Here's something worth a look:
December 10, 1999
Robertson Stephens
Network Stocks Weekly, Vol. 1, No. 29
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networkstocks
INTERNET INFRASTRUCTURE COMPANIES WITH STRONG FINANCIAL
FOUNDATIONS
John F. Powers (415)693-3314, e-mail: JP@rsco.com
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This week, we highlight four companies, Legato (LGTO $70), RSA (RSAS $39-1/16), Citrix (CTXS $108-5/8),
and Check Point (CHKP $202-7/8), which we believe share four common characteristics.
1. Infrastructure stocks are seeing a strong fourth quarter as Y2K concerns are subsiding.
2. Enterprise software companies that are legitimately repositioning themselves as Web plays rather than
enterprise are moving towards higher Internet valuations.
3. Next year, we believe spending should be strong as dollars move away from Y2K remediation towards
forward looking web oriented IT projects.
4. Business-to-business infrastructure requirements continue to be more complex and sophisticated than
business-to-consumer plays.
We believe Legato Systems is well positioned to benefit from the increasing need for storage management
solutions. As use of the Web grows, organizations need to store and access large amounts of data. At current
price levels, Legato trades at a discount to its main competitor, Veritas (VRTS $107-15/16). LGTO's CY00
market cap to revenue multiple is 13.7x versus 20.1x for Veritas.
We continue to view Citrix as the way to play thin client computing in both its enterprise and emerging Web
flavors. We believe Citrix is a unique franchise, largely without direct competition and in control of creating its
own destiny as a provider of highly available, high performance, scaleable, manageable and secure thin
client applications in enterprise and internet environments.
RSA Security's core authentication business is highly complementary with its emerging Keon PKI business. As
corporate B2B applications come to the fore, there will be even more synergy between the original
authentication and the new PKI business. As the company successfully rolls out its PKI business, we expect to
see upside to our estimates for next year. RSA is currently trading at a modest 6.4x our CY00 revenue estimate
of $252.1 million, with $12-13 per share in cash and equity value. The company has strong partnerships, strong
technology, great new product set, clean balance sheet, is a profitable business and is significantly
undervalued.
Check Point is an early leader in the VPN market, a space with enormous growth potential, and where much of
the demand will be driven by the emergence of B2B eCommerce. We expect increasingly to see more VPN
implementations for B2B eCommerce transactions. We believe Check Point has an opportunity to gain
significant share in the VPN market.
SUMMARY
We believe four major themes support the continued strength of network infrastructure stocks into the next year,
particularly impacting our focus companies, Legato, RSA, Citrix, and Check Point.
1. Infrastructure stocks are seeing a strong fourth quarter as Y2K concerns are subsiding. Q4 results are shaping
up well as management has been giving conservative guidance for Q3 and Q4 because of concerns of
Y2K-related impact. Management now feels that they can deliver results at or above analyst expectations as
the actual impact of Y2K has been minimal. While there may be some marketplace reactions in the last few
days of the quarter, we believe Y2K issues will not fundamentally impact these infrastructure company.
2. Enterprise software companies that are legitimately repositioning themselves as Web plays rather than
enterprise are moving towards potential for higher Internet valuations. Where the repositioning has a profound
impact on the business shape of the some of these companies, the repositioning have not been fully embraced
by the marketplace. Thus, we believe there is significant multiple upside for companies to be perceived with
more of a web-centric positioning than traditional enterprise software.
3. Next year, we believe customer spending continues to grow at an undiminished rate as company dollars
move away from Y2K remediation. Now, companies can continue to invest in building their web presence
through core IT spending.
4.Business-to-business infrastructure requirements continue to be more complex than business-to-consumer
applications, requiring sophisticated software infrastructures.
We are highlighting four stocks in the network infrastructure space that we believe are best positioned to benefit
from the positive trends affecting this space. Legato Systems, RSA Security, Citrix System Systems, and Check
Point are all leaders or near-leaders in their respective core markets. They are all profitable with proven
management teams, are experiencing strong growth, and we believe have the opportunity for significant
upside as they are re-valued as business-to-business Internet plays versus enterprise software. Moreover, the
excellent track record of profitability suggests less downside risk then with many high flying Internet stocks yet to
turn a profit.
