Whitney Tilson on Lifelock soaring 38% after announcing settlement with FTC and strong earnings. Excerpted from an email Tilson sent to investors last night (right now the stock is up 37% in pre-market trading).

Lifelock is a popular short (16% short interest) that really worked (I was short it until I did my mass-cover a year ago) – but they just announced strong earnings and a settlement with the FTC, which has sent the stock soaring 38% after hours.

It’s a good lesson on sticking around too long on the short side – and also the perils of being short: a) high-cash flow generative businesses; b) stocks that are cheap based on traditional valuation metrics; and/or c) situations that depend on regulators taking strong action (sometimes they do, sometimes they don’t).

That’s not to say such shorts can’t work – I’ve made a ton on WRLD this year and remain short WRLD plus HLF right now, despite these three things being true – but there’s risk…

Lifelock

LifeLock

LifeLock’s service is a combination of identity theft alarm and identity restoration insurance. For a monthly fee of $10 to $30, LifeLock (LOCK) will monitor to make sure a customer’s identity has not been stolen. LOCK looks for specific data points, e.g., change of home address or opening of new financial and other accounts, and alerts the customer if it suspects his or her identity has been stolen. In addition, LOCK will spend up to a million dollars to restore the customer’s stolen identity.

The identity theft protection field is very competitive and in all honesty very gimmicky. There are many players in the field that for the most part just pull consumer credit reports and spit out alerts based on changes in the reports. LifeLock’s business, too, was gimmicky – until 2012 when it bought ID Analytics.

ID Analytics has contracts with five out of six US wireless carriers and seven out of ten US credit card issuers. Here’s how it works: Let’s say a customer comes to a Verizon store to buy a phone. Verizon enters the customer’s info into the ID Analytics system. ID Analytics analyses millions (if not billions) of data points it has on the US population and tries to determine whether that customer in the Verizon store is who he says he is.

ID Analytics benefits tremendously from the network effect: the more vendors such as Verizon use it to detect fraud, the more robust and thus more valuable its data becomes. That consumer attempting to buy a cell phone at the Verizon store is another data point that goes into the ID Analytics system. ID Analytics charges Verizon pennies to prevent fraud that may cost Verizon hundreds of dollars.

 

And after the stock has risen 40%, analysts are playing catch-up

Wunderlich told clients:

We are upgrading our rating on LifeLock (LOCK) to Buy from Hold and raising our price target to $18.00 from $9.25 following the impending removal of the FTC overhang via an agreement on the outstanding litigation. Despite the headwinds created by the FTC accusations, LOCK reported strong 3Q15 results with revenue and EPS coming in above consensus estimates. The company also
set 4Q guidance above consensus expectations and raised full-year expectations. Over the past two quarters, LOCK has proven that these issues with the FTC were merely a minor distraction as the company continued to show the strength in the fundamentals of its business.