Tickers in this Article: BCSI, RVBD, CSCO, INTC, FTNT, WBSN, CTXS
Tech stocks have had a good run and when investors find tech stocks with what looks like a low valuation, they should be cautious. Blue Coat Systems (Nasdaq:BCSI) is a good example of why that is. While this security and WAN optimization company does indeed have multiples well below most tech companies (and the market in general), there is a good reason for that - Blue Coat is one of the least successful players in its markets today and the company is launching yet another organizational restructuring in the hopes of finding a new path to sustainable growth and better market share.

TUTORIAL: A Brief Introduction To Valuation

Fourth Quarter as Bad as Expected
Blue Coat warned in early May that this fiscal fourth quarter would be bad, and the stock has been sliding ever since, losing about a fifth of its value. When Blue Coat actually announced those results on Thursday, performance was indeed ugly.

Revenue dropped 9% from the year-ago level and 2% sequentially, led by declines in product revenue of 5% and 21% respectively. Some products did show some growth (PacketShaper was up 7% sequentially, and MACH5 revenue rose 15%), but together those products were only about 30% of sales.

Given the poor performance on the top line, it is surprising (and encouraging) to see that profitability held up relatively well. Gross margin was actually flat sequentially and up slightly from last year. Operating profits did fall, dropping 13% from the year-ago level and 6% from the prior quarter, but given the scale of operating leverage with most tech companies, this could have been much worse. While management should get some credit for pulling back significantly on G&A expenses, the drop in R&D is more concerning - the company has inferior technology and spending less on R&D won't help. (For more, see R&D Spending And Profitability: What's The Link?)

When Will Things Get Better?
To management's credit, there was very little in the way of hand-waving and double-talk trying to cover up this performance. The CEO said that he is "not satisfied" with the level of performance of the company and there will be further organizational changes designed to refocus the company around web security, WAN optimization and cloud services. Unfortunately, nobody has any real sense of when (or if) these changes will start to kick in; revenue for the next quarter will likely be lower still.

Is The Competition Too Far Ahead?
Blue Coat will be hard-pressed to regain its mojo in WAN optimization. Riverbed (Nasdaq:RVBD) is growing at a much better clip, and the company seems to be struggling to outdo Cisco (Nasdaq:CSCO) at a time when it seems Cisco can't do anything right.

It's also difficult to see where the company will get an edge in security. Better-established players like Intel (Nasdaq:INTC) (through its acquisition of McAfee) and Cisco are moving ahead and into new areas like security software as a service (SaaS). Worse still, Blue Coat is seeing other companies like Citrix (Nasdaq:CTXS) and Fortinet (Nasdaq:FTNT) branch out into some of their markets and build some momentum. (For related reading, see Riding The Momentum Investing Wave.)

Wait For Signs Of Improvement
There do not seem to be any easy answers for Blue Coat, especially as the company is too small to acquire a rival like Fortinet or Websense (Nasdaq:WBSN), and likely struggling to attract much attention as a target itself. The company is cash flow positive, though, and has a clean balance sheet, and that gives management some time and some options for small acquisitions. Still, being tagged with the label of "also-ran" can be lethal when it comes to marketing to IT customers and Blue Coat is running out of time to fix its shortcomings.

Although these shares do look a little cheap by backward-looking multiple analysis, a forward-looking cash flow model does not suggest any particular bargain here. If and when the company can lay out a clear path to recovery and growth re-acceleration (and provide a little proof that the plan is working), these shares may be worth another look, but there's too much uncertainty here to call this one a turnaround candidate yet. (For more, see Turnaround Stocks: U-Turn To High Returns.)

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