Marcial: Security Software, an Intriguing Corner of Tech

Savvy technology investors believe if there is any bright spot in tech stocks, which got hammered in 2008 along with the rest of the stock market, it is the Internet security sector—the outfits that provide software and related services that protect computer networks against viruses and other types of cyber attacks.

"Shares of tech companies in the security sector outperformed most other tech sectors in 2008," says Richard Parrower, managing director at J&W Seligman (AMP), who heads its Global Technology Fund. This group tops the list of tech industries that Parrower favors. Specifically, he's bullish on Symantec (SYMC), which provides software that protects computer network infrastructure; McAfee (MFE), a leading developer of virus protection and encryption software; and Check Point Software (CHKP), which makes protective firewall systems.

The 2009 outlook for the broader tech sector isn't looking any better than last year's unspectacular showing. One reason: The moribund corporate spending in 2008 on information technology is expected to spill into 2009. According to a survey conducted by Morgan Stanley (MS) among 150 corporate info tech executives, spending will slow, from 4.9% in 2008 to 2.3% in 2009. That has prompted Morgan Stanley tech analyst Adam Holt to cut his earnings forecasts on tech companies he follows. Holt expects 2009 earnings by tech companies to decline some 20% in 2009.

Nontheless, analysts expect the security software companies to outperform the tech pack again this year.

Shares of Symantec, McAfee, and Checkpoint are still way undervalued, says Seligman's Parower. He sees their stock prices climbing at least 20% over the next 12 months.

Symantec's unseen strengths

In spite of the market's turbulence, stocks of the three firms have managed to demonstrate staying power. Symantec has risen to 13.50 a share on Jan. 15, from a 52-week low of 10.50 on Nov. 20, 2008. But that is still below its 52-week high of 22.80 on Aug. 28, 2008. Independent research outfit PriceTarget Research , which has a "positive" rating on Symantec, puts the value of the stock at 26 a share, saying the drop in its price doesn't take into account Symantec's recent performance: its growth in investment to create value for shareholders, an earnings growth rate of 18%, return on equity of 9.4%, and cost of capital of 6.8%.

Parower notes that Symantec has a new line of hardware (which it markets to customers) running its software that makes its products easier to use and boosts operating profits. Its broad line of products include gateway and server security offerings for virus protection, firewall, and virtual private network (VPN) applications.

McAfee, which climbed to 29.22 a share on Jan. 15 from a 52 week-low of 24 on Oct. 30, 2008, traded as high as 40 on Sept. 2, 2008. Analyst Warren Thorpe of research outfit Value Line (VALU) says McAfee is "ranked to outperform the market averages in the next six to 12 months". He predicts McAfee will earn $1.55 a share in 2009 on revenues of $1.7 billion, up from $1.25 on $1.5 billion.

McAfee's financial flexibility

Analyst Jim Yin of Standard & Poor's, who rates the stock a hold mainly because of concerns over a slowdown in the global economy, believes sales will remain weak for several quarters. (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies (MHP).) But he says McAfee has the financial flexibility to make acquisitions that will strengthen its product offerings or initiate a share repurchase program. McAfee is a leading supplier of virus protection and software for help-desk network security.

Check Point, whose stock has climbed from a 52-week low of 16.80 a share on Oct. 16, 2008, to 20.90 on Jan. 15, is worth 37 a share, according to PriceTarget Research, based on Check Point's current earnings growth rate of 11% a year and return on equity of 18.7% against a cost of equity capital of 8.5%. The research firm gives Check Point its highest positive rating, indicating it has a better chance of achieving favorable investment performance over the near to intermediate term. One of Check Point's fastest-selling products offers protection for corporate network resources and Web-based business communications.

Despite growing competition in the Internet security market, Symantec, McAfee, and Check Point are positioned to capture greater market share this year, analysts say. "Cyber security threats, such as spyware and phishing attacks, are rising each day for both individuals and corporations," notes analyst Randy Shrikishun of Value Line. Furthermore, he says, the use of mobile devices and other platforms is growing, making Internet security problem a tougher challenge.

It's likely that tech companies in the Internet security segment will continue to see undiminished demand for their products and services, regardless of the economic downturn, because their products have become basic necessities. To be sure, competition will be on the rise, but companies like Symantec, McAfee, and Check Point, equipped with solid balance sheets, strong cash flow, and creative products, promise to go on thriving.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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