Is cybercrime good news for investors?

3rd February 2012

The risks posed by the connected world for both companies and governments was a top issue at last week's World Economic Forum in Davos last week. And in the UK, the KMPG Fraud Barometer revealed this week that financial crime – mostly fraud and online – cost the domestic economy a record £3.5bn over the past year.

But it's an ill wind…..as they say. Every online threat – and that's the vast bulk of financial crime – can be met with defences that can prove profitable for designers and makers. And as every wall is eventually overcome by hackers and other cybercriminals, necessitating yet another round of resistance measures. It's a continual fight where neither side can ever claim ultimate victory. Some suggest that online crime is more debilitating than the bond market crisis – it can involve all firms as well as non-corporates.

UK fraud in 2011 topped £3.5 bn – a record year – according to KPMG.  The second half of the year including the UBS £1.3bn "rogue trader" case, currently in the legal system, but even without it, the July to December 2011 period would have broken records for any six months. 

There are a five other cases where the fraud exceeds £50m -KPMG excludes crimes that are not prosecuted in Crown Courts as well as all those under £100,000.  So there are no petty cash frauds or expenses scams.

Hitesh Patel, KPMG Forensic Partner describes the background.

"2011 was an extraordinary year for fraudsters. The economic uncertainty has been the double edged sword behind these numbers: companies and government agencies have rooted out more fraud through implementing austerity measures and operational changes while at the same time the pressures on individuals as a result of the downturn continues to act as a catalyst for more fraud being perpetrated. These figures represent the thin edge of a much bigger wedge".

"Despite leading edge technologies to combat fraud, financial firms continue to be under relentless attack," Patel says. 

Patel commented: "Management often inflict the greatest damage to an organisation as they are able to operate fraudulently with greater ease by virtue of the trust and authority placed in them and their ability to conceal their tracks more convincingly. One case,  accounting for £380 million, involved a hedge fund owner accused of improperly inflating its reported assets following a series of fraudulent transactions, after the recession-hit fund collapsed"

Patel expects the situation will get worse before it gets better. 

He advises:  "It is vital organisations don't become myopic on this point and ensure they have robust prevention and detection mechanisms so that they don't lose value through the back door."

One of those "leading edge" robust prevention and detection mechanisms comes from the Israeli-based, Nasdaq-quoted software firm Check Point. 

"Providing protection against cyber-attacks is a fast growing business," says Giles Tulloch, an investment analyst specialising in technology at Henderson Global Investors. "We've a stake in Check Point – it's our eighth biggest holding, accounting for just over 3% of the Henderson Global Technology fund. Check Point is the number one in firewall market share in its large enterprises target audience. The "blade architecture" technology offers add-ons such as anti-virus and application control – it's adaptable to needs."

The investment case, according to fund manager Gordon Happell, is that Check Point "is a well run business with a market where firms will have to spend to defend themselves over and over. So it has huge recurrent revenues and the potential to grow earnings in the mid to high teens. It trades on 17 times price/earnings ratio and while its incredibly high 60% operating margin won't last, there will be plenty more top line growth."

Other ways into protection software, according to Tulloch, is via companies such as Intel, which acquired McAfee in 2010 and Juniper, which took over NetScreen.

"There are other software firms in protection which have good products such as Imperva and Fortinet. But we think their valuations have run ahead of themselves. It's good to see profits – I'm concerned by some smaller companies which grow too quickly and trade on very high multiples."

 

More from Mindful Money:

UBS Fraud: Ain't Nothin but a 'Rogue' Thing

How super-computers will make the City obsolete

Technology and the economy of the future

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