strongest footholds. In 1989, after being fired at age 40, Ken T. Hunt (current CEO) heard about a startup that had been selling security devices to ABN Amro for its new dial-up banking option. He started out as chief executive, took out a second mortgage on his home and bought out the company from VC's who were previously looking to liquidate. Today, VDSI has had 17 consecutive profitable quarters and adds a new bank client every day. Read more here

• Customers include 750 financial institutions worldwide, 4050 enterprise security customers (corporate VPN, remote access).
• Responsible for 80% of world's largest deployments of string user authentication products in financial sector
  • Internet banking (both retail and big clients for wire transfers security etc)
  • Internet brokerage firms
  • Six months ended June 30, 2007 86% of revenues from banking, 14% from enterprise security.
  • Revenue in 2007 Q2 from increased 76% over 2006 Q2 for banking and 63% for enterprise security which includes e-commerce (same period) (Source is latest Company financial statements at sec.gov)
  • Growth in banking is higher due to strength of market position in banking and direct sales force.
  • Growth in enterprise security market is more dependent on strength of indirect sales channel. They will continue to invest in this channel and their products will provide higher levels of security for purchases made online. Also protect their customers' revenue stream by making it more difficult for subscribers to their customers' internet services to share passwords (ex when you and your buddies share the same password)
• Now here's the clincher - for 6 mths ended June 30, 2007, 91% of revenue is generated OUTSIDE the United States. (company financial statements)
  • This positions VDSI favorably in the scenario of US $ weakening further (since most of their revenues is in Euros and Asian currencies)
  • If the credit problems do cause recession in US (which I doubt), VDSI would again remain unaffected.
  • Ken Hun, on Bloomberg TV said Europe has traditionally been the early adapters in security software and most American companies approached said they were deferring the switch. You can only imagine the growth once American companies jump in.

2. Fundamentals - Grow baby, grow

Annual Story (2002-2006) (Please refer to my Research Package attached above for complete details)

• The company first became profitable in 2003, and over the 5 yr period of 2002 - 2006
  • Revenues have increased 338% with an average of 46% annually over the previous year.
  • The EBITDA has increased 499% , with an average increase of 179% from the previous year.
  • The EPS (fully diluted and normalized), has increased 265 % from 2002 with an annual average increase of 168%.
  • Cash flow wise, their CFO from continuing operations growth has increased 337% from 2002, with an annual average increase of 161%.
  • Gross margins have increased 406%, with an annual average increase of 50%.
• The company has had a very sound balance sheet as well. From the 2002 - 2006 period
  • The working capital has grown 3864% with an average annual increase of 295%.
  • Accounts receivables (annual average increase of 72%) have grown at a faster rate than accounts payables (annual average increase of 47%).
  • The current ratio has increased from 0.929 to 2.145 (131 % increase) and Acid Test ratio from 0.659 to 1.785 (171 % increase).

Quarterly Story (2006 Q2 - 2007 Q2)

• Revenues are up 75 % in trailing twelve months (TTM),
• EBIDA up 123 % in TTM.
• Net Income before tax up 115% in TTM.
• EPS fully diluted and normalized up 132 % in TTM and up 37% from the previous quarter.
• Free Cash Flow up 4013% in TTM.

For further ratio analysis, click here (Reuters)

3.Current Valuation

It is currently trading at a multiple of 65.37 (as of Sept 6, market close) and could seem already too expensive. But the key here is too look at the growth - when stocks grow this fast, there is always a high premium people are willing to pay for the growth. If you refer to my Research Report, you will find that it has previously traded at much higher price multiples (for example at 66.45 times earnings when price was only around 6 bucks in 2004). Alternatively, the stock is still quite cheap from the Price to Book & Price to Tangible Book ratios.

4. Technicals & Timing (Setting up the big institutions)

• As the stock chart (courtesy stockcharts.com) above demonstrates volume has picked up in last couple of weeks and seems to have gone through a few cup and handle formations, breaking resistance.
• Investors Business Daily rates VDSI as follows
  • 99th percentile in EPS rating & Relative Price strength rating
  • A+ in industry group relative strength, A in Sales + Profit Margins + ROE ratings and A- in Accumulation/Distribution rating (
  • Industry group rank 4 out of 197.
  • One of the heaviest bought institutional stock today.
  • Overall rating of A+ (in the 99th percentile of all stocks in the Investor's Business Daily database)

• Some recent developments
  • CEO Ken Hunt was invited on Stock talk show on Bloomberg TV last night.
  • Invited at Kaufman Brothers Investor Conference, ThinkEquity's Fifth Annual Growth Conference, Cornell University "Innovations for a Global Economy"

I believe this stock is coming into the radar of the big boys (mutual funds, hedge funds, institutional investors) very soon, and that my friends is what can propel a stock upwards very fast.