By Jonathan Rudy, CFA With the second-quarter earnings season upon us and investors worried about potential earnings disappointments, we remain upbeat on the prospects for the Internet security group overall, and certain stocks in particular. Our top pick in this area is McAfee (MFE
; ranked strong buy; recent price: $27).
We believe Internet security will continue to get a larger piece of the information technology budget in 2005, and select companies should be able to grow revenues in the low double digits, as opposed to the low- to mid-single-digit growth forecast for overall IT budgets this year. Internet security remains a high priority in IT budgets, and we don't anticipate that changing anytime soon.
NETWORK OPPORTUNITIES. We believe McAfee's management team has done a better-than-expected job of streamlining the company over the past couple of years and focusing on its core Internet security businesses. In our opinion, its core security business is more profitable and growing faster than other business units were. McAfee sold its non-core Sniffer and Magic Solutions businesses in 2004 for approximately $260 million.
In addition to its core antivirus software, McAfee will benefit from strong growth in its IntruShield, Entercept, and Foundstone products, in our view. All of these products center around network and host-based software for enterprises that focus on intrusion-prevention technology and systems-management capabilities. Corporate revenues now account for approximately 57% of McAfee's overall revenues.
We anticipate second-quarter revenues of approximately $237 million, an increase of 5% year over year, and operating earnings per share of 26 cents. In 2005, we expect revenue growth of 7%, to $969 million, despite the sales of the Sniffer and Magic Solutions businesses, and operating EPS of $1.18.
OTHER PLAYERS. Additionally, McAfee has a strong balance sheet, in our opinion, with nearly $6 per share in cash and investments and no debt. With McAfee trading at a discount to peers on enterprise value-to-sales and p-e-to-growth metrics, we believe the shares remain attractive. Our 12-month target price is $32.
Other sector names we view positively include RSA Security (RSAS
; $12) and Check Point Software (CHKP
; $21), both of which carry buy recommendations.
RSA Security is a leader in identity-management software, including authentication under the SecurID brand name, ClearTrust access management, and RSA BSAFE encryption products. We anticipate RSA growing revenues about 10% in the second quarter, to $83 million, and EPS of 13 cents. For 2005, we see 11% revenue growth, to $340 million, and EPS of 56 cents.
PROFIT MACHINE. With a strong balance sheet (approximately $280 million in cash and investments, about $3.80 per share, and no debt) and stock trading at a discount to peers on an enterprise-value-to-sales metric, we recommend purchasing RSA shares. Our 12-month target price is $15.
Check Point Software is a leading provider of firewall and virtual private network (VPN) software. Check Point is one of the most profitable companies we cover, with a 58% operating margin and a 54% net margin. It also has more than $1.63 billion in cash and investments (about $6.30 per share) and no debt.
We anticipate second-quarter revenue growth of approximately 13%, to $143 million, and see EPS of 29 cents. In 2005, we anticipate that Check Point will grow revenues approximately 15%, to $590 million, and we expect EPS of $1.24. With the shares trading at 17 times our 2005 EPS estimate, we recommend purchase of Check Point. Our 12-month target price is $28.
In the U.S.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations, and 12.5% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations, and 20.3% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations, and 17.7% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations, and 13.8% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index, in Asia the S&P Asia 50 Index, and in Malaysia the KLCI or KL Emas Index.
For All Regions:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
Additional information is available upon request.
This report has been prepared and issued by Standard & Poor's and/or one of its affiliates. In the United States, research reports are prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). In the United States, research reports are issued by Standard & Poor's ("S&P"), in the United Kingdom by Standard & Poor's LLC ("S&P LLC"), which is authorized and regulated by the Financial Services Authority; in Hong Kong by Standard & Poor's LLC which is regulated by the Hong Kong Securities Futures Commission, in Singapore by Standard & Poor's LLC, which is regulated by the Monetary Authority of Singapore; in Japan by Standard & Poor's LLC, which is regulated by the Kanto Financial Bureau; in Sweden by Standard & Poor's AB ("S&P AB"), in Malaysia by Standard & Poor's Malaysia Sdn Bhd ("S&PM") which is regulated by the Securities Commission and in Australia by Standard & Poor's Information Services (Australia) Pty Ltd ("SPIS") which is regulated by the Australian Securities & Investments Commission.
The research and analytical services performed by SPIAS, S&P LLC, S&P AB, S&PM and SPIS are each conducted separately from any other analytical activity of Standard & Poor's.
S&P and/or one of its affiliates has performed services for and received compensation from MFE and CHKP during the past 12 months.
RSAS is not a customer of S&P or its affiliates.
This material is based upon information that we consider to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results. Analyst Rudy follows software stocks for Standard & Poors Equity Research