Is Cisco Strengthening Its Position in the Security Software Market?

Awais is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The network and communications industry has undergone a complete transformation to emerge as the one of the most evolving and innovation-driven industries. This change was brought about by unparalleled growth in high speed mobile internet, especially for wireless data and video.

With the launch of the mobile broadband technology, many new service areas were introduced with huge growth potential. They include IPTV, collaboration and cloud computing, video conferencing and mobile payments, and many more.

The usage of mobile broadband heavily depends on the internet, which gives rise to another concern -- cyber security. This is a rising concern for many users as more and more data is uploaded on the internet via cloud computing.

To be able to offer a complete package of expert level security service, Cisco Systems (NASDAQ: CSCO) acquired Sourcefire (NASDAQ: FIRE) to enhance its service portfolio in areas where the company was not up to the mark.

The synergistic benefits expected from the acquisition

Cisco has recently taken over Sourcefire, a leader in providing intelligent cyber security solutions. Sourcefire perfectly fits into Cisco's overall strategic vision for security. Cisco's security sales had dropped 4% in the previous quarter. This acquisition provides Cisco an opportunity to increase its market share in the intrusion prevention system (IPS) segment. The services provided by Sourcefire, the market leader in IPS, are expected to experience rapid growth in demand as reports of major hacking incidents put governments and enterprises on alert.

The high growth expected in this area is expected to add significantly to Cisco’s revenue and margins by speeding up the delivery of Cisco's security strategy of defending, discovering, and remedying the most critical threats. It will also enable the company to provide continuous and pervasive advanced threat protection.

The resulting impact on financials

Sourcefire’s revenue has grown at a CAGR of 31% in the last five years. However, the company's margins are very low at 2.2%. Margins are currently depressed as Sourcefire is a technology driven growth company, and is currently investing heavily in research and development activity. Its margins are expected to revert to its industry average of 10.2% by 2015.

Sourcefire is expected to grow 25% in the upcoming year. This is expected to raise the company’s revenue to $278.9 million in 2013. Net income is estimated to be $10.32 million in 2013, assuming the net profit margin will grow from 2.2% in 2012 to 10.2% in 2015. This acquisition is expected to add $0.016 cash flow from operations on a per share basis to Cisco’s cash from operations of $1.65, in 2013.

This industry is in its high growth phase, with the demand increasing at a fast pace year on year. Therefore, it is expected that earnings per share and cash flows will rise further in the future.

The current status of competitors

Palo Alto Networks (NYSE: PANW) is also a key player in the network and communication industry. The company recently launched the first platform to offer private cloud deployment option for APT detection, analysis, and prevention in a timely manner. It is intended to cater to the demands of customers with restrictions on accessing a public cloud option. When employed with Palo Alto Networks' next-generation firewall, this WF-500 appliance provides full prevention. Palo is currently the only company that is providing this "closed loop" prevention solution that comprises of private or public cloud deployment options.

In 2013, Palo Alto entered into a distribution agreement with Grupo Dice, a leading distributor of IT infrastructure equipment and services in Mexico. As per the terms of this arrangement, Grupo Dice will provide Palo Alto Networks' Next Generation Firewall (NGFW) portfolio to its existing customers and value added resellers. Combining many years of experience and a strong network and infrastructure of Grupo Dice, and the innovative next generation platform of network security introduced by Palo Alto, will enable Mexican enterprises to secure their networks and safely run more complex and rapidly growing number of applications on their networks.

Conclusion

Cisco’s recent acquisition of Sourcefire will immensely enhance its market presence in the security software and services market. Though currently, the margins of Sourcefire may seem low, they are expected to rise in the long run as the research and development being conducted starts to materialize. Cisco is also currently undervalued as its P/E (ttm) is 14.2 times, which is quite lower than the industry average of 29.9 times. 

In the light of Palo Alto's innovative launch of WF-500 and its geographic expansion in Mexico, the company is expected to continue to report higher revenue and margins. It is a technology driven high growth stock. The company has also previously reported a CAGR of 74% on revenue over a period of three years. Its net margin has also turned positive, after incurring net losses for a couple of years. The company is also investing heavily in research and development to continuously come up with innovative services for its customers. To sum up, I would advise this stock for investors who can lock their investment for a few years as the company does not declare annual dividends.

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Awais Iqbal has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems and Sourcefire. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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