Tuesday, July 11, 2006

Websense (WBSN) - Color on warning

Several firms are out cautious on Websense (NASDAQ:WBSN) following lackluster billings guidance issued last night:

* ThinkEquity downgrades the shares to Accumulate from Buy noting the co missed its billings guidance for the second quarter in a row. Says they misjudged the level of changes that the new management team would make. While they are positive on the changes, they think the transition will be disruptive in the near term.

Firm's mid-quarter channel checks were very positive on the addition of Roberts. Recent checks reveal skeptical resellers, with some worried about direct deals at the end of the quarter and Websense moving to two-tier distribution. Believes that Websense will resolve these issues, but it may take past the end of the year to regain channel partner enthusiasm.

Tgt goes to $25 from $37.

* Merrill Lynch notes Websense's second consecutive miss underscores transitional challenges prompted by tough competition and a slowing core enterprise market.Websense cited increase in total ASPs and steady renewal rates as evidence of a stable competitive environment. Preliminary results suggest Websense is doing well with its installed base, but price competition from Blue Coat and Surf Control is creating difficulty winning new business and lengthening sales cycles.

Maintains Neutral.

* JP Morgan notes revenue/EPS expected to be in-line, but it is the light billings and potential for shortening deals lengths and compressing margins that are the concern.

Questions over the ability to further shift contract mix to longer term 3 year deals in an uncertain macro environment, along with a need to expand into the more price competitive middle market, and a two tier sales distribution transition in 2H06 to make it happen will provide a cloudy outlook for the stock in firm's opinion.

Cash flow is the next question, as further slowdown is possible: argument for owning the stock has long been valuation on cash flow basis, but if contract length stagnates or even contracts in tougher economic/IT environment then cash flow estimates could keep coming down. Normalizing for option tax benefits last year they now see 2006 FCF growth of 27% from 61% last year, but decelerating further from there.

Reits Underweight rating.

* Deutsche Bank maintains Hold rating but lowers their tgt to $20 from $27 notin that while the shares have a more favorable risk/reward profile following the 43% decline YTD (vs -3% for NASDAQ), otheir scenario analysis suggests additional downside could remain.

* Jefferies out with the most negative comments saying Q2 billings weakness another sign of decelerating growth at Websense. Consistent with their checks, they believe the company faces a mature core market, growing competition, and ongoing sluggishness in new product sales. They do not see these challenges abating anytime soon.

Days of heady growth at Websense could be more elusive in future quarters. The Q2 billings shortfall marks two consecutive quarters with with preannounced weakness in billings, a trend that could be a harbinger of slowing growth at Websense. Eventually the slower billings growth will begin to pinch the company's revenue and EPS lines, as the flow-through impact of its subscription model becomes absorbed. The company faces an uphill climb as it attempts a product transition into the broader Web security arena, in addition to potential pitfalls as it moves to a 100% distribution sales model. With a mature core market and sluggish new product sales, the firm believes investors should anticipate some continued rough sledding in coming quarters. Firm continues to believe that Websense could embark on an M&A path to reinvigorate growth, although management downplayed such a strategy on yesterday's conference call. Should the company go the M&A route, they remind investors that any deal is likely to be dilutive to Websense's very rich 35%+ operating margin.

Maintains Hold but tgt goes to $18 from $26.

Notablecalls: Given how WBSN stock has reacted to reduced billings guidance in the past I was somewhat surprised by the lack of downside in after market trading. Yet, analyst comments this morning suggest there will be further downside in the shares. Trading almost 4x revenue (Mkt Cap/ 07 revs) the co has to come up with something better than constantly decelerating growth.

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