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Technology Stocks : Sonicwall Inc. - SNWL

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To: caly who wrote (53)6/21/2001 10:25:14 PM
From: D. K. G.  Read Replies (1) of 63
AFGC Profiles: SonicWALL

Research Analyst: Will Frankenhoff (6/21/01)

The advent of the Internet has brought many benefits to corporate America - improved operating efficiencies, enhanced customer support, and easier access to global markets, among others. At the same time, the 'Net has also increased corporate exposure to unwanted intrusions, be they malicious viruses or hacking attacks.

Take the hacker attacks experienced by Microsoft (NASDAQ: MSFT - Quotes, News, Boards) and eBay (NASDAQ: EBAY - Quotes, News, Boards) earlier this year or the infamous "ILOVEYOU" and "Melissa" viruses that swept the globe. It is clear that the need for effective information technology (IT) security has never been greater.

Indeed, a recent ISCA study found that companies reported an average of 9 viruses per 100 computers, a fact that led the International Data Corporation (IDC) to project sales of anti-virus products alone would climb from $1.2 billion in 1999 to more than $2.7 billion in 2004.

Similarly, the hacker attacks on various corporate sites pose a serious threat to the smooth functioning of the B2B e-commerce market, a market that eMarketer projects will grow from $225 billion in 2000 to $2.8 trillion in 2004.

While there are a number of well-known IT security companies - Check Point Software Technologies (NASDAQ: CHKP - Quotes, News, Boards), VeriSign (NASDAQ: VRSN - Quotes, News, Boards) and Internet Security Systems (NASDAQ: ISSX - Quotes, News, Boards) come to mind - one often overlooked company is SonicWALL (NASDAQ: SNWL - Quotes, News, Boards), the leading player in the small-medium enterprise (SME) markets that also targets the Virtual Private Network (VPN) market and the educational market.

SonicWALL dominates the SME market with an installed base of more than 140,000 appliances (up 20% sequentially) worldwide as of March 31, 3001, more than double that of its closest competitor Watchguard Technologies (NASDAQ: WGRD - Quotes, News, Boards).

The importance of this domination cannot be overstated for two reasons: First, this market is under-penetrated, boasting a mere 5% saturation level versus the 40%-45% saturation rate of the large enterprise market; and second, given the lack of penetration and the growing amount of small businesses accessing the Internet, demand for security products in this market will grow at a much faster rate than the overall Internet security market.

According to IDC estimates, the number of small businesses (fewer than 100 people) accessing the Internet is projected to increase from 50% in 1998 to more than 65% in 2001, for a total of 4.7 million businesses. SonicWALL offers the only ISCA-certified firewall for under $1,000, a not insignificant factor to these cash-strapped business. IDC projects that firewalls costing less than $5,000 will grow at a compound annual growth rate (CAGR) of 81% from $32.7 million in 1998 to approximately $635.4 million at the end of 2003. The overall IT security market is projected to grow at a 21% CAGR over the same period.
In a similar vein, SonicWALL's focus on the VPN market also is paying dividends. These networks, which support 1-1,000 users and can link branch offices of large corporations or be used in medium-size companies as an intranet, are projected by Infonetics Research to grow 100% annually at least through 2002. This is primarily because these networks cut telecommunications costs for internal communications by nearly 90%.

That SonicWALL has positioned itself extremely well is evident by examining its results since going public back in November of 1999. In each of the six quarters since that time, SonicWALL has grown revenue by an average 277%, had a profit in each quarter, and has amassed an average earnings growth rate of 205% over the past three quarters, excluding one-time items.

After racking up $69.4 million in sales in 2000 (up 230% over 1999), analysts are expecting revenue to come in at approximately $114 million in fiscal 2001 and $175 million in 2002, representing growth of 65% and 53%, respectively. Keep in mind that these numbers have been already been revised downwards to account for the slowdown in the industry.

Earnings are expected to remain relatively flat in 2001 at $0.35 per share due to current market conditions as well as the impact of the Phobos acquisition. But share profits are projected to climb to $0.59 in 2002, representing 68% growth.

We believe that these estimates could prove extremely conservative given the recent OEM agreement reached with Cisco (NASDAQ: CSCO - Quotes, News, Boards) , in which Cisco announced it would buy SonicWALL's Secure Sockets Layer (SSL) solution and brand it as its own (i.e. Cisco will buy the product, slap its own label on it and resell it as its own). Given Cisco's well-known distribution capabilities, we believe that upside from this product could be as great as 20% in revenue and 10% to 15% in earnings during the second half of 2001. Shipments of the products are scheduled to commence in the third quarter.

Bottom Line:

Shares of SonicWALL currently trade at around 28 times fiscal 2002 estimates of $0.59 per share, a 43% discount to the company's projected revenue growth rate and a whopping 59% discount to earnings growth. In time, we expect this stock to trade at a premium to its growth rate, as shares of VeriSign and Checkpoint do today. We rate the stock a "buy" at current levels.
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