Cybersecurity stocks set to benefit from heightened concern, despite current sell-off

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In the wake of Russia’s invasion of Ukraine, it made sense that cybersecurity companies would draw some extra investor attention.

And there was a decent bump over the first few days, in apparent recognition of Russia’s penchant for wreaking digital havoc as a facet of its military strategy.

But the gains quickly vanished, as the broader tech sector sell-off overwhelmed what many observers see as powerful trends working in favour of the cybersecurity space.

Most of the companies dedicated to keeping systems safe from digital attacks – as well as the funds that track them – have seen their shares decline by between 10 per cent and 30 per cent since November.

“Volatility is your friend, in this case,” said Paul Harris, partner and portfolio manager at Harris Douglas Asset Management. “If you really believe in the sector, this is the time to go and buy.

“When you look at the world, and how many companies have seen huge problems with this, like Microsoft and Marriott, it’s clear to me that there is just going to have to be more and more investment in cybersecurity at a company level.”

Both Microsoft Corp. and Marriott International Inc. have suffered colossal data breaches in recent years – attacks that Western intelligence agencies say were perpetrated by hackers employed by the Chinese government.

Russia, meanwhile, has been linked to two of the biggest digital attacks of the past couple of years. The hack of Texas-based IT management software company SolarWinds Corp. compromised thousands of U.S. organizations in 2020. And last year’s ransomware attack on the Colonial Pipeline disrupted nearly half of the U.S. East Coast’s supply of fuel.

Spy agencies are now warning of the potential for heightened Russian cyberattacks as retaliation against countries levying economic sanctions, including Canada.

It’s not just government agencies and giant corporations that are targets. Hackers, both state-sponsored and otherwise, are increasingly stalking smaller game, which are often more vulnerable.

One in five Canadian small businesses have reported being the victim of a cyberattack, according to an Insurance Bureau of Canada report from last year. And the total cost to Canadian organizations in ransoms paid and lost productivity was more than US$4-billion in 2020, according to cybersecurity company Emsisoft Ltd.

“What may have been viewed as an IT department problem in the past has been elevated to a full-scale business risk,” CIBC World Markets analyst Stephanie Price wrote in a recent note.

The rise in demand has spread throughout the cybersecurity industry, from threat detection to attack response, Doug Taylor, an analyst at Canaccord Genuity, said in a recent note. Last week, Google underscored the growing interest in security software when parent company Alphabet Inc. GOOGL-Q announced a deal to acquire cybersecurity firm Mandiant Inc. MNDT-Q for US$5.4-billion.

The downturn in cybersecurity stocks seems to run counter to all of the recent attention on the space.

“The sell-off is somewhat surprising,” said Daniel Straus, director of ETFs and financial products research at National Bank Financial. “I would have thought that with the eruption of hostilities in Russia and Ukraine there would be renewed concerns around cyber warfare and demand for these companies’ services.”

The Evolve Cyber Security Index ETF CYBR-T, which is the largest of its kind trading in Canada, is down by 20 per cent since November – a period of time that has seen the market retreat from growth stocks of all kinds.

CI Global Asset Management launched its own digital security ETF earlier in March, while iShares XIU-T has filed a prospectus for a similar fund. They will trade alongside additional existing cybersecurity ETFs from First Trust CIBR-T and Horizons HBUG-T, crowding the field for such a defined investment theme.

“The ETF provider community believes the theme is here to stay,” Mr. Straus said.

At the company level in Canada, CGI Inc. GIB-A-T and Magnet Forensics Inc. MAGT-T are the two names best positioned to capitalize on the trend in cybersecurity spending.

CGI, which has a dedicated cybersecurity practice, is trading down by 7 per cent year to date. Over the same time, Magnet, which focuses on investigations into cybersecurity incidents, has lost 13 per cent. It is now trading at about nine times this year’s estimated revenue – “too cheap for a name of this calibre,” Canaccord’s Mr. Taylor wrote.

“We recommend investors take advantage of broader software sector malaise to add to positions.”

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