Internet security software is one of the last tech sectors left standing, but investors don't expect the good times to last for long. Analysts, however, said those worries may be misplaced.
Internet security companies, which specialize in deterring hackers, setting up firewalls and delivering virtual private networks to corporations, are allegedly recession resistant. The consensus view is that security is needed to keep e-business moving. It's a necessity.
But shares such as Check Point Software (Nasdaq: CHKP), Internet Security Systems (Nasdaq: ISSX) and Netegrity (Nasdaq: NETE) have taken their lumps of late as Wall Street frets about possible profit warnings.
Investors should worry. After all, alleged safe havens in the tech sector have fallen before. Everyone knows about the slowdown in information technology spending, but until recently the view was that some niches were immune.
Storage was viewed as bulletproof until EMC (NYSE: EMC) and Brocade Communications (Nasdaq: BRCD) stumbled. E-business applications companies were supposed to weather the storm and then Oracle (Nasdaq: ORCL) slumped. Cisco Systems (Nasdaq: CSCO), the Nasdaq poster stock, also fell.
Are Internet security companies next in line to issue profit warnings?
It's a reasonable question, but analysts note there's a disconnect between the Wall Street worry and what's going on at the companies. Internet Security Systems, which makes software that detects intruders, recently reiterated its targets for the first quarter and stuck to its growth targets at a recent analyst meeting. The company is expected to post a profit of 15 cents a share on sales of $62.4 million, according to First Call. Analysts said the company will hit its targets and maintain its guidance.
Check Point Software, a firewall and virtual private network company, is also sticking to its guidance. In a recent research note, Salomon Smith Barney analyst Chuck Jones said his checks indicate Check Point is on track to meet his first-quarter and fiscal 2001 targets. Check Point reported strong fourth-quarter results in January and predicted 50 percent growth in the first quarter. Jones reckons it's a good time to buy and hold Check Point shares, which trade at about 44 times Salomon's 2001 earnings estimate of $1.32 a share.
"We haven't yet seen any significant slowdown in the sector," said Chris Russ, an analyst at First Union Securities. "While they're not immune, there is less risk."
Jordan Klein, an analyst with UBS Warburg, outlined three primary reasons why Internet security stocks can hold up despite a tech recession.
• Internet security is a small piece of IT spending. Analysts estimate security represents less than 5 percent of IT spending. In other words, there's not a lot of spending to cut.
• The average deal size is smaller. Oracle and other tech firms recently said CEOs just pulled the plug on spending. Why? Oracle is asking customers to spend millions. Internet security software is a $50,000 to $150,000 decision. It's a rounding error in many enterprise budgets.
• Security is a necessity. Any e-business depends on trust. Internet security software isn't something companies are willing to cut back on. If there's a security breach companies could lose money, business and good press.
Chris Hovis, an analyst at Robinson-Humphrey, said investors are trying to pin a valuation on Internet security stocks. "People were paying a high multiple for these names and they were beating estimates and raising guidance," he said. "Now they're taking that premium away because of uncertainty."
Analysts said a lot of these Internet security companies will hit estimates, but keep the outlook consistent. That's good news in this market, but investors will remain skittish. Klein noted that investors are going to nitpick over any strong earnings because they simply don't want to believe good news.
Here's a look at Wall Street's favorites and their market niche:
• Check Point - A clear favorite among analysts. The company historically delivers good results and has a 50 percent market share and profit margins of about 60 percent. It's the clear leader in virtual private network and firewall software, and competes with Cisco Systems, Symantec (Nasdaq: SYMC) and Network Associates (Nasdaq: NETA). Check Point is expected to report earnings of 30 cents a share on sales of $143 million in the first quarter, according to First Call.
• Internet Security Systems - Seen as the leading player in the what Wall Street dubs the "IDnA" (intrusion detection and vulnerability assessment) subsector. In a nutshell, the company provides a hacker alarm system. It competes with Symantec and Network Associates, two companies that are tied to consumer spending and PC sales.
• Netegrity - This company focuses on access management software, which keeps unauthorized users away from key data. Netegrity is expected to report earnings of 8 cents a share on sales of $25.3 million in the first quarter, according to First Call.
• VeriSign (Nasdaq: VRSN), Entrust (Nasdaq: ENTU) and Baltimore Technologies (Nasdaq: BALT) - These three companies are viewed as near equals in providing digital certificates, which enable secure e-commerce transactions VeriSign has been pummeled largely because it was viewed as one of those Nasdaq superstocks. The Nasdaq tanked and so did VeriSign.