You've got mail! - Entrust (ENTU)

Reader S.A. writes:

I read your blog everyday. I think it's great. Can you provide information on Entrust (NASDAQ:ENTU)? With consolidation in the security sector, I think its worth watching. Thanks for running a great blog.

NC writes:

Entrust, Inc. is a global provider of security software that secures digitalidentities and information. The Company is engaged in the design, production and sale of policy and access management software products and related services for securing digital identities and information. Entrust software and the associated services enable businesses and governments around the world to conduct high-value, highly sensitive transactions, over wired and wireless networks including the Internet. Over 1,450 enterprises and government agencies in more than 50 countries use Entrust solutions to help secure the digital lives of their citizens, customers, employees and partners.

(Source: Reuters)

Summary of recent analyst comments:

- Avondale Partners' P. Sean Jackson issued a lenghty industry report on the current state of internet security on August 3. In the note he highlighted ENTU several times:

HSPD-12. According to this presidential directive, by October 27, 2006, all federal government employees and contractors will be required to have a standard smart card to be used for physical access as well as computer access. If agencies do comply on time (a big if given agencies do not have a budget for it), companies like ActivIdentity, SafeNet, and Entrust will get a significant boost. This legislation will affect over 15 million individuals and will result in over $1 billion of security spend.

FFIEC Legislation. In November 2005, the Federal Financial Institutions Examination Council (FFIEC) instituted a directive stating that banks need to offer a two-factor authentication method by the end of 2006. While this directive really has no meat to it yet, firm's checks indicate that banks are taking it seriously to at least strengthen their authentication. Ultimately, they believe this will result in more token penetration by business online banking users, and additional layers of software authentication by retail online banking customers. Companies benefiting from this legislation include RSA, Vasco, Secure, and Entrust.

EMC Buying RSA - Who's Next? The significant part of this news is not necessarily that RSA got bought, but that it got bought for 44x 2006 earnings and 5x revenue by a company (EMC) whose synergies are not clear with most RSA's business. Also, the fact that it was a competitive bid suggests that another acquisition might not be far off. Companies that are also in the user authentication space that might be in play include Secure, Vasco, ActivIdentity, and Entrust.

Jackson also notes there has been a lot of consolidation in the security sector over the last 3-4 years. Like many tech areas, much of the consolidation was the result of an overflow of venture money coming into the space in the late 1990's, which resulted in a glut of small security companies. Coupled with the tech recession of 2001-2002, there were a lot of security companies available for sale through 2003.

After 2003, the acquisitions began to get larger and have more impact. The tech environment was improving, and the security bellwhethers were no longer focused on internal issues, but being more aggressive in looking for growth. More importantly, customers began desiring to work with fewer security vendors. This made the critical to have as broad a solution as possible to meet all the security needs of the customer. Symantec was the poster child for this strategy as it gobbled up 21 companies between 2002-2006 to strengthen its presence first in the enterprise security market and then the administrative and storage markets.

The company that probably made the greatest transformation due to an acquisition strategy was SafeNet. Between January 2002 and the end of 2005, SafeNet made 9 acquisitions growing from a company that recorded $16m in revenue in 2001 to an expected $284m in revenue in 2006. While SafeNet's target government market was different than Symantec's targeted enterprise market, the same market dynamics were happening. The customer was weary of dealing with many point product vendors and wanted more integrated solutions.

In recent times, many well established security companies are choosing to forgo the public markets and agree to become part of a larger organization. This is evidenced by the fact that despite security being one of the stronger tech segments in the last five years, the last IPO was Netscreen in 2001. Companies that could have accessed the public markets and chose not to include Brightmail (acquired by Symantec in 2004 for $370m), Sybari (acquired by Microsoft in 2005 for $412m), and most recently CipherTrust (pending acquisition by Secure Computing for approximately $200m).

What's next. Going forward, the firm expects to see even more consolidation on a bigger scale. Security is becoming a mainstream topic, and many buyers will likely come from outside the security world as they attempt to find not just growth, but also better synergies with their existing technology. More than ever, CIOs are asking what security precautions are being embedded in applications and the infrastructure solutions. Cisco has been at the forefront of this integration and has been an active acquirer in security. On the desktop side, Microsoft is following the same strategy in buying solutions that make sense to offer with its core products. The recently announced EMC deal with RSA Security is an example of an acquisition of a market leader within security, and they expect more transactions of this type going forward.

- Wedbush Morgan Securities' Horacio Zambrano issued some comments on ENTU after the co reported its Q2 results on July 21. Wedbush dropped their coverage on ENTU on August 14 due to analyst departure:

Zambrano maintained a Hold rating on ENTU but lowered price target from $4 to $3 based on EV/sales comparables. He noted Entrust's Q2 results point to a healthy core business and modest momentum in its emerging products. Believes the acquisition of Business Signatures is generally a good move for Entrust as it signals a change to their current strategy. It should strengthen IdentityGuard's appeal to financial institutions, but he was concerned that RSA's dominance in this market may hinder short-term results. Firm's new price target reflected a 1.3x EV/sales multiple on $120m '07 sales estimate, representing a 35% discount to InfoSecurity peer group, which is trading at a median of roughly 2.0x '07 sales estimates. They adjusted their enterprise value to take into account a cash balance of roughly $25m post today's acquisition. Believed that given the company's size, the highly competitive nature of its growth markets, and recent execution performance, the 35% discount is merited.

Notablecalls: Can't say I'm a big fan of ENTU as the co has failed to produce any growth over the past 4-5 years. Profitability has been weak. It may be a potential takeover target but thats no reason for owning a stock.