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Wall Street, California | STOCK SPOTLIGHT

A Question of Security

Consolidation Underway Among Developers of Antivirus and Firewall Software

June 16, 1998|EDWARD SILVER | Times staff writer Edward Silver writes regularly about technology investing

"Only the paranoid survive."

When Intel's Andy Grove popularized that phrase, he was talking about rivalry in the warlike chip business.

But managers of computer networks have made Grove's motto their own amid threats from hackers, viruses and intrusions of all kinds.

Their domain has become more vulnerable as computer links get more complex and companies seek opportunities on the Internet. In fact, many analysts believe that security is the No. 1 issue preventing electronic commerce from blasting off.

The burgeoning need for security has given birth to a handful of hypercompetitive software companies that provide antivirus, firewalls, encryption and other, even more arcane products that are becoming essential to running modern networks.

The most common industry estimates have this young sector expanding at a 50% annual clip and reaching $5 billion in revenues in 2000.

"No one has to be sold anymore on the power of the Internet," said Ted Julian, an analyst at Forrester Research. "It's crucial to how companies will be doing business going forward."

But, he added, "none of that happens unless the networks are secure. If you buy into that idea, you see the potential of this industry."

For investors, however, there's little security in this marketplace.

An intense consolidation cycle is underway, as the larger players take over single-product innovators, many of them private, to offer customers one-stop shopping. Just last week, Network Associates (NETA) announced it will acquire Dr. Solomon's of Britain to broaden its antivirus line and get a foothold in Europe.

Also, with corporate spending beginning to flow in this direction, many analysts expect Goliaths like Cisco Systems, Microsoft and others to invade. That issue weighs heavily on the stock of firewall leader Check Point Software Technologies (CHKPF).

In a game of leapfrogging technology and shifting partnerships, assigning reasonable values to these companies is more of a puzzle than sizing up mainstays like Procter & Gamble.

"The Street is wrestling with how to define and value these companies," said Paul Merenbloom, an analyst at Prudential Securities. "You can make almost what you want of it because the business is so young."

For instance, both Yahoo and Check Point base their businesses on a hot Wall Street theme--the Internet. Check Point reported a booming profit of 41 cents per diluted share for the March quarter, compared with Yahoo's 8 cents, and edged it out in revenue, $30.9 million to $30.2 million. Both grew stupendously during the previous 12 months.

Yet Check Point's market value, $1 billion at Monday's close, is less than one-fifth that of Yahoo.

Why? One big reason is that investors believe they know where Yahoo is going, and they like the destination. Bulls expect the search engine to become entrenched as a primary provider of content and services on the Web and attract boatloads of advertising dollars.

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Investors are gradually learning that security is part of that scenario, but they are unsure which companies in this emerging industry will survive to provide it.

The same is true, in large part, for customers. Last year they might have purchased firewalls, which act like sentries around the perimeter of networks to control access. This year, they may want to add encryption for scrambling data, perhaps credit card numbers.

Deployments are getting more expensive and more complex, and the pieces have to reflect a strategy that won't be obsolete in a year.

"The need today is for a road map," Merenbloom said. "They need to know that what they are investing in today will be viable tomorrow."

The company with the clearest road map is Network Associates Inc. Itself born of last year's merger between antivirus leader McAfee Associates and Network General, a network management specialist, Santa Clara, Calif.-based NAI is making acquisitions at a manic pace.

The relentless appearance of new viruses--currently pegged at 350 a month--has opened the Fortune 500's doors to NAI. Now it plans to sell those customers suites that include firewalls, encryption, intrusion detection and more. Not every item in the arsenal is best of breed, analysts say, but that's not the point.

"NIA is wise to put together this portfolio. It is getting very aggressive about packaging and pricing and distribution, which is appropriate as the market matures," said Julian.

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The company's financials are robust. It earned a split-adjusted 37 cents per share in the March quarter, beating Street forecasts. Most estimates for the year hover at $1.65 and $2.15 for 1999. So at a recent $41, the company sells at a price-earnings ratio that's similar to that of the S&P 500 index, though it's growing at a much faster rate. Analyst Michael Stanek of Lehman Bros. has a price target of $60.

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