LEGATO SYSTEMS
Legato Systems has demonstrated leadership in the storage management arena. Given the trends in the
network infrastructure market and the company's valuation in relation to Veritas, we believe there is upside in
the stock.
We believe that there is an attractive overall market opportunity for enterprise storage management software, as
corporate web presence requires storage of large amounts of information. Strategic Research and IDC forecast
that the market for distributed storage management software is expected to grow from $987 million in 1997 to
$3.3 billion by 2002, equating to a 27.3% annual growth rate over the forecast period. Depending on the
speed at which new networked storage management models such as Storage Area Networks (SAN) are adopted,
the overall market opportunity could actually be an estimated $3.5 to 4 billion by 2002. We believe Legato
and Veritas should continue to grow faster (5-year CAGR of 35-40%) than the overall market as they gain
market share from their competitors.
The technical migration towards SAN opens up a new software opportunity for software solutions that deliver
instantaneous availability of data. In our view, Legato is uniquely well positioned to deliver the software
infrastructure for storage area networking.
We continue to find the Legato story compelling: At its current price of $70, Legato is trading at 23.2x our
CY99 revenue estimate and 13.7x our CY00 revenue estimate. On an EPS basis, Legato is trading at 116.3x
our CY99 estimate and 75.8x our CY00 estimate. LGTO is trading at a discount when compared to Veritas, at
current price levels trading at 23.2x our CY99 revenue estimate and 13.7x our CY00 Revenue estimate. Veritas
is trading at 145.5x our CY99 EPS estimate and 111.2x our CY00 EPS.
CITRIX SYSTEMS
We believe Citrix will also benefit from the four themes outlined. The company has strong momentum and
faces a good opportunity to reposition itself as an Internet stock versus and enterprise stock. Citrix's growth is
driven by the following factors:
The continued evolution of microprocessors enhances the economic value of application servers. The more
concurrent users in an application server, the lower the total cost of ownership. With a difficult global
economic environment, corporations are looking for cost savings measures. As total cost of ownership (TCO)
becomes more important, Citrix is well positioned to offer companies significant savings.
Web is increasingly looking for Application Service Providers to offer applications that were once licensed as
enterprise software as services. Citrix's recent developments over the last 6-8 months has provided a unique
opportunity to provide an underlying infrastructure delivery of high quality, sophisticated applications using
these distributed ASP business models.
Citrix is currently trading at 26.3x CY99 revenue estimates and 18.0x 2000 revenue estimates. The stock's P/E
is 82.2x CY99E earnings and 67.4x CY00E earnings.
RSA SECURITY
RSA is the leader in the user authentication space and is an emerging player in the PKI space, partnered with
VeriSign, the leader in the PKI space. RSA Security's core authentication business is highly complementary
with its emerging Keon PKI business. As the company successfully rolls out its PKI business, we expect to see
upside to our estimates for next year.
RSA Security has three lines of businesses; authentication, encryption and PKI. The core business is the
token-based authentication business for certifying the identity of the users as they come into a network, either a
corporate or an ISP network. This is the original business line. The second line of business is the encryption
business that came in with the acquisition of RSA. This business has an IP-based model with big upfront
license fees and smaller run rate for business ongoing, resulting in a relatively lumpy flow of revenue. Third is
the emerging PKI business built with the former Security Dynamics and RSA co-developed technology as well
as technology licensed from VeriSign.
The authentication business is highly complementary with the PKI certificate business. Public investors
continue to undervalue the original authentication business because of an incorrect perception that it is
directly competitive with the PKI business. In fact, PKI technology that authenticates users, machines and
sessions is highly complementary with technology that authenticates users coming into networks. As corporate
B2B applications come to the fore, we believe the need for strong security technologies such as strong
encryption and authentication of both systems and computers as well as users should be paramount. Going
forward, there will be even more synergy between the original authentication and the new PKI business.
