Dont know why I still have some of this
at least these guys didnt do the convert offering
Sniffer: A Closer Look at the
Business Unit
STRONG BUY–V
Price (August 16, 2001): $14.85
Price Target: $19
52-Week Range: $27 - 3.25
• Sniffer Product Line is a Key Driver
Sniffer products make up roughly 24% of total consolidated
revenues and the company has a leadership position.
• A leader with best-in-class network management products
We estimate that this business should show significant growth,
driven by strong results from the Distributed Sniffer solutions as
the mix shifts away from the portable product line.
• Dominant market share with competitors stumbling
With nearly 20% market share Sniffer continues to execute well,
even as some rivals struggle to regain their footing.
• Reiterate our Strong Buy
We believe the stock remains undervalued trading at 22 times
our 2003 earnings estimate.
Page 1
FY ending Dec 31: 2000A 2001E 2002E 2003E
EPS ($) (0.16) (0.11) 0.40 0.68
CEPS ($) (0.16) (0.11) 0.40 0.68
P/E (92.8) (135.0) 37.1 21.8
P/CE (92.8) (135.0) 37.1 21.8
Price/Book 4.1 – – –
EV/EBITDA (57.8) – – –
Yield (%) – – – –
Market Cap ($ m) 2,033
Enterprise Value ($ m) 2,123.8
Debt/Cap (06/01) (%) –
Return on Equity (06/01) (%) –
L-T EPS Grth ('01 - '05) (%) 20.0
P/E to Growth (6.75)
Shares Outstanding (m) 136.9
Q'trly 2000A 2001E 2002E
EPS actual curr prior curr prior
Q1 0.20 (0.17)A – NA –
Q2 0.24 (0.02)A – NA –
Q3 0.27 0.01E – NA –
Q4 (0.87) 0.07E – NA –
Price: Abs. and Rel. To Market & Industry
: NETA NASDAQ: NETA
MORGAN STANLEY DEAN WITTER Comment
Company Update
Please refer to important disclosures at the end of this report.
Network Associates - August 17, 2001
Page 2 MORGAN STANLEY DEAN WITTER
Please refer to important disclosures at the end of this report.
Sniffer: A Closer Look at the Business Unit
Summary and Investment Conclusion
We recently spoke to different contacts at the company to
gain greater visibility into the Sniffer product line. The
Sniffer business made up roughly 24% of consolidated
revenues last quarter and we believe it is a key growth
business going forward. We believe this business unit
continues to see stable demand relative to expectations and
should continue to enhance the momentum of the company
overall.
Sniffer: 15 Years of Product Leadership
The Sniffer business unit of Network Associates designs,
manufactures, markets and supports software-based analysis
and monitoring solutions for managing computer networks.
Sniffer products and services help maximize network
productivity and minimize downtime. Sniffer has been
shipping product for 15 years and more than 200,000
Sniffers have been sold to date. The Sniffer business unit
became a part of Network Associates in 1997 with the
acquisition of Network General for $1.1 billion in stock.
The Sniffer product line consists of both portable tools and
distributed systems, and employs proprietary technology to
link advanced protocol support with expert analysis
capabilities to provide real-time identification, diagnosis
and resolution of network problems. Sniffer’s
manufacturing operations consist primarily of final
assembly, testing and quality control of materials,
components, subassemblies and systems. The business unit
also provides product support, education, and network
consulting services.
Portable Sniffers are fault isolation and management tools
that consist of software and a choice of network interface
cards that run on a variety of portable and notebook
personal computers. With support for a variety of network
vendors, protocols, and topologies, Portable Sniffers can
adapt to the specific analysis needs of customers as their
network configurations change. Portable Sniffers began
shipping in 1986, and currently make up roughly 50% of the
business unit’s product revenue, down from 80% five years
ago.
Distributed Sniffer is a network availability and
application management system designed for monitoring
and troubleshooting distributed enterprise networks.
Distributed Sniffer solutions are composed of distributed
intelligent servers and centralized console software. When
installed on distributed segments, Sniffer servers analyze,
process and consolidate information from individual
network segments and communicate through the network to
one or more central consoles, which collect and display the
information. The systems are centrally administered for
remote management, such that a Distributed Sniffer in New
York could be managed from California.
With best in class technology and leading market share, the
Sniffer business unit represents an important part of the
Network Associates story. As the product emphasis shifts
away from low-growth Portable Sniffer to higher growth
Distributed Sniffer, we estimate that this segment should
show significant growth for the next few years.
Market and Customers
Sniffer’s largest customer group is made up of network
management personnel with responsibility for supporting
the operation of enterprise networks. Sniffer products are
designed to enable network managers to function more
effectively by minimizing network downtime though speedy
identification and resolution of problems, reducing
operating costs through centralized management, and
identifying problems before they occur. In particular,
Portable Sniffers are marketed to field service engineers for
use in the maintenance and repair of networks, while
Distributed Sniffer sales are more focused on the enterprise.
The company also markets to systems integrators and field
service organizations that specify, implement, and service
data networks for customers or service the equipment and
software which they have supplied. In both cases, network
fault and performance systems are useful in identifying and
resolving the cause of network problems. Benefits to these
organizations include increased customer satisfaction and
reduced service expense from rapid problem resolution.
Sniffer products also allow relatively less skilled field
service personnel to capture customer problems at the
source for remote analysis, reducing the need for more
experienced personnel to travel or to replicate problems.
IDC estimates that this segment will account for 44% of the
total market or $472 million in revenue in 2001, with a
compound growth rate of 14% annually through 2005.
Network Associates - August 17, 2001
Page 3 MORGAN STANLEY DEAN WITTER
Please refer to important disclosures at the end of this report.
