Wave Systems Breaking Out or Down?

Wave Systems' stock has surged 730% over the past year, evidence the maker of hardware-based digital-security products has its believers. Rob Holmes examines the stock in The Dollar Store.
Publish date:


Updated to reflect $6.3 million raised in 2009 offerings


LEE, Mass. (


) --

Wave Systems'


stock has surged 730% over the past year, evidence it has its fair share of believers it is poised to dominate the emerging hardware-based digital-security space with a very large addressable market.

But to sway bearish investors expecting a break down in share price,

Wave Systems

first needs to bury its history as a serial stock issuer. To accomplish this, it is evangelizing the technology to make consumers and corporations understand that built-in digital security is available at a flick of a switch and that it offers a cheaper, better performance than that of software-based security solutions.

For the better part of the last decade, Wave Systems shares have languished below the $5 mark, partly due to the company's frequent need to issue stock in order to fund research and development of its security technology. In the first few months of 2009, Wave Systems launched four separate stock offerings totaling nearly $6.3 million.

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"We certainly raised a lot of capital aggressively in the past, but we were relatively efficient in the raising of capital," Wave Systems CEO Steven Sprague told


. "But that's the old story of getting to where we are now."

Now, Sprague says, Wave Systems is funding its future development off revenue the company creates, rather than funding research and development through investors. Key to its success is partnerships with a veritable who's who of the technology space:


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This shift came thanks to a greater awareness by consumers and corporations of the need for better performing, cheaper digital security. Consider several media reports where valuable data was stolen along with a computer, like when

government officials lost laptops

containing classified information.

"People are beginning to take security more seriously, and we have a regulatory environment driving this," Sprague says. "There are now fines if you lose a laptop that contains private information that is not encrypted. There are some pretty substantive data protection laws that are forcing every organization to make sure the laptops and desktops that they have are protected."

As it supports both trusted platform modules and self-encrypting hard drives, Wave Systems stands to benefit greatly. The trusted platform modules (TPM) Wave Systems supports refers to a hardware chip on a computer's motherboard used to store keys that are identities to log you onto different services, such as VPN or cloud computing. In the past, encryption was done by software added to a machine after production, but now security is being integrated from the get go.

"Think of it like the SIM module on your cell phone, which keeps your cell phone secure. The keys are actually in the hardware," Sprague says. "This is bringing that capability to the PC, where the keys cannot be stolen by software."

On the other side of the business, Wave Systems supports self-encrypting hard drives, which consumers and companies buy when ordering a new computer. Last year, Sprague estimates that nearly 65 million copies of the company's software shipped with Dell computers. However, most users don't realize the security is built into the system.

"It's taken much longer than anyone has expected, no question," Sprague says of consumers' awareness of the technology. "I would have never believed that we'd have gotten to 65 million copies of software shipped and we'd be just talking about engagement."

Much like it has struggled with consumer awareness, Wave Systems has had difficulty finding profitability, despite a jump in revenue. In the third quarter of 2009, Wave Systems saw revenue total $4.8 million, a 164% increase from the prior year. By comparison, Wave reported revenue of only $335,000 in the third quarter of 2005.

That surge in revenue has done little to sway investors concerned about the company's bottom line. There is also trepidation that Wave Systems has more than 70 million shares outstanding but is generating little cash. At the end of the third quarter, Wave Systems said it had total current assets of $5.2 million.

With no analyst coverage of the company, investors in Wave Systems have to rely on the company's quarterly reports and how the stock has traded historically. John Welsh, a daytrader who tweets his stock trades on

Twitter as johnwelshphd

, says that Wave Systems has potential and could report a profit when it posts fourth-quarter numbers on March 11.

However, Welsh argues that after the big move in shares recently, history and valuation could mean a sell-the-news reaction when the company reports. Welsh does not hold a position in the company.

"History has shown Wave Systems news items usually do not pan out and are sell points," Welsh wrote in an email. "A typical Wave Systems move consists of nice news releases like it's encrypted hard drive for Dell or H-P computers, and the old 'cult followers' of Wave Systems hopped back on board for a usual beating. Even though the company is generating cash at low levels, one could think they may take advantage of a big run in stock to get some extra cash in the bank. Either way, the valuation of WAVX does not look compelling."

While Sprague acknowledges that one could always sit back and design the perfect balance sheet, he says that Wave Systems is perfectly comfortable as things are now.

"We've clearly stated we have no intention to be out in the capital markets," Sprague says. "The challenge was that we were consistently in a mode of raising additional capital. As we've been able to show, we don't need to raise additional capital and we can fund the company out of our own operations. We're at cash flow break-even and we're very comfortable."

Wave Systems also gained momentum recently thanks to a $5.7 million license and maintenance order it received from a U.S.-based automotive company. The deal brought in $1.9 million in revenue at the very end of 2009 and should bring in another $2.25 million through the end of this year.

"That's the first really big corporate use of this hardware technology. There have been quite a few enterprise customers who have turned it on, but nothing on this scale," Sprague says. "With the nature of emerging markets, there's nothing better than having a really big customer when you're trying to sell another big customer. It makes it easier to close with the next guy."

Looking ahead, with the advent of


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Windows 7, there is the general expectation that the PC industry should see good volume growth in 2010, which should benefit Wave Systems directly.

Beyond that, Sprague is targeting other practical uses of Wave Systems' technology, like in the health care industry.

"The probability is that all of the machines in the health care industry have a common device for authentication in the box. But it has still yet to be turned on," Sprague says. "It's in the early stages of awareness and there are great advocates of its use, like the U.S. government."

But for now, Sprague is delighted that the emerging market of hardware-based digital security has gotten big enough and strong enough to fund the development of the technology in the market itself. As the lone company to support both trusted platform modules and self-encrypting drives, Sprague says Wave Systems is the main beneficiary of greater awareness of the technology.

"The need for data-protection and network access and the performance of solutions have become very clearly understood," he says. "Security is now something you can buy that's built-in, and it is emerging as an interesting solution. Don't staple on security afterwards. Don't tape an airbag to your steering wheel. Buy it built in."

-- Written by Robert Holmes in Boston


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