Analysts Are Unsure If Network Associates Can Reclaim Lost Glory
Dow Jones On Line - May 25, 1999 16:27
NEW YORK -(Dow Jones)- Analysts aren't sure when or if Network Associates Inc., a developer of software that helps companies protect computer networks against viruses and computer hackers, will be able to resume spectacular growth.
Santa Clara, Calif.-based Network Associates (NETA), formed by the $1.3 billion merger of McAfee Associates Inc. and Network General Corp. in 1997, shortly thereafter went on a shopping spree. Many analysts think the primary rationale behind the McAfee-Network merger was to create a vehicle for consolidating very fragmented segments of the software industry.
In six years at the helm of McAfee and Network Associates, Bill Larson proved he's a brilliant salesman and a visionary. As a manager, however, the verdict is still out. Last month, Larson blindsided Wall Street with a projection of revenue declines this year, after years of dramatic growth.
Now, analysts and shareholders aren't sure whether Larson and the monster of a company he built can perform over the long haul.
"The company has good products; I do think they've been pushing too hard and they finally ran into a wall," said Christopher Stix, an analyst with S.G. Cowen & Co., in Boston. "There will come a time when they'll grow again, but probably not for a while."
Larson has added many software businesses - encryption, firewalls and utilities, with acquisitions that include Pretty Good Privacy Inc., Trusted Information Systems Inc. and Dr. Solomon's Group PLC. He's also credited with unifying a fragmented data-security market and moving the entire industry toward a subscription-pricing model. At the same time, he built the company to revenue of $990 million in 1998, from less than $20 million in 1993.
But expectations have fallen dramatically since late last year, when analysts foresaw a continuation of 30%-plus growth rates and super earnings reports that were a hallmark of Larson's tenure. Analysts now see a revenue decline of about 30% in 1999, and a loss of 45 cents a share where they once expected earnings of $2.13 share.
Network Associates shares have fallen to $15.125 Tuesday from a high of $67.69 in Decmber. A rash of shareholder lawsuits accuse Larson and other insiders of selling $33 million in stock ahead of the downturn.
Stix has a "neutral" investment rating on the company. He thinks the stock could rebound to the mid-20s a year from now, but management's guidance has turned so conservative that he and other analysts are waiting to see improved results.
"I think they have to outperform the Street consensus on the top and bottom line for a couple of quarters" to regain investor confidence, said Dawn Simon, an analyst with Brown Brothers Harriman, who lowered her rating on the firm in April. She's "neutral" on the stock for the long-term; for the short-term, "avoid" it, she said. Simon is waiting to see better inventory management and more detail on how the distribution channel is managed.
"They need to be more up-front about what's going on," said Bob Lam, a Bear Stearns analyst who also rates the firm a "hold." Long-term, Lam said, "I think it's a good company. They have good products, good technology - they do have a franchise."
Several events played a role in the stock dive and its reduced standing in the investment community. These include:
- A Security and Exchange Commission inquiry disclosed Jan. 6, which ultimately led to the reversal of $214 million in acqusition-related write-offs. Recurring amortization expenses will hurt the bottom line for several quarters.
- A warning in early April that first-quarter revenue and earnings would fall short of analysts' expectations, after Larson, in January, went out of his way to back full-year earnings views.
- The April 19 bombshell: Network Associates, faced with a stuffed distribution channel, will curtail shipments in the second quarter, and revenue will fall in 1999.
Network Associates offers several reasons for the miss - a slowdown in the business software market, customer preoccupation with the year 2000 computer problem, a longer sales cycle and a product transition. All of these factor in to the company's problems. But analysts see other ones, too, that remind them of other hard-driving software companies that stumbled.
Network Associates changed the sales strategy of Sniffer, the core network-analysis product that it acquired in the Network General merger. The new strategy emphasized sales through third parties instead of direct sales to end users. Stix and other analysts say the change allowed Network Associates to book revenue in earlier periods and resulted in a temporary revenue boost.
"That helped the growth rate," Stix said. "You get a one-time benefit, not from stuffing the channel, but by moving it into the channel to fulfill normal levels of inventory." The earlier shipments made demand for Sniffer appear stronger than it really was in 1998, Stix said, and contributed to the company's current problems of excess backlog in the distribution channel.
The company disputes the notion that its problems stem from inventory management. "I think the levels that we had in the channel in 1998 were what were required to meet demand in 1998, and what we've seen is a downturn of demand in 1999," said Zach Nelson, executive vice president of world-wide marketing for Network Associates.
Analysts are drawing their own conclusions. They've seen lots of companies sputter after phenomenal growth; it's almost a rite of passage in the software sector. They're also put off by what they call a lack of candor on Larson's part, for ignoring warning signs and reacting defensively when others raised questions.
Larson "was very sales oriented, which was the right type of person to change the pricing strategy for the entire industry," said Simon. "But once they got to a certain size, it was almost as if he was trying to convince investors he had the right strategy after investors were already convinced. He could have taken a step back and been more relaxed at that point."
Larson gained the rap of being too "promotional," Wall Street's shorthand for overly aggressive in sales, revenue recognition, acquisition strategy. "When you get to the point where the SEC issues you a letter, you have a scenario where the market is looking for a reason to justify its mistrust," Simon said. "That's where the downward spiral began."
Despite suggestions by some in the investment community that Larson and/or Chief Financial Officer Prabhat Goyal should make way for stronger managers, the team appears determined to stick it out.
The company just released a new suite of network security tools, and in May its board approved plans to use up to $100 million of its $750 million in cash to buy back stock over the next two years. "There's absolutely no discussion of (a management change), certainly in the executive ranks of the company," said Nelson.
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