Markets & Finance

Software Stars of Internet Security


By Jonathan Rudy All things considered -- a war in Iraq, a global economic slowdown, and a deadly disease outbreak in Asia -- the Internet security software group turned out some pretty solid results in the quarter ended Mar. 31. Of the sector names in Standard & Poor's universe, only one, Internet Security Systems (ISSX

; ranked 3 STARS, hold), warned that it would miss the consensus revenue estimates, by about 6%, yet it managed to hit the consensus earnings per share estimate.

Another one, Network Associates (NET

, ranked 3 STARS), sold off sharply after reporting revenue about 5% below our expectations, and EPS that was a penny below estimates. The other three, Check Point Software (CHKP

; ranked 4 STARS, accumulate), Symantec (SYMC

, ranked 4 STARS), and RSA Security (RSAS

; ranked 2 STARS, avoid), had very solid first-quarter performances.

Within the world of application and systems software, results achieved by the Internet security software group as a whole far outpaced the broader category. Enterprise software vendors Siebel Systems (SEBL) and PeopleSoft (PSFT) experienced declines in license revenue, a key indicator of the health, of 54% and 39%, respectively. While these enterprise vendors were significantly hurt by business contracts not being closed due to the war and severe acute respiratory syndrome (SARS), we at S&P believe that the relative outperformance in Internet security demonstrates the importance of the products these companies provide.

CHECKS AND BALANCES. On a positive note, Symantec once again beat EPS estimates, coming in at 47 cents, vs. an expected 46 cents. Revenues rose a strong 26%, surpassing our estimates. Symantec's consumer Norton AntiVirus business continues to grow at a torrid rate, with a 32% increase year-over-year in the quarter. Its enterprise business also posted stronger-than-expected results. Symantec's outlook for the coming fiscal year was kept at high-teen revenue growth and approximately 10% EPS growth.

We at S&P remain impressed by Symantec's execution and market-share expansion in a challenging information-technology spending environment. At 23 times our fiscal year 2004 EPS estimate of $1.89, with our forecast of 15% to 20% growth over the next couple of years, we believe that shares of Symantec remain attractive.

Check Point Software results were in line with EPS estimates at 24 cents, down from 26 cents in the year ago quarter. The market leader in firewalls and virtual private networks (VPNs) has seen earnings growth level off during the past two years along with the broader technology market. Despite Check Point's continued challenging near-term prospects, it remains extremely profitable, with operating margins around 60%. Check Point was guarded in its outlook for the coming year, but its forecast was basically in line with our expectations.

JUST TOO STEEP. Additionally, its balance sheet is exceptionally strong, with approximately $5.50 in cash per share and no debt. At 15 times our 2003 EPS estimate of $1.01, a discount to its peer group, we believe that shares of Check Point remain attractive considering its strong profitability and balance sheet.

RSA Security also turned in better-than-expected results, with EPS of 3 cents, 2 cents better than Wall Street estimates. The leader in identification, authentication, and encryption products has rebounded faster than we had previously anticipated. RSA did anticipate better earnings performance than we had expected in 2003.

However, we have an avoid recommendation on RSA shares primarily because of valuation concerns. At 72 times our 2003 EPS estimate of 13 cents, with a weaker balance sheet than its peers, we would avoid its shares despite the better-than-expected recent execution.

HOLD TIGHT. Internet Security Systems preannounced slightly worse-than-expected results, and the shares rallied sharply when ISS reported that its business had not deteriorated. It's a leading provider of intrusion-detection software. ISS slightly lowered its outlook for 2003, but we still anticipate about low double-digit earnings growth in 2003.

It has a solid balance sheet, with over $4.30 per share in cash and marketable securities. At 23 times our 2003 EPS estimate of 56 cents, with lower growth prospects than certain competitors such as Symantec, we would not add to positions.

Network Associates issued the most disappointing outlook for 2003 in the Internet-security sector. Its Sniffer product line, which is designed to maximize network availability and performance, and McAfee enterprise antivirus software both failed to meet expectations in the first quarter, and should continue to face near-term challenges.

However, we believe that Network Associates has a solid product line and will be able to rebound by yearend. With the shares trading at 18 times our 2003 EPS estimate and 1.8 times sales, a discount to peers, we would hold the shares in anticipation of better times ahead. Analyst Rudy follows software stocks for Standard & Poor's


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