Yes, There Are Still Cheap Net Plays

Amid the hoopla over soaring Internet stocks, one related group-companies that provide network and enterprise security software worldwide--has trailed the pack. That's odd, points out Marc Usem, Internet analyst at Salomon Smith Barney, since most of the hottest Net plays have yet to post any profits and "the security-related companies already have substantial earnings."

But this disparity may not last. As the Internet expands, more and more companies will need systems to protect their networks from external and internal threats. That suggests security companies may be one of the few ways that you can still participate in the growth of the Net on the cheap, if you invest promptly.

BREEDING GROUND. Many of the top security companies are based in Israel, and many are traded on the NASDAQ stock market (table). The companies were founded by former members of the Israeli Defense Forces' crack intelligence units, which served as a "training ground for security solutions based on cutting-edge encryption and data-transfer technology," says Zeev Holtzman, president of Giza, a Tel Aviv investment bank. "Israel has the potential to be the world leader in the Internet and enterprise security field," says Gil Shwed, president of Check Point Software Technologies, the top maker of firewall products that protect corporate networks from external attack.

Despite the company's 40% share of the world firewall market, earnings of 41 cents a share in the first quarter, and a wide following among institutional investors, Check Point shareholders have had little to cheer about lately. At almost $32, Check Point fetches two-thirds of what it traded for last November. It carries a price-earnings ratio of 21.5, a fraction of the sky-high multiples awarded to, Yahoo!, and Lycos.

Behind the drop in Check Point are concerns that Microsoft will enter the security market. However, Check Point and Microsoft recently announced an expansion of an existing cooperation agreement. Gibbs Moody, enterprise software analyst for UBS Securities in San Francisco, is a fan of Check Point stock. He thinks the stock could return to $50 in the next 12 months and adds that if its valuation doesn't improve, Check Point could become a takeover target.

Another leading security player is Memco, whose products guard corporate network servers against internal assaults. Its stock took a beating recently after Memco shelled out $55 million to acquire AbirNet, another Israeli security company, and Network Information Technology (NIT), a potential competitor based in Saratoga, Calif. In the aftermath, Memco's shares are hovering around $18, near its 12-month low. Elan Zivotovsky, Israeli technology analyst at Goldman Sachs, thinks Memco--along with Check Point--is a bargain. "Both have strong potential earnings growth over the next couple of years," he says. Zivotovsky thinks Memco could see its earnings per share double, to $1.10, in 1999, driving its shares to $35. He also likes what he sees of New Dimension Software, a systems management software company that recently entered the security field.

ON THE PROWL. Memco isn't the only company prowling Israel for security industry takeovers. In November, Cylink, a California-based network security company, ponied up $82.7 million for privately held Algorithmic Research. "All the major computer and software companies are on the lookout for Israeli security technologies," says an investment banker in Tel Aviv. Intel, in fact, recently invested an undisclosed sum in RadGuard, a developer in Tel Aviv of secure data products for private corporate networks. JAFCO, Japan's largest venture capital firm, has also invested in the Tel Aviv startup, and there's talk the company could go public next year.

Another promising startup that may announce an initial public offering is First Access, based in Haifa. A venture capital fund backed by Sun Microsystems and Germany's Siemens has already invested $1.5 million in the company, whose "vicinity smart cards" authenticate computer users from a distance of several yards. Such credit-card-size cards do away with the need for passwords and shut down a system when you walk away, barring access to unauthorized users. Whether or not First Access actually goes public, it's no secret that plenty of other Israeli security plays are selling for prices that won't make you wince.