One mans opinion
Price: $34 7/8
12 Month Price Objective: $64
Estimates (Dec) 1997A 1998E 1999E
EPS: $1.04 $1.53 $2.13
P/E: 33.5x 22.8x 16.4x
EPS Change (YoY): 47.1% 39.2%
Consensus EPS: $1.51 $2.12
(First Call: 15-Oct-1998)
Q4 EPS (Dec): $0.29 $0.45
Cash Flow/Share: $1.25 $1.65 $2.53
Price/Cash Flow: 27.9x 21.1x 13.8x
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: D-1-1-9
Mkt. Value / Shares Outstanding (mn): $5,126.6 / 147.2
Book Value/Share (Sep-1998): $1.71
Price/Book Ratio: 20.4x
ROE 1998E Average: 40.9%
LT Liability % of Capital: 51.1%
Est. 5 Year EPS Growth: 30.0%
Stock Data
52-Week Range: $56 7/8-$25 1/2
Symbol / Exchange: NETA / OTC
**The views expressed are those of the macro department and do not
necessarily coincide with those of the Fundamental analyst.
For full investment opinion definitions, see footnotes.
Investment Highlights:
· NETA should shake out of its recent trading
range after clean 3Q 98 upside earnings
surprise.
· Investors can own 40% estimated earnings
growth for near-market-multiple valuation.
Liquidity attractive in current market
environment.
· CY 99 EPS $2.13; 12-month price objective of
$64 (30x CY 99 EPS) implies significant price
appreciation from current levels.
· Reiterate Buy opinion, among most significant
disconnects between valuation and growth
rate in our universe.
Fundamental Highlights:
· 3Q 98 revs +33% to $242 million and EPS
+51% to $0.41 (operating). ML ests $239 mil
and $0.38 per share ($0.03 upside surprise).
· Margins shine: Gross margin up 80 bps
sequentially and 60 bps above estimates.
Operating margin 32.8%, 220 bps better than
expected.
· Accounts receivable quality as expected,
deferred revs increase $17 million
sequentially.
Network Associates, Inc. – 20 October 1998
2
· Pipeline into 4Q 98 “strongest ever”.
· Europe and N. America strong; Asia weak.
Network Associates, Inc. – 20 October 1998
3
20th Quarter of Upside
Summary
We believe that Network Associates stock may move to
the upside, out of its stagnant trading range, as the
company delivered the 20 th straight quarter of earnings
upside to the Street. NETA's solid 3Q 98 upside results
(and continued bullish outlook for further successes in 4Q
98 and 1999) should convince investors that 16x CY 1999
estimates is too steep a valuation discount for a company
delivering consistent earnings growth in excess of 40%.
We reiterate our Buy opinion and believe the company can
earn a 30x valuation on CY 1999 EPS estimates of $2.13,
or a $64 price objective over the next 12 months.
NETA's price performance has been a disappointment
since the company announced the Dr. Solomon's
transaction earlier this summer. Confusion over estimate
revisions and a distressed chart weighed on the stock this
fall, as rumors of earnings shortfalls and difficulties at
security point-solution providers weighed on the stock.
This quarter's results should put many of those fears to
rest, as NETA posted results above those promised to the
street while maintaining earnings quality.
The company was bullish about the outlook for its business
moving into 4Q 98 and beyond. We are currently
forecasting earnings growth of 39% in 1999. The
company indicated on its conference call last night that 4Q
98 will place the company's revenue base above the $1
billion run rate, with good visibility into the flow of
business and an incresaing pipeline of larger deals as the
company increases the pace of its “upselling and cross-selling”
into enterprise-level customers. Network
Associates continues to evolve into a major player in the
enterprise software market.
3Q 98 Results
NETA's revenues increased by 33% over 3Q 97, with total
revenues of $242.4 million, $3 million above our
expectations. Strong growth in Europe compensated for a
poor showing in Asia, which capped further upside for the
quarter. License revenues grew approximately 34% and
services revenues were up approximately 30% for the
quarter. The company reported gross margin of 81.6%,
which was an 80 basis point sequential improvement and a
60 basis point upside to our estimate.
Operating margins expanded at an even greater clip,
growing to 32.8% for the quarter. The company has
already realized significant productivity gains from
headcount reductions this year, as operating margins have
expanded 520 basis points year to year and 220 basis
points sequentially. Operating margins were well above
our 30.6% expectations, fueled mostly by significant G&A
savings and a reduction in amortization costs.
The resulting combination of upside revenues and post-merger
cost benefits led to a $0.03 EPS upside surprise.
The 32% tax rate was 100 basis points below our
expectations.
As advertised, accounts receivable days sales outstanding
(DSO) were 84 days, up six days since the SOLLY
acquisition and the company's deferred revenue balance
grew $17 million sequentially. NETA management
indicated that DSOs may rise to the low 90s next quarter,
as the Sniffer base shifts to subscription contracts but will
then stabilize for the long-term. We would characterize
the earnings quality as solid at NETA.
Outlook
We are forecasting EPS growth of 55% in 4Q 98 to $0.45,
with a conservative revenue growth forecast of 28%, to
$266.7 million. 1999 revenues are forecast to grow 30%
to $1.256 billion and EPS should grow 39% to $2.13. We
sense that management has become more confident in the
visibility and quality of its earnings stream. The revenue
mix has become roughly equally divided between Net
Tools Secure and Net Tools Manager. The company
reiterated that it would be ceasing all merger activity now
that it has fleshed out its entire product line. Technology
integrations are proceeding in line with our expectations
and we have heard anecdotally of very positive reviews of
progress with SOLLY integration as well as Magic help
desk.
[NETA] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1998 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was
obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.
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statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive
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