Smallcap Israeli Spam Killers: Commtouch Software, IncrediMail

Includes: CYRN, PERI
by: Wyatt Investment Research

Imagine shopping in a store where the majority of merchandise on display was complete junk, or subscribing to a cable television service where three-quarters of the programming was devoted to unwanted ads for sexual enhancers or weight-loss schemes.

It sounds implausible and in most legitimate businesses it would be. But those hypothetical scenarios help put into perspective the severity of the email spam problem. By the most conservative estimates, some 75% of all email sent today is spam. Some analysts put the figure closer to 95%. Of course, anyone who regularly loses important emails in a sea of junk mail for low interest mortgages and Nigerian money making schemes needs no statistics to understand that spam is to email what kudzu is to the South.

We are so used to it, we have almost come to accept it. But it threatens the viability of one of our most cherished communications tools, and no one can seem to stop it.

That’s not for want of trying. Scores of young companies have cropped up in recent years offering ways to separate the legitimate mail from the spam, and some have won a lot of attention. Earlier this year, Cisco Systems Inc. (Nasdaq: CSCO) acquired the security technology and anti-spam company IronPort Systems Inc. for $830 million. Just this month, Google Inc. (Nasdaq: GOOG) paid $625 million for Postini Inc., an email security company.

Both businesses have developed promising ways to block spam, but neither has managed to solve the problem.

So the search for a killer anti-spam technology continues. Two Israeli small caps working on a solution - Commtouch Software Ltd. (Nasdaq: CTCH) and IncrediMail Ltd. (Nasdaq: MAIL) - have seen strong sales growth and stock price gains this year.

Commtouch Software Ltd.

Commtouch Software Ltd., a Netanya, Israel company with U.S. headquarters in Sunnyvale, Calif., makes anti-spam and virus detection products for enterprise customers, and has seen its stock price almost triple from $0.82 a year ago to about $2.37 today.

Commtouch was founded in 1991 but for most of its history operated as a standalone email and messaging provider. A shift in 2004 that focused the company more narrowly on anti-spam solutions led to a period of soft results and instability, from which Commtouch is now emerging.

The company’s revenues have grown from $1.5 million in 2004 to $3.9 million in 2005 and $7.2 million in fiscal 2006. After shrinking its net loss to $415,000 last year from $2.7 million the year before, the company in 2007 reached profitability on a quarterly basis. Last month it reported that first quarter revenues rose 63% to $2.4 million, on net income of $267,000.

Like most companies developing anti-spam products, Commtouch has managed to grow its business by constantly developing new products to keep up with the spammers’ shifting tactics. It is now working on products to block so-called hijacked newsletter spam, which commandeers a popular email newsletter and attaches the spam image or the message at the top.

CTCH 1-yr chart


IncrediMail Ltd.

IncrediMail Ltd. of Tel-Aviv, Israel, has enjoyed similarly strong growth recently by selling technology for the consumer anti-spam market. The company incorporates junk mail filters as part of a broad consumer email service that lets users design their mail with handwritten signatures, emoticons, and customized background and letterhead.

After going public in January 2006, IncrediMail was just last month approved for listing on Nasdaq. While its stock price has done well over the past year, trading around $7.56 today, up from $4.32 a year ago, it has also endured a number of choppy periods. Today it sells for less than the $8.51 per share it closed on its first day of trading following its initial public offering on Jan. 31, 2006.

IncrediMail’s revenues have grown rapidly, to $10.9 million last year from $7.4 million in 2005 and $6.2 million in 2004, but earnings growth has been more elusive, partly reflecting the company’s commitment to investing in growth. Its 2006 net income of $2.3 million was down from $3 million in 2005 and $2.6 million in 2004.

Nonetheless, IncrediMail is aggressively working to expand its business. It recently unveiled a Chinese-language version of its software, which is already published in nine other languages, and it has introduced advertising to supplement its mostly subscription-driven revenue model. During the most recent first quarter, it said that advertising revenue grew seven-fold from the prior year.

MAIL 1-yr chart


The good news for both these companies, and for many others trying to make a dent against spam, is that businesses and consumers are desperate enough to try almost anything, and in fact are increasingly throwing two or more technologies at the same problem.

And, as some of the recent acquisition activity by Google and Cisco shows, there’s a strong belief that a groundbreaking spam killer could come from a relatively small company. It’s also likely that even companies that are unable to block spam altogether will continue to thrive by selling technology that blocks just a little bit of the spam that overwhelms most email users. That’s all anyone has been able to achieve to date.

But investors should be warned: competition is fierce in this industry, and much of it is coming from well-backed companies like Symantec Corp. (Nasdaq: SYMC) and McAfee Inc. (NYSE:MFE). The market is wide open today, but that could change suddenly if anyone develops a truly superior product.

Disclosure: none