Security Breaches Create Opportunity

This article is part of our Rising Stars Portfolio series.

In June, Citigroup announced that a hacker had compromised the personal information of 200,000 customers. Just a month earlier, Sony was dealing with a massive encroachment on personal user information from its PlayStation video game units; that hack affected more than 100 million accounts. These breaches test the level of trust consumers have with their product and service providers, and if that trust is broken, companies could see customers defect en masse and watch their revenue plummet.

That's why protecting against security violations is big business.

The Web-security market
The growing diversity of security threats and the expansion of the ways enterprises use and rely on technology are driving growth in the network-security market. Total network and data-security spending grew by 11% last year to $6 billion, according to ABI Research, and it's likely to rise to $10 billion over the next five years -- an 11% compound annual growth rate. This growth outlook appears to be solid, as IT departments increased the proportion of their budgets devoted to Web security to 14% in 2010, up from just 8% in 2007.

Part of that new spending will be for hardware and software upgrades, as large companies add layers of complexity to their protection and smaller enterprises will begin to defend their systems in earnest. The seriousness of the threats may enable security providers to raise prices, and those with a solid reputation should do well.

The players
Participants in the network-security market sell a combination of hardware (called "appliances") and software solutions that protect against threats at each point of connectivity. The increase in mobile and remote connectivity has added complexity and areas of weakness to many networks, creating a market for providers that specialize in protection against compromises at specific access points. Other companies take a broader approach.

Here's a look at how the market views the major players.

Company

Market Cap (Millions)

EV/FCF Ratio

Return on Equity

Expected 5-Year EPS Growth Rate
Blue Coat Systems (Nasdaq: BCSI  ) $931 5.3 10.9% 12.5%
Check Point Software (Nasdaq: CHKP  ) $11,303 15.1 18.3% 12.0%
Cisco Systems (Nasdaq: CSCO  ) $82,118 6.0 15.8% 10.0%
Fortinet (Nasdaq: FTNT  ) $3,928 30.7 24.7% 16.0%
Intel (Nasdaq: INTC  ) $112,402 10.7 27.0% 10.0%
Websense (Nasdaq: WBSN  ) $1,005 12.5 18.9% 12.5%

Data provided by Capital IQ, a division of Standard & Poor's.

An unloved opportunity?
Sporting respective $82 billion and $112 billion market caps, Cisco and Intel are mammoths, yet only a small portion of their businesses is dedicated to security. Of the remaining four, Blue Coat Systems looks to be the unloved member of the group, trading at an EV/FCF multiple equal to one-third of the group's average. But with its considerably lower return on equity, perhaps this lower valuation is justified. Let's look a little more closely.

Blue Coat's position in the network-security market is strong. Since 2002, it's built its reputation on securing communications over corporate networks. It's the market leader in this field and counts more than 80% of the Fortune 500 among its customers. Blue Coat has a weaker position in the midsized (1,500 to 10,000 users) and small (fewer than 1,500 users) enterprise market, but it's developing a cloud-based security solution to bolster sales to these segments.

However, as competition has increased and the large-enterprise security market has matured, Blue Coat has seen its growth rates slow. This challenge, along with some early stumbles trying to enter the quickly growing network-optimization market, has led to a falling stock since the middle of 2010.

The company brought in a new chief executive to right the ship last September. Since then, new CEO Mike Borman has revitalized and retrained the company's global sales force, shuffled the management team, and put out some of the remaining fires that have been holding the company back.

The Foolish bottom line
Trading at only 5.3 times free cash flow, Blue Coat doesn't get high expectations from the market. But it remains a trusted leader in the large-enterprise market and has shown impressive research and development progress with its network-optimization releases. The company has exposure to quickly growing and mission-critical areas of IT spending and is developing a solution for smaller businesses. I'll be looking into Blue Coat further as a possible candidate for the Un Portfolio, and you should add it to your watchlist, too.

This article is part of our Rising Stars Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money free stock picks. See all of our Rising Star analysts (and their portfolios).

Bryan Hinmon holds no financial position in any company mentioned above. The Fool owns shares of Intel and Cisco, has bought calls on Intel, and has created a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of Cisco Systems, Intel, and Check Point Software Technologies and creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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