As the company successfully rolls out its PKI business, we expect to see upside to our estimates for next year.
RSA is currently trading at a modest 6.4x our CY00 revenue estimate of $252.1 million, with $12-13 per share
in cash and equity value. The company has a strong balance sheet and is very profitable. Management has
addressed some of the channel issues that caused the core authentication business to slip during 1998. We
feel comfortable the new CFO who has significantly stabilized a somewhat shaky platform from a financial
control standpoint. We feel comfortable with our revenue and EPS estimates of $61.6 million and $0.23,
respectively, for Q4:99. We believe that there is significant multiple upside; this is a stock that we estimate
could trade easily in the $50-60 range. Significant upside remains as the company delivers through Q4 and as
we start to see additional adoption of the Keon product in the first half of next year.
RSA has strong partnerships, strong technology, great new product set, clean balance sheet, is a profitable
business and is significantly undervalued. We believe that it is a great investment for those investors that want
to participate in the upside from Internet and B2B applications.
CHECK POINT SOFTWARE
Check Point is the early firewall market leader and has now opened its business towards delivering VPN
technology for site-to-site connection over the Internet. Check Point is an early leader in the VPN market, a
space with enormous growth potential, and where much of the demand will be driven by the emergence of
B2B eCommerce.
We expect increasingly to see more VPN implementations for B2B eCommerce transactions. To date, VPN
technology has been used for remote users connecting into a corporate hub or node; that is connecting single
users into a large presence. Going forward, as interoperability standards get set, what we will see increasingly is
more site-to-site, intra-corporation implementations. More and more VPNs will be created for B2B eCommerce
transactions.
We believe Check Point has an opportunity to gain significant share in the VPN market. With the early
leadership Check Point has shown, the significant market share it has in the installed base, and with a big and
very healthy channel, we believe Check Point has an opportunity to gain if not the kind of 40-50% market share
it has in the firewall market, a significant share in the VPN market which we expect to be a larger market than
firewalls.
Check Point, similar to the other three stocks, has enjoyed its positioning, however, we believe, still has more
upside. At current price levels, Check Point is trading at 27.6x our estimated $305.0 million CY00 revenues. It
is pricier than the other three stocks we discussed, however, much like Citrix, Check Point can be seen as a
fundamental piece of the Application Service Provider (ASP) and B2B infrastructure for the new Internet and
truly deserves an Internet-like multiple and Internet-like positioning. We see multiple upside as well as
significant business opportunity upside for Check Point for next year.
INVESTMENT RISKS
Legato Systems. Among the risks are (1) new emerging market; (2) increasing competition; (3) timely
development of new products and upgrades; (4) successful leverage of partners for development and
distribution; (5) successful international expansion; and (6) managing rapid growth.
Citrix Systems. Among the risks are that Citrix Systems has a limited operating history as its initial products were
shipped in 1991. Citrix's quarterly operating results in the past have varied and may vary in the future
depending on the success of their strategic relationships. Competition from organizations that seek provide
remote computing solutions based on a variety of approaches including 3Com, Bay Networks, Cisco, Microsoft,
Novell, Shiva and Symantec.
RSA Security. Among the investment risks is the dependence on a single product line addressing the network
security market, which is only recently emerging. There is no guarantee that changes in technology or a
change in the perceived value of network security will not change the market opportunity for the company.
Check Point Software. Among the risks are competition from security focused companies as well as companies
focused on providing hardware and software to the enterprise network market, including Cisco Systems,
International Business Machines, Microsoft, and from other emerging and established companies such as
AT&T.
We hope that you have found our thoughts on Legato, Citrix, RSA and Check Point helpful, and we look
forward to hearing your feedback at jp@rsco.com. As always, we enjoy hearing from you and we do our best to
personally answer all of our reader mail. Please write to let us know what interests you and what you'd like to
see us cover in future newsletters.
Thanks for your interest,
John Powers, Evren Dogan, Connie Pon
ragingbull.com |
