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The Challenge of Buying Cyber Companies

May. 5, 2013 - 03:45AM   |  
By ZACHARY FRYER-BIGGS   |   Comments
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WASHINGTON — Every major US defense contractor is busy building a new cyber center or announcing a revolutionary new cyber tool. And to support those cyber efforts, they are buying companies with new technology and approaches, buttressing their in-house capabilities.

The trouble is, experts say, it’s exceedingly difficult to figure out if a cyber company is of value in a noisy landscape where everyone claims superiority and few are knowledgeable enough to know the difference.

“Entrepreneurs are very, very clever, they figure out where the investors want to invest, and all of a sudden, every company looks like one of those companies; that’s the noise level,” said Bob Ackerman, managing director of Allegis Capital. “That’s how bubbles develop. Cyber is not going to be different.”

Ackerman has been investing in cyber for nearly two decades, and Allegis specializes in small cyber companies out of Silicon Valley. Because of the difficulty in evaluating cyber companies, Ackerman said his team is focused on technical talent. When push comes to shove, the critical factor in the potential of a company is its people.

“We evaluate the people, which is absolutely essential,” he said. “At the beginning and end of the day, everything else being equal, we invest in people.”

Cyber is still a young market, with security coming to the forefront only in the past couple of years as increasingly sophisticated attacks have gained publicity. And defense contractors are listening to Pentagon cues indicating that cyber capabilities is one of the few areas for potential gains.

Those stresses could be pushing defense companies to invest in cyber, despite the relative immaturity of many of its technologies.

“What the heck are these large defense companies doing messing around with these speculative assets?” asked Steve Grundman, principal, Grundman Advisory. “I think the answer is that they’re grasping after growth.”

But because most cyber companies are still relatively small, with minimal staff, falling more under the heading of startup than established company, contractors are paying peanuts.

Those investments are being trumpeted by companies as a critical part of their growth strategies, but the potential for the cyber market is limited, said Byron Callan of Capital Alpha Partners.

“It’s just not a needle mover,” he said. “Lockheed Martin at the end of the day is going to be about the F-35; Raytheon ... is probably going to be about their international growth; and Northrop Grumman kind of betwixt and between. It’s just not a big enough, growth-y enough market, that it could fundamentally alter the outlook for any one of these companies.”

For those looking to invest in cyber, there’s another potential issue: the deeply secretive nature of much of the work. Many of the smaller, more innovative companies do cyber work for the US intelligence community on classified projects.

For investors, figuring out the significance of a company’s intelligence community work can be difficult.

“It’s going to be a very difficult area for them to play in, unless they have people who have been cleared and know exactly what’s going on and who’s doing what,” Callan said. “Otherwise, people who try to enter it without those tools at their disposal are going to get their heads handed to them.”

One of the reasons so many small cyber companies are working in the intelligence community is because it’s one of the few areas of the federal government that can avoid the yearslong acquisition process common to most competitions. Instead, because of the urgent need for cyber tools, small companies can get to work quickly, provided they know the right hands to shake.

“There are customers in the federal sector where there’s a recognized mission that can’t do business the legacy way, where they can move much more agilely and much quicker, but they’re in the minority,” Ackerman said.

In general, however, when Ackerman has encountered companies looking to sell to the federal market, he has viewed it as a non-starter because of slow acquisition processes.

“Historically, if an entrepreneur had come to me in my office and said, ‘We’ve got this great idea, we’ve got this disruptive vision of the future, we’ve got a killer technical team, and our target market is the federal government,’ I would have politely found a way to get them out the door as quickly as possible,” Ackerman said.

But with the thirst for cyber capability in the defense market, large defense contractors are relying on middlemen like Ackerman to help weed out companies to find real value, he said.

And because it’s complicated, those types of suggestions carry weight, Ackerman said. “Cyber is an area which is very, very complex. This is not social media. This is not an iPhone app. This is hard-assed stuff.”

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