This Cybersecurity ETF Is Chocked Full Of Takeover Targets

The PureFunds ISE Cyber Security ETF HACK has garnered rock star status and become one of the best-performing technology exchange traded funds due in large part to the positive impact negative cybersecurity news has on HACK and its 32 holdings.

Although HACK and cybersecurity stocks have dithered in recent weeks, there is another looming catalyst with the potential to drive the cybersecurity higher: Mergers and acquisitions activity. Takeover activity as a possible catalyst for HACK and its components makes sense. Consider this: At the end of the second quarter, the average market value of the ETF's holdings was $8.4 billion and the weighted average of market capitalization of HACK member firms was $9.9 billion, according to PureFunds data.

Said another way, cash-rich technology companies such as Dow component Cisco Systems Inc. CSCO, a top 10 holding in HACK, that are looking to bolster their cybersecurity foot prints could go shopping among some of HACK's holdings.

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“Any traders interested in the buyout prospects can take heart from the deals of recent years. Cisco purchased security vendor Sourcefire in 2013 for a 29% premium to its stock price at the time, at a rich valuation of 76 times projected earnings and nine times projected sales. Never mind that Sourcefire at the time had just $233 million in annual sales, much less than Palo Alto and Fortinet,” according to Barron's.

Barron's cited Gartner security analyst Lawrence Pingree, who noted Palo Alto Networks Inc. PANW and Fortinet Inc. FTNT could be attractive takeover targets. Those stocks are both top 10 holdings in HACK, combing for over 7.5 percent of the ETF's weight. Only two stocks command weights north of 4 percent in HACK.

The ISE index HACK follows “tracks the performance of companies actively engaged in providing services for cyber security and for which cyber security business activities are a key driver of their business model. These cyber security services are designed to protect computer hardware, software, networks and data from unauthorized access, vulnerabilities, attacks and other security breaches,” according to PureFunds.

FireEye Inc. FEYE, which accounts for over 3 percent of HACK's weight, has also been identified as a possible cybersecurity takeover target. Of course, if large scale mergers and acquisitions activity comes to pass in the cybersecurity space, that would really benefit the newly minted Direxion Daily Cyber Security Bull 2X Shares HAKK. HAKK debuted earlier this month as the first leveraged cybersecurity ETF. The new ETF seeks to deliver twice the daily returns of HACK's underlying index.

“The Identity Theft Resource Center (ITRC) reported that 563 data breaches have been recorded in the U.S. year-to-date through 9/22, involving roughly 150 million records, according to 24/7 Wall St. The business sector accounted for only around 1 million (0.7%) of the exposed records, but 222 (39.4%) of the breaches. While the medical/health care sector ranked second in number of breaches at 199 (35.3%), the number of records exposed totaled 120 million (79.8%). The government/military sector experienced a total of 41 (7.3%) breaches involving 28 million (18.7%) records. In 2014, the ITRC tracked a record 783 data breaches, up 27.5% from 2013. From 2005 through 9/22/15, it recorded 5,593 breaches involving 829 million records,” according to ETF issuer First Trust.

First Trust sponsors the First Trust NASDAQ CEA Cybersecurity ETF CIBR, which came to market in July.