Cyber security is a fast-growing area that I expect to get much bigger over the next few years. Today I want to look at a UK tech stock in this sector whose share price has already doubled this year.
The company in question is digital privacy specialist Kape Technologies (LSE: KAPE). Sales doubled at this £800m firm last year. A near-$1bn acquisition this week has also attracted my attention. Should I buy Kape now?
What’s the big deal?
Kape specialises in digital privacy and security products such as VPN software and antivirus systems. The group has 2.7m paying customers, spread across brands such as Private Internet Access (PIA), Cyber Ghost VPN and Intego Antivirus. VPN services encrypt users’ internet connections, so they can’t be spied on or monitored.
A $936m deal announced on Monday will see Kape acquire ExpressVPN, which has more than 3m customers. This will double Kape’s customer base overnight and leave the group well-positioned to become a leading player in the VPN space.
Based on last year’s results, ExpressVPN will add $279m of revenue to Kape’s group results, with adjusted EBITDA profits of $75m. The equivalent figures for Kape last year were revenue of $122m and adjusted EBITDA of $39m.
It’s clear that deal should transform it into a much bigger business.
A fast-growing tech stock
I can see plenty to like about Kape shares. Ahead of this week’s news, the group’s sales were expected to rise by 60% to $200m this year. Adjusted EBITDA was expected to double to $73m-$76m.
This guidance priced the stock at 18 times forecast earnings, which doesn’t seem excessive to me. The acquisition will complicate its accounting for this year, but management has given updated guidance for 2021 revenue of $610m-$624m and pro forma adjusted EBITDA of $166m-$172m.
I estimate that Kape will issue around 145m new shares to help fund the acquisition. Management believes that the extra profit generated by ExpressVPN will cancel out this dilution to existing shareholders.
Indeed, the company’s guidance is that 2022 earnings per share should be around 28% higher than they would have been without ExpressVPN.
I’d buy – but carefully
If it can maintain its recent rate of growth, then I think this UK tech stock could be good value at current levels.
However, the situation isn’t completely without risk. A fair amount of growth is already priced into Kape’s share price, in my view. Big acquisitions like this don’t always work out well — if future growth disappoints, then the shares could slump.
Another point worth noting is that Kape has a majority shareholder who can effectively control the business. Israeli billionaire Teddy Sagi — who founded FTSE 250 gambling software company Playtech — owns 60% of Kape through his company Unikmind Holdings.
In a situation like this, external shareholders are basically along for the ride — they will never be able to outvote Sagi. This isn’t necessarily a problem, especially as he has a strong track record. But it’s worth remembering.
On balance, I’d be happy to buy some Kape shares at current levels. But I’d only make this a small position in my portfolio, for the reasons I’ve outlined above.