Leading Cybersecurity Firm NetScout Could Be A Huge Winner (NASDAQ:NTCT)

A Computer System Hacked Warning

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NetScout Systems (NASDAQ:NTCT) is one of the top cybersecurity firms in the U.S. that has not garnered much investor interest in years. The primary catalyst for a rising stock quote could be a growing number of attacks and hacks around the world in 2022, partially caused by the Russia/Ukraine war. The list of users and partners is quite long and includes nearly every major tech company and numerous Fortune 500 outfits. Honestly, the company’s products help keep the internet functioning and many wireless networks from crashing daily.

Recent headlines in the news include President Biden and his administration getting corporate America ready for heightened levels of hacking, extortion, and electronic attacks on websites and computer networks around the world from Russia and its agents. Part of the initial attack on Ukraine, and now a reaction to economic sanctions imposed on the Russian aggressor by nations all over the planet, cyberattacks have increasingly become a risk all businesses that use the internet must deal with.

Listening to a variety of corporate conference calls during 2022, some available to the public and some not, CEOs and top management in the U.S. are quite worried business models today are built on websites and computer networks that run smoothly. For example, if the internet went down for an extended period, online-only businesses like Amazon (AMZN) would not be able to function at all. What if one of the big phone carriers lost their 4G or 5G network availability?

NetScout is a little-known company out of Massachusetts, operating for decades with some of the highest-rated cybersecurity software on the market currently. The company describes its network monitoring and security solutions like this,

Digital transformation enables enterprises and service providers to profit from the flexibility, agility, and scalability of software-based platforms such as network functions virtualization (NFV), software-defined networking (SDN), software-defined data centers (SDDC), and public, private and hybrid cloud environments. Delivering uninterrupted, high-quality service requires real-time, pervasive visibility to proactively identify issues; and the right troubleshooting tools to fix the problems, no matter where they occur.

NETSCOUT’s business assurance solutions, powered by our patented Adaptive Service Intelligence™ (ASI) technology, provide the visibility and insights you need to accelerate, transform, and innovate your networks and services for a flawless, agile, and cost-effective delivery.

https://www.netscout.com/

Company Website

https://www.netscout.com/

Company Website

Just last week, the U.S. government labeled NetScout competitor, Kaspersky, a national security threat, a company based in Moscow. Back in 2017, the government ordered all agencies to remove the antivirus and cybersecurity software offered by Kaspersky. Now it is suggesting all companies do the same to prevent the potential for spying and intentional disruptions to online/network communications by Russia.

So, for NetScout specifically, the whole Russia/Ukraine mess should remove one of its main competitors while pumping demand for its product materially the rest of 2022, especially if cyberattacks actually begin to rise in America.

Operating Margins/Returns

Basic returns and margins outlined by the operating business are in the middle to upper end of the range vs. peers and competitors in the cybersecurity and computer networking space. Below is a cross-section of names vs. NetScout looking at gross profit margins and final after-tax GAAP results vs. sales over the past five years. The peer list includes Microsoft (MSFT), Cisco (CSCO), Amazon, Citrix (CTXS), International Business Machines (IBM), Juniper Networks (JNPR), Extreme Networks (EXTR), Radware (RDWR), NortonLifeLock (NLOK), Rapid7 (RPD), and F5 (FFIV). [Of course, there are many more tech peers to compare and contrast, but my space is limited to 12 stocks on YCharts.]

YCharts by SA

YCharts

YCharts by SA

YCharts

Cash flow as a percentage of sales is also quite impressive, used as a proxy for underlying margins. Below is a 1-year chart of this data point.

YCharts by SA

YCharts

On a balance sheet review, NetScout runs one of the most conservative financial setups in the sector. At the end of December, the company held $553 million in cash vs. $417 million in total debt. Including other current assets like receivables and inventory, its short-term asset total of $840 million compares quite favorably against $1.09 billion in total liabilities, both short and long-term. Below are 5-year graphs of low total liabilities/IOUs vs. assets owned, and high cash flow to debt readings vs. peers.

YCharts by SA

YCharts

YCharts by SA

YCharts

Inexpensive Valuation

The good news is this conservative balance sheet, flush with cash and low levels of debt, is well-positioned to fund cybersecurity demand growth. The great news is an ownership stake is now available to investors at a clear undervaluation point vs. peer alternatives.

Below is a 10-year graph of the basic fundamental valuation ratios Wall Street likes to monitor. Despite 20-year high valuations for many technology companies over the past year, NetScout’s current price is closer to a decade-low vs. operating results. Using price to trailing GAAP earnings, sales, cash flow, and book value, NTCT shares have better-than-average underlying worth at $32 in April 2022 vs. its recent past or peer setups.

