Software's $31 Billion Megatrend

At the InformationWeek 500 conference last week, McAfee (NYSE: MFE  ) CEO David DeWalt said that corporate America continues to underestimate the perils of cyber security threats. In fact, he said that the magnitude of the problem is about $105 billion, which is larger than the global illegal drug trade. It's scary stuff, but it is also an opportunity for investors. Let's take a look.

DeWalt has some interesting stats: Malware is 10 times more prevalent each year; there are 17,000 phishing attacks a month; and about a quarter of people in the U.S. have been victims of some type of identity theft.

More importantly, DeWalt has some nice projections for the overall security software market. He forecasts that the market will surge from $13 billion in 2006 to $31.4 billion in 2010.

So with all this activity, what are some interesting stock plays?

Actually, I'm a fan of McAfee. The company has a customer base of about 125 million, generates $100 million-plus in operating cash flow per quarter, and has more than 250 patents. With more than $1 billion in cash and cash equivalents in the bank, the company also has opportunities for acquisitions. This is critical in dealing with the emerging cyber security threats.

True, McAfee has had a dicey past, especially with its questionable accounting. But that's why the recent hiring of DeWalt is so important. He was a top executive at EMC (NYSE: EMC  ) and helped the company put together its software franchise. 

In fact, DeWalt is already getting traction with McAfee. In the second quarter, the company posted a 57% increase in earnings and snagged 11 deals in excess of $1 million, which was its best performance in five years.

Besides McAfee, I also like the prospects of Check Point Software (Nasdaq: CHKP  ) , which names all the Fortune 100 companies as customers. For Q2, Check Point saw a 27% increase in revenue to $176.2 million and 11 deals in excess of $1 million. Net income was $69.5 million. Through an aggressive acquisition strategy as well as strong internal development, the company is putting together a comprehensive offering of security solutions. Check Point thinks customers want to rely on fewer vendors to reduce costs and administrative headaches, which means the company gets a bigger wallet share from customers.

Check Point understands that security threats are expanding because of the growth in new platforms, such as social networking, mobile devices, virtualization, and even car and home appliances. (Cisco (Nasdaq: CSCO  ) recently announced a partnership with China's Haier to develop personalized consumer appliances.)

To deal with such things, Check Point has nailed savvy acquisitions. There was the purchase of NFR, which allows for real-time protection of networks, and the deal for Protect Data, which provides security for mobile devices.

I also think there are some interesting smaller players in the security space. Take Sourcefire (Nasdaq: FIRE  ) . The company is based on a popular open-source program called Snort. This means anyone can download the software -- for free. The upshot is that it has opened doors to major customers.

Unfortunately, the company's performance has been uneven since its IPO early this year.  But Sourcefire plans to launch a variety of products over the next couple of months, and this should help boost the top line.

Because of the volatility, I remain cautious on the stock. But I think investors should still keep tabs on it. Perhaps by next year, Sourcefire will get the business back on track.

All in all, things look pretty interesting for security software vendors. Basically, it's hard to imagine that cyber security threats will slow down. The sector looks like a good choice for investors who want to find growth.

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