Analysis

IT security deals flourish in wake of NSA scandal

Source: DACH unquote | 14 Nov 2013
Spying is terror

The public outrage over the NSA scandal is still going strong in Germany. Kim Richters investigates whether recent reports of government spying have influenced the local private equity market

Since the first revelations in June over the US National Security Agency's (NSA) mass surveillance programme, there have been six private equity transactions in the data and IT security sector across Europe. Four of these deals took place in Germany and three were completed just last month: BayBG's backing of B2B IT security solutions provider SSP EuropePinova Capital and BIP Investment Partners' buyout of B2B cyber-security provider Utimaco Safeware; and Project A Ventures' investment in ZenGuard, an internet security solutions provider. While these deal numbers may appear relatively low, some may already see an early trend emerging as Germany's corporations, politicians and individuals engage in heated debates around data and IT security issues.

Andreas Heubl, partner at BayBG, which acquired a minority stake in SSP Europe, argues the scandal was a deciding factor in its investment. In his opinion, the demand for made-in-Germany security solutions providers is increasing as distrust from firms and individuals towards foreign software businesses grows. "The NSA scandals helped in adding value to this sector," Heubl says. "In my opinion, its influence on the data security sector is clearly visible. At the moment we receive a steadily increasing number of fundraising requests from firms concerned with producing IT and data security solutions. Furthermore, our references for SSP Europe's due diligence confirmed that the demand for German software has flourished among customers. All of this has happened at the same time as the NSA scandals."

Pinova partner Joern Pelzer is also bullish on the IT security sectors, but disagrees when it comes to the impact of the NSA affair: "Corporations often handle sensitive data that needs to be secured. Through the recent trend to store information in less secure cloud spaces, the demand for IT security solutions increases. Therefore, the IT security sector offers exciting investment opportunities for private equity firms and I'm sure it will continue to do so in the near future. However, the recent NSA scandals did not start a sudden data protection hype, nor did they have any influence on our investment in Utimaco."

Heubl concedes the spying scandal was not the only reason BayBG invested in SSP Europe. "Of course, the actual attractiveness of an investment always depends on the unique selling proposition of a firm itself," he says.

Looking back at the media's reaction, Pelzer recognises the large public outcry across Germany but is convinced the outrage will blow over quickly, especially in the B2C segment, as is very often the case with political issues. Individuals may be demanding more protection for their personal information at the moment, but the majority will continue posting such data on social networking sites, which makes it accessible to third parties anyway.

Heubl agrees the public will continue to freely provide personal information on social networks, and in doing so is not overly-concerned by data protection. He also predicts that when mainstream media ceases to report on NSA surveillance, decreased demand for B2C data security solutions is a likely outcome.

However, Uwe Horstmann, founding partner at German incubator Project A Ventures, disagrees. He thinks B2C data security solutions have increased in popularity following the NSA scandals, creating promising and interesting investment opportunities for early-stage venture firms. Project A recently backed a seed financing round for ZenGuard, a company that provides software security by redirecting internet activity via its own cloud-based solution, therefore encrypting online activity and protecting the source code. Horstmann says: "We see demand for data protection tools in general, yet many potential users are put off by the rather complicated process to use them. We think offering simple, easy to use and non-expensive security solutions will serve exactly that market niche."

Corporate over consumer
Heubl sees a bigger success story for data security investments in the B2B sector, however: "Looking at the IT security B2B market, the NSA scandals will have a lasting effect on this segment. During the SSP Europe due diligence, it was made clear that most experts we consulted expected only a few – if any – government regulations concerning securing company or individuals' data, hence leaving the economy to its own devices. This leads to a rise of businesses looking to acquire IT security software in order to protect themselves and their data from unauthorised insights."

Furthermore, the B2B sector is far more attractive to the asset class thanks to the smaller equity commitments required and the lesser level of competition compared with B2C companies operating in the space. Pelzer agrees: "In my opinion, the most profitable investment opportunities are IT security solutions for other businesses rather than for the individual consumer. Corporations will continue to protect any sensitive internal information from unauthorised usage – more than the individual consumer generally cares about protecting private data."

Although disagreeing on whether the NSA scandal is influencing the popularity of IT security solutions – and therefore the possibilities of a profitable investment on the private equity side – most industry participants see the sector as a constantly growing and promising market segment, notably in the B2B sub-sector. However the recent security scandals are interpreted, one thing is for sure: data security is set to be the next big hit in Germany.

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