YCharts by SA

YCharts

When we add total debts and subtract cash on hand, NetScout is about as cheap as any networking-related organization on enterprise value to earnings before interest, taxes, depreciation and amortization. The current 12.6x EV to EBITDA calculation is definitely hard to ignore, if you are OK owning other overpriced tech names. (The S&P 500 is priced around 16x EV to EBITDA.)

YCharts by SA

YCharts

Price to basic cash flow measurements also highlight a super-low entry point for investors. Against the peer group today, 10.3x is far below the median average of 18x.

YCharts by SA

YCharts

What about free cash flow, the metric smart investors think most important for long-term holdings? Well, NetScout is the clear-cut leader on this calculation, with a 9.2% trailing free cash flow yield on a $32 stock price (including $54 million in cashless stock-based compensation for employees). This number is roughly DOUBLE the median average for the group.

YCharts by SA

YCharts

Bullish Technical Chart

Besides the positive fundamental valuation argument for ownership, technical momentum has been improving markedly since October. At the same time as most technology-focused equities PEAKED in price in late 2021, NetScout did the opposite – it bottomed. And the timing of its turnaround in fortunes closely mirrors the increased tensions in Eastern Europe as Russia massed troops on its border with Ukraine, then invaded a little over a month ago. For those adhering to relative price strength in decision-making for their investments, your bullish antenna should definitely be tuned into this name.

Measured from late October, several software security names, including NetScout, have been leading the technology sector for total return performance. You can see this positive development for shareholders in the two charts below – one of the peer networking group, and another looking at major U.S. indexes plus the go-go tech names crashing and burning in the latest Wall Street corrective phase.

YCharts by SA

YCharts

YCharts by SA

YCharts

On the 12-month chart below of daily trading action, you can review the steadily rising trends in the Negative Volume Index and On Balance Volume indicator. The two are telling us aggressive buyers have generally outnumbered sellers on both low- and high-volume trading sessions for months. Low Average Directional Index scores under 15 in February and March also highlight an intermediate-term trend of lighter volume and slackening volatility. Taken together, the background technical story is the stock looks to be under accumulation, and the latest rest in price could be the foundation for another leg higher.

After consolidating price gains since November, the stock is once again above its important 50-day and 200-day moving averages. Before big gains are possible, logically a stock quote has to get above price trends of the last several months. All told, for NetScout, we can check off the technical boxes that often predate a major price advance in securities historically. We’ll see what happens from here.

StockCharts.com

StockCharts.com

Final Thoughts

The main argument against holding NetScout shares is its low growth rate and expectations for the same by Wall Street analysts. This is the reason an undervalued picture exists on current results. However, the Russia/Ukraine war could dramatically change the demand for its products going forward, and give the company better pricing power. If such occurs, today’s $32 price is truly a bargain for investors. The non-GAAP EPS and revenue estimates below would prove way too conservative, while a “growth multiple” could push the stock to $45 or even $50 over the next 12-18 months.

SA Table

Seeking Alpha Table – Consensus Estimates April 1, 2022

For me, the fundamental investment story is just too appealing to pass up. I purchased a small stake in the company last week for the first time, as recommended in parallel by my proprietary technical trading formulas. A combination of strong fundamentals and technicals usually (but not always) leads to outsized outperformance in my experience.

The interesting part of the NTCT setup is few investors know anything about the company. However, if the U.S. is hit by major disruptive cyberattacks, everyone will be searching for a reasonable back-office network security play. I am thinking large numbers of investors will gravitate toward this name with better coverage by Wall Street brokers and improving operating metrics, perhaps wildly above expectations in 6-12 months.

What’s the downside? A great question. With the likelihood of terrific demand characteristics developing for its products, an overly aggressive acquisition streak of bolt-on asset buys that moves management away from its conservative balance sheet would be a negative. The flip side of this idea, nevertheless, is NetScout would itself make a solid acquisition candidate by a larger technology concern wanting cybersecurity exposure.

I would say the biggest outside risk is more macroeconomic in nature. Namely, a major bear market or crash on Wall Street would work to hold back NTCT’s share price. Overall, I am modeling worst-case downside scenarios to $25 over the next year vs. upside potential to $50. Since the company does not pay a dividend, theoretical percentage risk on invested capital of -25% vs. reward of +55% seems to tilt heavily in favor of bulls. I rate the stock a Buy currently.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

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