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By Rohit Gupta

Proofpoint PFPT is one of the leading SECaaS vendors that provide email protection and data protection services to large and mid-sized global organizations. The company's service offering comprises an integrated suite of capabilities, which include threat protection, regulatory compliance, archiving and governance, and secure communications. In August this year, it acquired a private company, Armorize, to grow strong in this market. Still, it faces stiff competition from other market leaders. What does the future hold for Proofpoint?

Armorize acquisition a boon

Proofpoint acquired Armorize for $25 million in cash to capitalize on the growing market in Advanced Persistent Threats, or APT. APT is a network attack where a hacker illegally gains access to the restricted network. Hackers may attempt to steal data or cause damage to the network's organization. Through this acquisition, the company will be able to increase both the technology capabilities and capitalize on the advanced malware protection market.

Armorize will provide Proofpoint direct access to real-time cloud-based threat intelligence and protection. Additionally, it will get a strong portfolio of about 70 employees, 35 of these are certified ethical hackers. This will provide a huge tailwind opportunity to Proofpoint's team, as it currently consists of only ten certified ethical hackers. We believe this will allow Proofpoint to launch more advanced anti-malware solutions as well as expand Armorize's solutions to its customer base of over 2,700 customers. We expect the company to launch a premium version of its Targeted Attack Prevention Module to offer improved capabilities, leading to a boost in the company's average selling price and gross margin.

This year the company expects this deal to have a negative impact on its EPS of $0.01 in the third quarter this year and -$0.03 in fiscal year 2013. We expect the company to absorb this cost by the first half of 2014 and break even by the end of that period.

Big competitors growing through acquisitions

Proofpoint will be facing substantial risks from big players like CISCO Systems (CSCO). It's easy for large companies to acquire the small companies, indirectly enhancing their teams and eliminating competition. By the end of this year, Cisco will complete the acquisition of Sourcefire (FIRE) for $2.7 billion, announced in end of July this year. Post completion of the deal, the employees of Sourcefire will join Cisco Security Group, which will be a huge value addition for the company. Despite Cisco's announcement last month to lay off 4,000 employees worldwide, or 5% of its workforce, none of the Sourcefire employees will be removed. This turnaround strategy was due to the weaker sales from various regions like Japan, China, and Europe.

We believe Cisco's management focus to grow its business in this market poses a huge threat to comparatively small companies like Proofpoint.

Valuations

To provide a more understanding regarding Proofpoint, we are comparing it with its competitors AVG Technologies (AVG) and Sourcefire, in terms of their present valuations. Firstly, we will consider the price to sales ratio. This metric helps provide a better understanding regarding the company's revenue position in relation to its present stock price. Here, lower is considered better.

Valuation Comparison

Proofpoint

AVG

Sourcefire

Price/Sales

9.29

3.37

9.65

Enterprise Value (in $ Billion)

1.03

1.27

2.19

EV/Sales

8.69

3.2

8.84

AVG posted the best results with the lowest ratio, while Proofpoint and Sourcefire compete at similar levels, Proofpoint being the better of the two. The major reason for AVG's metrics is its low stock price trailing around $25. It also has the highest trailing 12-month revenue of $395.57 million. This shows that AVG is an attractive stock among the three companies.

Comparing the enterprise value, or EV, Proofpoint impresses as the lowest of the league, while Sourcefire is the highest. The reason for the difference is their respective market capitalization. Due to Sourcefire's share price of $75.89, it pushes its EV, despite having zero debt.

The EV to sales metric helps investors find out how attractive the sales of the company are in terms of its enterprise value. Again, the lower the better concept is applied here. AVG has better results, as it has the lowest EV to Sales, due to its low EV and higher sales. Proofpoint presents better results than Sourcefire, as its EV is nearly half of Sourcefire's, due to which it is lower by a mere 0.15 times.

Overall, these calculations show that AVG has the best valuation among the three companies, while Sourcefire is the least attractive. On the other side, Proofpoint has fair valuations, leaving room for further improvement in the coming quarters, through fundamentals like its new acquisition.

'Buy' is the word for this stock

We believe Proofpoint will see significant traction with its Targeted Attack Prevention product. With the Armorize acquisition, it will have access to cutting-edge technology that provides malware detection in a virtual environment. Additionally, the licensing fee it had to pay to Armorize earlier will be discontinued post deal, leading to better savings.

However, the growing competition in this market raises concerns. Especially, when big companies like Cisco, which are increasing their focus in this industry, pose a significant risk to the small companies like Proofpoint. Despite this growing competition, we expect Proofpoint's billings and revenue to exceed expectations from 2014 onwards.

Source: Proofpoint: One Slo-Mo Growth Stock

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.