Competition Heats Up in IT Security

Dell Inc. last week continued its push into the enterprise market, announcing the acquisition of privately held SonicWall Inc., a provider of unified threat management (UTM) solutions. UTM combines a variety of networking security functions (including firewalls, intrusion prevention, anti-spam, and content filtering) into a single appliance.

IDC estimates the worldwide UTM market is growing at a compound annual growth rate of 13.3% and will top $3.8 billion by 2015. According to the research firm, SonicWall controlled 8.3% of the UTM market in the third quarter of 2011, which was good enough for third place. Fortinet Inc. (Nasdaq: FTNT) held the top spot, with an 18% share, and Check Point Software (Nasdaq: CHKP) was in second place, holding 14% of the market. Juniper Networks Inc. (Nasdaq: JNPR) and Cisco Systems Inc. (Nasdaq: CSCO) rounded out the top five, with shares of 7.9% and 6.5%, respectively.

This is the second time in less than two years that SonicWall has changed hands. The company was publicly traded until private-equity firm Thoma Bravo bought it in July 2010 for $717 million. While Dell did not disclose its purchase price, word is the total value is around $1.2 billion. That represents a nice, quick return for Thoma Bravo, and Dell paid a fairly reasonable 4.6 times trailing 12-month revenue.

I'll admit Dell got a good deal on the price. It also got a relatively slow-grower with a stagnant market share. I followed SonicWall for several years while it was publicly traded and always considered it an also-ran in IT security. The criticism then was that SonicWall served mainly smaller customers and could not expand its reach into the large-enterprise market, which offers bigger deal sizes and plenty of follow-on business. Obviously, Dell plans to use its deep sales channel to attempt to push SonicWall into larger accounts.

Before it went private, SonicWall was on track for 2010 revenue of around $230 million. On the conference call announcing the deal, Dell management said SonicWall had trailing 12-month revenue of $260 million. That means 2011 revenue rose roughly 13%. In comparison, Fortinet's revenue grew 34% last year from a much higher base. Even behemoth Check Point, with 2011 revenue of $1.24 billion, saw growth of 14%. Since the end of 2010, both Fortinet and Check Point have increased their UTM market shares.

During the past few months, there was speculation that Dell was looking at Fortinet. But we know that Dell management prefers to purchase smaller companies and is price sensitive. With a market cap of $4.2 billion, Fortinet trades at 9.7 times its 2011 revenue of $433.5 million and 8.1 times the 2012 consensus revenue estimate of $516.4 million.

Another interesting player in IT security is Sourcefire Inc. (Nasdaq: FIRE), an intrusion-prevention vendor that launched its next-generation firewall (virtually the same as a UTM appliance) at the end of last year.

Sourcefire shares, which are up 48% so far this year, jumped 26% in one session last month, following a strong fourth-quarter report. Per-share earnings of 25 cents topped the consensus estimate by six cents, while revenue rose 40% to $53.2 million (above the consensus of $46.9 million), driven by product revenue growth of 44%.

US commercial revenue advanced 46% to $32.4 million, and international revenue rose 29% to $13.7 million. The company added 171 new customers, up sharply from 121 additions in the third quarter.

The number of six-figure deals in the December quarter accelerated to 126 from 87 in the third quarter. Of these large deals, 28 were worth more than $500,000 each, with several being seven-figure deals. Commenting on the largest deals, Sourcefire management said they were with "substantial enterprises."

The company has 576 channel partners and the channel influenced nearly 60% of total sales in the December quarter. This is an important metric, because Sourcefire now has a strong channel in place as it begins to ramp up its next-generation firewall business.

At the Morgan Stanley tech conference last month, Sourcefire management estimated the company would be twice its current size if it could win just 5% of the next-generation firewall market. With Sourcefire's total addressable market now at $7 billion (up from $1.5 billion) thanks to its expanded product portfolio, there is plenty of upside potential on the revenue line over the next few years.

For 2011, revenue rose 27% to $165.6 million. Sourcefire has a market cap of $1.4 billion and trades at 6.9 times the 2012 consensus revenue estimate of $201.5 million.