SafeNet's World Falls Apart (SFNT)

| About: SafeNet Inc. (SFNT)

The world fell apart at SafeNet Inc. (NASD:SFNT) this last week. The company CFO resigned (aka was probably forced out). The company's $150 million buy-out of nCipher PLC fell apart. And the company announced that Sarbanes-Oxley compliance was more expensive than expected on top of revenue being less than forecast. Safenet said that revenue would be $63 to $65 million and not the previously expected $65 to $69 million.

SafeNet's stock promptly hit a 52-week low at $20.41 down from a peak of $38.22. This shaved about $500 million off the company's market cap and leaves it with a total valuation of $535 million.

Funny, because some of this looked like good news in disguise: First, the company said the nCipher acquisition was too expensive to pursue. Maybe it was just an excuse, but if this is accurate, better that they abandon it now. Many, many acquisitions don't work anyway, so the risk of future trouble with the integration is taken off the table.

Next, Sarbanes costs are likely to be high this year, but that will probably fade in future years as it will at most companies that go through the process of getting their houses in order for the new regulations. If this is a one-time problem, the impact going into next year should be de minimis.

And, then there's that revenue miss. Never good. However, the company's financial performance has been very impressive in the past. Revenue in 2003 was $66.2 million. This rose to $201.6 million in 2004 and $263.1 million in 2005. The first quarter of 2005 showed revenue of $59.8 million and a $1.4 million operating profit. By Q4 05, revenue was up to $76.9 million and operating profit hit $5.8 million.

A look at the company financials for the last couple of years would seem to indicate that cost controls are not Safenet's forte. But sometimes the firing of the CFO focuses the company's mind on that count. Let's hope so.

Revised guidance for Q1 05 would still show a decent increase over the same period a year ago. Granted, now the company has to show that it can show solid increases in future quarters, but the business could hardly be described as being in trouble now.

SafeNet's business of providing encryption to protect IP, communications and digital identities should remain in demand for the foreseeable future. The company claims that its products are "the de facto standard in remote access client software". If this is a fair characterization of its business, the outlook for the company is likely to be fairly bright. The company holds 43 patents, which means that is has built a relatively strong defense around its own IP.

Late in the week, Lehman Brothers downgraded the stock and voiced concern about whether the company "could deliver consistent results over an extended period of time" according to the Associated Press. Janney Montgomery Scott analyst Joel Fishbein described the company as being in the "penalty box" due to inconsistent results.

If the company regains its revenue foothold and the new financial management keeps costs in check, it sounds like contrarians might view it as a "buy" recommendation.

SFNT 1-yr Chart

Douglas A. McIntyre is the former Editor-in-Chief and Publisher of Financial World Magazine. He was also president of when it was the 10th most visited site on the internet, according to MediaMetrix. He has been chief executive of On2 Technologies, Inc. and FutureSource, LLC and has served on the boards of and Edgar Online. He does not own securities in companies he writes about. McIntyre can be reached at

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