“Build the best widget and buyers will beat a path to your door” is the dream of many entrepreneurs.

But the reality is, unfortunately, very different.

That reality is even tougher for small companies with highly specialised products which are often forced to rely on a single global distributor, leaving them highly exposed to merger and acquisition (M&A) activity.

Take the case of Senetas Corp.

With over 1 billion shares on issue and a share price that has hovered for years between 10c and 20c, it is often overlooked as a penny dreadful.

Yet it has carved out a presence as a global player in the data encryption market, with its products used by an array of governments and companies globally.

Its annual revenue of only around $20 million understates its core position in security markets.

The difficulty is that more than three quarters of its revenue is generated through a Dutch distributor Gemalto, which is in the process of being bought by defence equipment major Thales.

Senetas Corp shares (ASX:SEN) over the past five years
Senetas Corp shares (ASX:SEN) over the past five years

Thales launched a €5 billion ($7.9 billion) bid for Gemalto late in 2017. The deal is due to wrap up in the next few months.

For Senetas investors, the concern is that Thales, which distributes a rival encryption product from an outfit ATMedia, could pull the plug on the Senetas product.

That concern has prompted analysts to advise investors to be wary about investing in Senetas, with Baillieu Holst recently slapping a ‘hold’ on the shares, downgrading an earlier ‘buy’ recommendation.

Uncertainty weighs on shares

“It is my understanding the Senetas product is superior [to the ATMedia product], but until the dust settles [on the takeover] it is difficult to recommend the shares,” an analyst with the broker told Stockhead.

Similarly, while Bell Potter has a ‘buy’ on Senetas shares, it has highlighted the Gemalto deal as a key risk, warning that “if for whatever reason’’ the distribution deal “is broken or not renewed, then this would provide material downside risk to our estimates and valuation”.

Investors hate uncertainty and for now, Senetas has put a brave face on the potential for bad news.

“We think the combined strength of Gemalto’s digital security business and Thales’s e-security business will be powerful and present new and exciting opportunities for Senetas,” Senetas chief Andrew Wilson said on news of the planned merger.

Subsequently Senetas disclosed a deal to tie some of its products in with German outfit ADVA Optical Networking, although any revenues from this deal will take time to emerge.

Steady progress has seen it build up a handy cash buffer of $20 million and no notable borrowings.

That high level of cash has given the company significant firepower to fund not only ongoing product development but potential acquisitions if they emerge.

Eighteen months ago, Senetas acquired Suredrop which had developed a file security software, giving it entre to a new market sector.

With no cash paid up front, any payments will depend on product success.

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