IT Security: Takeover Tech Talk

01/29/2014 10:00 am EST

Focus: TECHNOLOGY

Rob DeFrancesco

Founder, Tech-Stock Prospector

Tech guru Rob DeFrancesco, sees increased M&A activity in the internet security sector; here, the editor of the Tech-Stock Prospector highlights some potential takeover speculations.

Steve Halpern: We are here today with Rob DeFrancesco, a technology sector specialist and editor of the Tech-Stock Prospector. How are you doing today, Rob?

Rob DeFrancesco: Doing great, Steve, thanks. How are you?

Steve Halpern: Good. You begin your latest newsletter by saying the tech M&A machine is humming again and you forecast that consolidation is likely to continue over the coming year. Could you expand on that?

Rob DeFrancesco: Sure. We've already seen some consolidation here in the industry. Basically, IT security is estimated anywhere from a $12 billion to $15 billion market, and there's the traditional technologies that are signature based: firewalls, intrusion prevention, and things like that.

But we're starting to see a lot of attention being paid to advanced persistent threats, targeted attacks, where it takes a different type of technology. And that, I think, sparked Cisco (CSCO) buying Sourcefire earlier last year, and we've seen some consolidation.

FireEye (FEYE) purchased Mandiant in a big deal that virtually doubled their revenue, so FireEye-the stock-has done extremely well, and I think that's what sparked some other M&A in this area, because companies are looking at this market-even traditional vendors like F5Networks (FFIV).

Just on F5's call last night, the CEO said that security was the main incremental growth driver for this year. They are an ADC vendor (application delivery controllers), so I think that even legacy vendors are starting to see a lot of opportunities in security.

They're going to look for acquisition candidates. But, of course, the stocks have done very well. We've had a lot of ramp up in a lot of stock prices, based on news stories about attacks with Target and Neiman Marcus, and things like that. So that's also raised interest in these names.

Steve Halpern: Now, after FireEye announced the purchase of Mandiant, as you know, that sparked interest in a company called Qualys (QLYS). What's the link there and what do you see for that company?

Rob DeFrancesco: Well, there are two companies, Qualys and Proofpoint (PFPT) that are both cloud-based, so they offer cloud-based security. These are smaller. I think Proofpoint's market cap is around $1.3 billion; Qualys is around a billion.

And Qualys does vulnerability management, but they're also getting bigger in the Web application firewall segment, firewall security, and they have about 25% with the SMB market (small and mid-size businesses), which is another key growth driver.

And Proofpoint is similar. The core business was e-mail security; about 50% of revenue comes from that. And then they're also involved in archiving and data loss protection.

Interesting thing about Proofpoint is, they're often in the same customer accounts as is FireEye, so Proofpoint gets e-mail security and FireEye gets the Web portion. So that's one, but that stock has also done well.

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I think Qualys and Proofpoint-given their lower market caps-are more likely to be takeover candidates. Then there is a company like Fortinet (FTNT), which has about a $3.5 billion market cap, and it has a much higher revenue base.

But it is growing slower, and they're just starting to get into this targeted attack protection, so they're a little late to the game.

Fortinet has also had some execution issues; they've had some CFO turnover and some sales execution overseas, but I think they're starting to get back on track here, so they might have a better yearend.

They're setting them up to possibly be an acquisition target as well, but with slower growth, so they need to step it up a bit.

Their CEO recently said that he wanted to get to a $1 billion revenue in a few years, so that's going to involve, either raising their current revenue, which they're growing about 13%-so either raising that, or doing a pretty big acquisition.

However, I'm not sure that they would be a buyer. I see Fortinet as more of a seller, but it's possible that they could also be interested in purchasing something in security as well.

Steve Halpern: Now, in your latest research, you also highlight a company called Palo Alto Networks (PANW), and you did note that there's some ongoing litigation and some risk. Could you tell us about, both the possible upside, as well as the downside risk in that situation?

Rob DeFrancesco: Well, they have ongoing IT litigation with Juniper Networks (JNPR) and that's sort of been a drag on the stock, although Palo Alto, this year, has started to perform better.

This is another big company. They're looking at revenue, in particular, yearend of July of around $560 million and you have a market cap of about $4.5 billion. And Palo Alto is growing 35% to 40% a year on revenue, so, the growth is pretty strong. So, relative to FireEye, Palo Alto looks attractive.

But, yes, you have the risk that the Juniper IT litigation will go against them-although we have nothing concrete to say that that will happen. We don't really know, but the stock is sort of being held back by that. But I think the trial is set over the next coming months, so we should get some resolution of that soon.

Steve Halpern: Now, in addition to the IT security sector, you've also discussed the potential for increased merger and acquisition activity in cloud computing. We only have a minute, but could you share a name or two that our listeners might want to look at in that area?

Rob DeFrancesco: Sure. In cloud, there are two big names-these are high market cap. But I think that there's a possibility of acquisitions. One company called ServiceNow (NOW), and Splunk (SPLK).

They both have market caps above $8 billion, so these would be large acquisitions, but both are key cloud players these days. Splunk is getting more into the cloud service area now, with ServiceNow focused on cloud-based IT management offerings.

Also, on the smaller side, Marketo (MKTO) in marketing automation, and Cornerstone OnDemand (CSOD), which is involved in cloud-based HCM (human capital management) solutions.

So those four names. Marketo and Cornerstone are smaller, so that could make them more likely, given that they would be easier acquisition targets.

Steve Halpern: Well, we really appreciate you taking the time today in sharing your insights. Thanks for joining us.

Rob DeFrancesco: Sure, thank you very much.

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