Distribution
Sniffer sells its products and services to domestic end users
principally through its direct sales force, numbering 100
quota bearing sales reps. The business unit also maintains
an indirect distribution channel using authorized resellers
and systems integrators. Internationally, Sniffer is more
reliant on channel partners including distributors, systems
integrators and authorized resellers. The business unit also
sells its products and services through its direct sales force
in several countries totaling 50-60 representatives. The
company’s leading market is financial services, which
includes brokerage, banking, and insurance.
Competition
As recently as three years ago there were as many as five
major vendors of remote monitoring (RMON) probes such
as Sniffer Portable, but as growth in this segment has
slowed the field has winnowed to include competitors such
as Agilent (A, $28, Strong Buy-V) and NetScout (NTCT,
$5, Not Rated). However, the recent termination of
NetScout’s private label OEM relationship with Cisco,
which accounted for roughly half of NetScout’s revenue in
the last five years, is a clear setback for this rival. Exhibit 1
below outlines the relative market share of the top five
vendors the network traffic management space.
Exhibit 1
Network Traffic Management Market Share
Company/Ticker 2000 Revenue ($MM) Market Share
Network Associates 201 19.8%
Agilent 194 19.1%
Acterna 104 10.2%
NetScout 83 8.2%
Fluke Networks 72 7.1%
Source: IDC
In addition, there are no off the shelf products that
incorporate network management and it is costly for
customers to customize their own hardware, limiting the
availability of close substitutes for this equipment.
Key differentiators for the Sniffer product line include
support for new technologies including 802.11b, wireless
LAN, VoIP, and mobile wireless. Sniffer supports more
than 450 different protocols, a level unsurpassed by other
vendors. Sniffer also offers a consistent user interface
across all of its products.
Another important advantage is Sniffer’s Expert Analysis
software that incorporates artificial intelligence technology.
Expert Analysis learns network configurations as it captures
network data, automating the identification and diagnosis of
network problems in real-time. By doing so, the product
can diagnose problems within 5-10 minutes rather than
hours required by some competing products.
Interaction With Systems Management
To facilitate centralized network monitoring and optimize
customers’ hardware investments, Distributed Sniffer
solutions are integrated with leading network management
system platforms including Tivoli, CA, and Micromuse.
These vendors tend to be “managers of managers” in that
they report problems but do not drill down into why
problems are happening. Sniffer addresses the fundamental
problem of why problems are happening and allows the
engineer to pinpoint and address the issue. A Distributed
Sniffer system provides alarms and other information to
network management consoles, which integrate analysis of
the data with other network management functions.
Service Business
Sniffer’s services group provides educational, consulting
and product support services to increase the productivity of
network managers and to solve problems where expertise
may be scarce. These services assist customers in
deploying Sniffer products throughout their networks, in
integrating products with other network management
systems, and in performing fault and performance analysis.
Consulting services provide both proactive and reactive
network services to customers, and education services for
its products are conducted in dozens of major cities
worldwide as well as at customer facilities.
Domestically the business unit supports its products
directly, and employs a combination of direct support and
the assistance of distributors internationally. Sniffer
products are typically sold with a support agreement of up
to one year included in the price, with support services
beyond the initial period available for a fixed fee. Support
agreements generally include software updates, technical
support, and repair coverage on all hardware components.
Financials
Network Associates does not break out operating results by
segment, and particularly in light of the changes to the
revenue model it is difficult to gauge with accuracy the
results of any particular segment. However, to gain sense of
the potential for the business, we examined the results of
Network General for the three full fiscal years prior to its
acquisition.
During this period total revenue was split roughly 80%
license and 20% service, with an average of 24% coming
Network Associates - August 17, 2001
Page 4 MORGAN STANLEY DEAN WITTER
Please refer to important disclosures at the end of this report.
from international operations. For this time gross margins
ranged between 74% and 77% with an average of 76%,
while operating margins ranged between 16% and 22% with
an average of 19%. At the end of fiscal year 1997, Network
General reported total revenue of $241 million and earnings
of 55 cents per share.
We estimate that total product revenue from the Sniffer
business unit totaled $137.2 million in 1999 and $167.7
million in 2000, figures which do not include service
revenue. Our forecast calls for 3% product revenue growth
in 2001 to $172.1 million, a somewhat depressed number
that reflects the transition on January 1 from a sell-in to a
sell-through revenue recognition model.
Recent Developments and Outlook
In the most recent quarter Sniffer launched Sniffer Voice, a
network management solution for managing voice over IP
networks. Distributed Sniffer received recognition from
Network Computing magazine as the top network protocol
analyzer, and was recognized by strategic consultant Frost
& Sullivan with its 2001 Market Engineering Leadership
Award for the product’s dominant market share in
LAN/WAN management. In this space the company
reported replacing NetScout in at least three accounts,
including six figure deals at Amgen and EarthLink.
We believe the majority of growth for Sniffer will come
from the distributed product line, for which we forecast
annual growth of 20-30%. We believe growth in the
domestic market is between 10-12% annually, driven
primarily by adding additional protocol decoders and
system functionality. In the international market there are
significant growth opportunities in the academic and
research markets. The company is focused on improving its
execution internationally, and sees opportunity to gain
market share in all areas. Future directions for the product
line include expansion beyond the traditional network with
products that monitor and analyze enterprise applications.
While we recognize that demand for the overall IT sector
has softened over the past several quarter, we believe the
Sniffer product line has been hitting its targets the past
couple of quarters. In addition, we believe demand has
been stable although we will be watching for any signs of
weakness given the challenging economic and IT
environment. Spending on these solutions has held up
partly due to the fact that while customers used to throw
more bandwidth at network related problems, now they are
being forced to be more efficient with existing infrastructure
which is driving demand for products like Sniffer.
Network Ass |
