Who is Hot in the IT Security Sector?

By Lee Samaha - April 9, 2012 | Tickers: CHKP, CSCO, FTNT, IBM, JNPR | 0 Comments

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Payments processor Global Payments served up the latest hacking horror story by admitting that 1.5 million credit card user's details were compromised. It is the latest in a long line of stories of malicious security breaches. Whilst highly embarrassing to the firms and government agencies involved, investors should be looking to see which companies will benefit.

I think that the greatest marginal shift in demand that will be created by this sort of news flow will come from the small and midsize business (SMB) sector. After scares like this, SMBs might be more inclined to return IT security companies’ sales calls. Suddenly, everyone wants to talk about security and vendors' sales cycles will start to shorten. Moreover, this trend looks only set to increase with the growing importance of cloud computing and "big data."

So who is Hot in the IT Security Sector?

Fortinet (NASDAQ: FTNT) and Check Point Software (NASDAQ: CHKP) are the standout candidates.

Fortinet is the leader in Unified Threat Management (UTM), which is a grandiose way of describing network security solutions that cover all the core security requirements of an enterprise’s connection to the internet. This encompasses firewalls, virtual private networks, intrusion detection and prevention, and anti-malware.

The UTM market is primarily targeted at the SMB market. Fortinet faces competition from Cisco (NASDAQ: CSCO) and it would be foolhardy to write off Cisco. It has a dominant market position in the network infrastructure market and this gives it significant sales leverage into SMBs. The bad news is that Cisco has not been seen as executing well with its network security product line in 2011. However, Cisco is being aggressive in revamping this line, so Fortinet can expect stiffer competition in future.

Juniper Networks (NYSE: JNPR) is another option. However, according to Gartner Research, Juniper’s current offering has limited channel support for the midmarket UTM needs. In addition, Juniper has enough on its hands with fighting Cisco in network infrastructure before it should be thinking about pursuing the UTM market!

What about IBM? Last November, IBM (NYSE: IBM) announced that it would be discontinuing support of its Proventia Multi-Function Security Product. Moreover, the company is believed to want to extend offerings of IT solutions to the SMB market. Commentators have speculated on the possibility of IBM buying Fortinet and I think it is a possible deal. IBM has the resources to take Fortinet to the next level and the smaller company has the market share and proprietary technology. A match made in heaven?

Why I like Fortinet

A few bullet points on Fortinet's growth drivers

• Economic growth causing an expansion in IT spending
• Growth in internet functionality for SMBs
• Benefit of a UTM "One-Stop-Shop" solution for SMBs in securing inbound and outbound traffic through one appliance
• Growth in cyber crime raising awareness of security needs
• Growth in Fortinet’s top line leading to operating margins that are closer to, say, Check Point Software
• Takeover potential.

Economic growth looks good and business surveys are indicating a loosening of IT spending budgets. In addition, the increasing importance of e-commerce and the utilization of internet portals to increase globalization of trade should drive SMBs to increase their internet functionality.

Furthermore, given the inexorable rise in cyber crime, there will be more emphasis placed on monitoring internet (internal and external) based threats. Similarly, smaller corporations may seek to reduce time and personnel cost by adopting a one-stop-shop solution with a UTM system.  

All said, I think the key driver for Fortinet’s share price will be revenue growth and its effect on its key metrics.

Clearly, these numbers indicate that Fortinet has room to expand margins and cash flow as it grows revenues. Fortinet is excellent at converting revenue into cash flow and prospects look good.

Check Point Offers Growth and a Good Evaluation

Check Point competes more at the upper end of the UTM market. Its real strength lies in the network security options for larger enterprises and this tends to price its products out of the SMB market. It has a diversified and multi-faceted approach to the enterprise market.

Once its hardware is in a customer's system, Check Point then tries to sell a variety of software blades of various applications. This means that average selling prices can expand as Check Point sells more blades into its installed base. The model is scalable and helps to protect Check Point's market position.

I’ve listened to conference calls and the management seems think the company is winning market share and generating growth. This is demonstrable by looking at revenues and deferred revenues.

Note how strong the last sequential growth rate for deferred revenues was. Analysts are forecasting a 12.3% sequential decline in revenues to Q1 2012, but I think Check Point could beat this.

Who to Buy?

Fortinet offers stronger growth and the prospect of a takeover. Check Point has more secure growth and is less susceptible to the possibility of market erosion. In addition, the Israeli company is on a more attractive evaluation with significant cash on the balance sheet. Do you want higher but less certain growth or lower but more secure growth?  Fortinet’s rating looks a bit rich right now. On balance, I would favor Check Point.

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