Symantec (NASDAQ: SYMC) surprised investors in March, firing its CEO after just two years of weak financial results. The IT-security giant has lagged smaller peers on its legacy software offerings and is undergoing a reorganization to reinvigorate the business. Strong market forces for cybersecurity and a great balance sheet should put this turnaround story on your radar of potential investments.
Cybersecurity: One of my Favorite Megatrends
The loss of credit card information for 40 million Target (NYSE:TGT) customers in December is just one in a growing list of high-profile cyber-crimes. The increase in these attacks, both financial and politically-motivated, is on the rise and is one of our megatrends for the next decade.
Hacking has been around even before Matthew Broderick made it cool in 1983's WarGames but high-profile attacks have made cybercrimes a top corporate priority over the last couple of years. The National Counterintelligence Executive estimates U.S. financial losses in the tens of billions a year and economic losses to R&D secrets as high as $398 billion. Research firm Gartner Inc. estimates that the worldwide security market could grow to $86 billion by 2016, a compound annual rate of 8.5% from $67 billion last year.
The market has not missed the potential in the cybersecurity space sending shares higher last year before valuation concerns recently. After the sharp drop in the first quarter, shares of most pure-play cybersecurity firms have rebounded since May. Shares of Symantec have rebounded 17.7%, underperforming a 30% jump in Palo Alto Networks (NYSE: PANW) but beating the 10% rebound in shares of Barracuda Networks (NYSE: CUDA).
The acquisition of SourceFire by Cisco Systems (NASDAQ: CSCO) last year for an enterprise value of 12.1 times sales boosted valuations though much of this has been erased this year. Palo Alto trades for an enterprise value of 11.5 times sales, more than double the 5.4 EV/sales multiple on shares of Barracuda and well above the 2.2 multiple on Symantec.
Poor performance against peers
With a market cap of $14.9 billion, Symantec is by far the largest pure-play security software company and one of the few that does not trade at a significant buyout premium. The company reports in three segments: user productivity and protection (43% of FY2013 Revenue), information management (38%) and information security (19%). The company books 52% of its revenue from outside the United States.
Shares slid 6% late January when the company forecast fourth quarter sales between $1.62 and $1.66 billion, slightly lower than expectations. The disappointment is nothing new to investors with the shares down nearly 9% over the last year and underperforming the broader market since the end of the recession.
The problem at Symantec is that it is a legacy security company in a world where legacy systems have not evolved to meet new cybercrime challenges. Santosh Rao, analyst at High Alert Capital Partners, describes the environment in a recently completed sector report on cybersecurity,
"Secular shifts in technology like the growing practice of BYOD (bring your own device and the adoption of cloud services, combined with the modern network infrastructure with its widely-dispersed multiple end points has made legacy signature-based security technologies obsolete. Today's attacks can appear harmless to legacy systems by coming through as file formats other than .exe (executable) and can be initiated through the system's random access memory instead of being written to the hard drive."
Revenue has grown at a compound annual rate of just 3.3% over the last five years, even as high-profile cyberattacks drove faster growth across the industry and opened the door to smaller competitors. Revenue is expected to decline by 4% this year even against a 9% increase in the market for security software spending.
Cash pile and a new Symantec
The company has increased cash on the balance sheet to $4.08 billion, nearly a quarter of its market capitalization. Long-term debt has remained relatively consistent at $2.1 billion and interest expense of $84 million was covered more than 14-fold by operating income in fiscal 2014.
Despite a disappointing fourth quarter, operating results were surprisingly positive. The company reported $0.47 per share, beating expectations by 12%, and posted $1.92 in earnings for the year. Symantec cut about 5% of its worldwide employment last year and reorganized the sales division to focus on new business and new products. It also increased its operating margin to 30.4% over the last quarter, beating expectations and continues to post free cash flow over one billion a year. Shares outstanding have decreased every year since 2006 as management augments its attractive 2.7% dividend with the share buyback.
Symantec was reported to have hired consultants to advise on defending against activist investors that might be attracted to the company's massive cash hoard. The news is a negative for investors but I do not think it rules out some very positive solutions.
With more than four billion in cash and little debt, Symantec could easily afford an acquisition of one of the smaller cybersecurity upstarts. Palo Alto Networks is one of the largest and still only has a market cap of $6.3 billion. Beyond a large acquisition, a spinoff of its storage business from security is still a possibility. Holding the two segments together offer few synergies and the company might be able to get a good price for storage. The split could allow management to focus on higher margin security business and develop some innovative products.
There is always the chance that the company can complete its reorganization successfully. We should here more about direction over the next couple of quarters as the company searches for new leadership. With shares trading at an enterprise value of just 2.2 times trailing revenue, I like the value and the potential for market-moving news is good.
Earnings are forecast slightly lower this year to $1.88 per share on $6.7 billion in sales. A valid change in the business plan should improve sentiment and the acquisition of another pure-play peer could boost the enterprise multiple significantly. I have a target of $27.55 on the shares using a slight beat to sales and an enterprise value of 2.5 times revenue.
Symantec is not the fastest growing company within the cybersecurity megatrend but completion of a restructuring program and strong market growth should lead higher revenue and margins in the years to come. Over the short-term, the shares could jump higher on news of an acquisition or spinoff.
Disclosure: The author is long SYMC, CSCO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.