Security Software Companies Avoid U.S. Slowdown

By Eugene Bukoveczky | August 07, 2008 AAA

Make no mistake about it. The digital networks that have become an integral part of our lives are increasingly becoming our greatest point of vulnerability to fraud and theft. The latest indication of that vulnerability came when the BBC reported that U.S. authorities busted a international gang that managed to hack the computer systems of several major retailers, stealing more than 40 million debit and credit card numbers and then selling the information.

According to the Department of Justice, the scam resulted in widespread losses for retailers, banks and consumers. Among the companies hacked were fashion retailer TJ Maxx and bookstore Barnes & Noble (NYSE:BKS).

While this might just be sort of thing that causes sleepless nights for many a corporate chief information officer, for network security software providers like Symantec (Nasdaq:SYMC) and McAfee (NYSE:MFE), its just further confirmation that demand for their products is growing.

International Growth Protects Against Tech Spending Slump
Judging by the latest results for both companies, the increasing need for data and network security around the globe appears to have made this business nearly recession-proof. For its fiscal first quarter ending July 4, 2008, Symantec reported earnings per share of 22 cents compared with 10 cents for the same period a year earlier. Excluding special items, EPS for the latest quarter would have been 40 cents, well clear of the 35 cents analysts had forecast. International sales growth was about 19% during the quarter, which was enough of a positive impact to more than offset the slowdown in U.S. information-technology spending growth, which is expected to slow to 5% this year, down from 7% in 2007.

Rival McAfee also beat expectations, producing second quarter profits of 52 cents per share compared to the 45-cent-per-share consensus estimate of analysts surveyed by Bloomberg. Corporate sales climbed 32%, while revenue from consumer products rose 18%.The company also delivered a sales forecast that topped projections.

Symantec-McAfee Rivalry Fierce
While both companies appear to be exceeding Wall Street's growth expectations, competition between them remains intense in the main battleground of corporations, government agencies and institutions that spent $2.15 billion on antivirus software last year, according to information technology consultant Gartner Inc. Given that markets are now mature and saturated, aggressive price cutting to "rip-and-replace" a competitor's product is the order of the day.

While McAfee has been gaining market share points from Symantec of late, Symantec has responded with aggressive discounts. The entry of new players to the game like Microsoft (Nasdaq:MSFT) which started selling its own line of security software last year, and a major defection by General Electric (NYSE:GE) from Symantec to UK-based Sophos plc, suggests that competition could get even more intense going forward, which will shrink margins for all involved. Incidentally, Sophos recently announced that it was planning to take a second shot at doing a US-based IPO after pulling a plug on an earlier attempt.

Tax Issue Uncertainty
Another potential headwind facing not only Symantec, but other big tech names like Microsoft and Google (Nasdaq:GOOG), is the ongoing litigation by U.S. regulators to block the widely employed practice of using transfer pricing to reduce U.S. tax liabilities by shifting intellectual property abroad. Recently Symantec won a favorable ruling from a judge who agreed to have the public record sealed on the matter, a decision that will likely impede a better understanding of the transfer pricing issue at the heart of the government's case. However, the sizable tax losses seen by the U.S. government as a result of this practice suggest that the IRS's lawyers won't be throwing in the towel on this one anytime soon.

The Bottom Line
For the moment strong international growth, and the essential nature of their products, should help companies like Symantec and McAfee avoid most of the recession-induced downside in sales experienced by other companies in the tech sector. On that basis, the recent jump in the shares of these two companies appears justified.

For related reading, check out From Beads To Binary: The History Of Computing.

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