A Buying Opportunity in These IT Stocks

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

IT Security stocks are an attractive but peculiar sector to invest in. I like them in the sense that they offer exposure to an area of IT that corporations will be highly reluctant to cut back on. It only takes another story of a damaging and embarrassing security breach at a large company and CTOs will be signing off on security spending. However, I find it strange because the stocks in the sector are so volatile and seem to move around on nothing more than rumor and sentiment. I think we are going through a mini-period of negative sentiment right now that has created a useful buying opportunity in certain stocks.


Conspiracy Theory 101

Forgive my indulgence here, but I am going to put two and two together and try very hard not to come up with five. Earlier in the year IT security firm Palo Alto Networks (NYSE: PANW) floated on the main market. The stock has soared since, and it is a fine and worthy company. My interest is not so much in Palo Alto but in the exuberance that is usually created around an IPO.

Strange things happen when someone is trying to sell someone else something. Just ask Facebook shareholders. Analysts start becoming exuberant, journalists start becoming a bit more sensationalist and brokers start getting excited. Everyone seems to want things to go well; indeed, sometimes I listen to market professionals and conclude that they think there is a divine right for investors to make money out of flotations. And sometimes this boils over into negative sentiment over other companies.

Around the time of the Palo Alto IPO, I noted that the commentary around the industry was that Palo Alto was positioning itself as the Check Point Software (NASDAQ: CHKP) ‘killer.’ Cisco Systems (NASDAQ: CSCO) was also seen as an also-ran, and nothing was going to stop Palo Alto from dominating the IT security space in due course.  Now that may well turn out to be the case, but it sure didn’t show up in either Check Point or Fortinet’s (NASDAQ: FTNT) subsequent results.

Why do I raise this issue?

Well, according to rumors Palo Alto is planning a secondary offering, and suddenly Check Point and Fortinet have been very weak amidst speculation that they are losing share to Palo Alto. I’ll leave you to draw your own conclusions.


What the Industry is Actually Saying

Security was one of the few bright spots for Cisco in its full year results, as it reported a 12% increase in revenues and cited Cloud and bring your own device (BYOD) as being two key sources of growth. In fact, Cisco’s security revenues grew from sequentially from $320 million to $350 million in the last quarter. This is not a sign of a company losing out, and it is believed to be chasing market share in data center security.

Indeed, F5 Networks (NASDAQ: FFIV) is also expanding its nascent data center firewall security offering. It grew revenues sequentially and predicts momentum to grow further into the year. Moreover, F5 was buoyed recently when news came out that Cisco was cutting back on investment in its application delivery controller (F5’s core product). While F5 is expanding its security offering and is well positioned to sell it to its existing customer base, it is fair to say that it represents a small part of its total sales, and it is a tall order to argue that it is threatening Check Point in one of its core markets right now.

With regards to Check Point there is no doubt that product revenue growth is slowing, and seemingly every time the company gives a presentation it is forced to explain why.  They must be bored of doing so, so allow me to have a go!

Simply put, it has a razor/blade business model and it is expanding the types and number of blades (software) that it sells. This means as product and software is bundled together the product component part of the sale is being reduced in favor of more software. And more software means more deferred revenues, which means greater future cash flow but less product sales now. Unfortunately what it also does is encourage analysts to conclude that slowing product sales growth is a cause of Palo Alto ‘killing’ Check Point or F5 Networks/Cisco muscling in--or whatever. Actually the underlying metrics are strong for Check Point and the stock looks cheap.

Turning to Fortinet, it reported a very strong set of figures and surprised the market with its guidance. The company primarily sells its unified threat management (UTM) solutions to the SMB market and is possibly benefiting from mid-size corporations ‘trading down’ to buying its solutions rather than more expensive and specialized solutions. No matter, the point is the same. There has been no demonstrable change in performance, and if anything Fortinet is getting stronger.


A Buying Opportunity?

I think Check Point and Fortinet are good buying opportunities down here. Just because Palo Alto may or may not be offering some secondary stock and investor focus is somehow shifting to envisaging how it is taking market share, this doesn’t mean that anything has changed with these stocks. On the contrary, their last reported numbers were quite good. Sentiment can move stocks around, particularly in sectors like IT, but there is no reason to get caught up in market chatter or speculation. Focus on the facts.

SaintGermain has positions in Check Point Software and F5 Networks. The Motley Fool owns shares of Check Point Software Technologies and F5 Networks. Motley Fool newsletter services recommend Check Point Software Technologies and F5 Networks. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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