Sourcefire's Smokin' Debut

Online-security provider Sourcefire (Nasdaq: FIRE  ) priced its IPO last week at $15, topping its $12-$14 expected range. But investors apparently couldn't get enough, driving the stock price to $18. Wall Street seems enticed by Sourcefire's unique business model, which is rapidly capitalizing on the growing network-security market.

Sourcefire's business began in 1998, when Martin Roesch created Snort, a program to prevent and detect unauthorized intruders on computer networks. Snort's open-source approach helped it rapidly gain popularity, allowing programmers to add their own enhancements to the software. "Now, just about any organization in the U.S. that has a serious security department is running Snort," said Nick Selby, an enterprise security analyst with The 451 Group.

In 2001, Roesch used Snort's success to launch Sourcefire, a commercial firm developing enhanced security software based on his original creation. Snort's success provided an excellent calling card for Roesch's new company, helping it compete with larger rivals such as IBM (NYSE: IBM  ) , Symantec (Nasdaq: SYMC  ) , and McAfee (NYSE: MFE  ) . From 2003 to 2006, Sourcefire's revenues ramped from $9.5 million to $44.9 million. While the company posted a net loss of $865,000 in 2006, that figure considerably improved upon its $5.4 million loss in 2005. Sourcefire also posted a $205,000 net profit in Q3, and $1.98 million for Q4.

Despite its solid reputation and improving numbers, Sourcefire has its drawbacks. Last year, PredatorWatch filed a lawsuit against the company, Roesch, and Sourcefire's venture capital firm, Inflection Point Ventures. Its key claims include misappropriation of trade secrets and unjust enrichment. Whatever the eventual verdict, the case will require Sourcefire to spend a chunk of its IPO proceeds on pricey attorneys, distracting its management in the process.

At nine times revenues, Sourcefire also sports a nosebleed valuation. However, companies like Cisco (Nasdaq: CSCO  ) , EMC (NYSE: EMC  ) , and others have proved willing to pay premium prices for security companies. Check Point Software (Nasdaq: CHKP  ) recently purchased Protect Data AB for eight times revenues.

Funny enough, Check Point Software tried to buy Sourcefire last year for about $225 million in cash, or seven times revenues. The larger Israeli firm ultimately withdrew its offer because of alleged national security concerns.

It's a good bet that Sourcefire will continue to attract the M&A departments of major tech companies. The company's global community of 100,000 registered Snort users is extremely powerful and tough to replicate. As a testament to the program's strength, the top 30 U.S. government agencies all use Snort.

That doesn't mean investors should jump headfirst into the stock, though. Remember that recent IPOs are especially volatile in their first couple months. It's probably smart to wait for the market to calm down a bit before picking up any Sourcefire shares. Nonetheless, this online security firm merits Fools' close surveillance.

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Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked 3,625 out of 24,208 in CAPS.

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