& Healthcare Companies
and network security
First Analysis Security
233 S. Wacker Drive
Chicago, IL 60606
Interview conducted by:
Walter Banks, Co-Publisher
Howard joined First Analysis in 1994 and, as a senior vice president, coordinates the
firms Internet infrastructure investment and research activities. As a private
capital investor focused on growth equity opportunities in the sector, Howard works with
entrepreneurs building cutting-edge Internet-based businesses, and evaluates hundreds of
business plans annually. As a public equity analyst covering Internet infrastructure and
network security companies (such as Exodus Communications and VeriSign), Howard regularly
speaks with the senior management teams of the sectors leading public companies, and
he has deep knowledge of the sectors competitive dynamics and market trends. Howard
has also played a key role in several mergers, acquisitions, and public equity
underwritings in the sector (such as the IPO of PKI player Zergo, now Baltimore
understanding of the sector is grounded in his earlier work in the telecom infrastructure
and equipment sector, where he established coverage of several prominent public companies
(such as Comverse Technology). Prior to joining First Analysis, Howard was a senior tax
consultant with Arthur Andersen, where he advised investment partnership clients on
of Chicago: MBA (finance)
University of Illinois at Urbana-Champaign: B.S., accountancy, Highest and Bronze Tablet
Certified Public Accountant (1991 Elijah Watt Sells AICPA award winner
Founded in 1981, First Analysis is an integrated,
research-driven investment organization serving:
- emerging growth
companies, with (growth) equity and venture capital investments
institutions, with public equity research and
with corporate finance and M&A advisory services
Analysis applies a unique strategy to achieve deep domain expertise in the areas of
focus. Its 40 investment professionals average more than 10 years of relevant
Successful execution of this strategy has yielded
- $500 million in
private capital funds invested in over 150 companies since 1985
quartile private capital performance supported by over 50 IPOs and major M&A
- research on more
than 100 publicly traded companies
CEOCFOinterviews Mr. Smith, what is
your position at First Analysis Security?
Mr. Smith: I coordinate our technology
research practice, my area of expertise is network security.
CEOCFOinterviews Please tell us about the industry which you
Mr. Smith: The network security industry is
a very dynamic industry, and a high growth industry. Weve been following it
here at First Analysis Security since the Internet caused an up-tic in the growth, which
happened about 1995. There are several different sectors within this industry. First,
there is anti-virus, which has been around since the 1980s. The other sectors are
firewalls, which have been around since the mid 1990s, virtual private networking
equipment, intrusion detection to try and detect when people are coming into a network who
shouldnt be, and strong authentication that is when youre logging onto
a network or computer, making sure you are who you claim to be. As the world has become
more distributed in terms of how it controls data and where that data is placed, and who
has access to the data, such as outside partners, vendors, and suppliers, the security
issues associated with that data have increased exponentially, so its been a
phenomenal investment area.
CEOCFOinterviews What do you see on the horizon for these
Mr. Smith: There will be no shortage of new
threats coming about. To date, the incidents which have gotten a great deal of attention
have been websites that have been defaced, and its more of a PR issue for the
companies that have been attacked rather than a real financial loss issue. You are
starting to hear of issues of credit cards being taken off servers, and more serious
issues just recently with some companies such as Microsoft where a Russian hacker
stole source code. Lucent is another example of a company that got some press because one
of its R&D projects was stolen by some engineers. I think that you will start to hear
more of those types of incidents. Therefore, the real threats as most data has suggested,
is with internal employees, actually stealing or manipulating or causing problems with the
systems and the real financial losses will start to get more publicity. All of this will
just serve to force more attention on the sector. Chief Security Officers will probably be
as common as Chief Information Officers in large corporations a couple of years from now.
CEOCFOinterviews What effect will that have on investors?
Mr. Smith: I think that it will continue to
create opportunities. There are a couple of nice things from an investment perspective.
First, the numbers and types of threats keep changing, so that there is always a new area
of security emerging to address those newer threats. Therefore, its not a static
area where you have a leader today, and thats the leader for all time. Secondly,
there are two aspects to security. Number one is prevention or protecting assets and the
other is opening up new revenue opportunities or new ways to do businesses. People are not
going to conduct business online and have a paperless economy that many of the exchanges,
such as the B2B exchanges, and the B2C exchanges have been talking about, unless the
security issue is solved, and that is a whole different area of security thats at a
newer stage in its life cycle than the asset protection solutions. Another
interesting area is wireless security, which is not a whole new sector, but there are some
unique wireless security angles such as wireless commerce and wireless data which are
really going to take off, and security is going to be right along with it and that will
provide an opportunity for investors.
CEOCFOinterviews What companies do you like in this sector?
Mr. Smith: We have two strong buys in that
sector right now. One of our long-term favorites has been Check Point Technologies (NASD:
CHKP), which is an Israeli based company, and they are the leader in the firewall and VPN
markets, which are two of the most dynamic markets. The company is well managed, and has
one of the highest margins of any publicly traded company. Their net after tax margin has
been running over 50% for the last several quarters. We have a strong buy on that
Our other strong buy is a very different type of company, called
ValiCert Inc. (NASD: VLCT). This is an emerging opportunity, a very small company
with much greater risk, but is in an interesting emerging market, and given its
market capitalization and the opportunity in front of it, we think that it provides, for a
risk tolerant investor, a good opportunity.
CEOCFOinterviews What is your evaluation of their management
Mr. Smith: I think their management team has
proven to be very adept at changing with the market, and that is one of the things that we
look for and one of the things that we like about the company. Weve know this
company for quite some time, pre-dating its IPO in July of 2000, when the company
was really a pure play on certificate validation. A certificate is a little esoteric
term in security. Its basically an identifier that could be issued to a person, much
like a passport, and once its issued it has an expiration date but there is really
no mechanism to find out if, for some reason, it was revoked before its stated expiration,
by the person who issued it. For example, a company might issue certificates to its
employees. Once a person is no longer an employee of the company and they want the
world to know that it has revoked that credential. However that credential is still
out there, with an expiration date that hasnt come up yet. Therefore, ValiCert Inc.
has some very unique technology for solving that problem of letting the world know when a
certificate is no longer valid, and that is a pure play on derivatives of digital
certificate adoption, which hasnt been as fast as a lot of people have thought. So
they were very quick to go out and expand their offering and their value proposition to
customers by acquiring some digital receipt technology and some secure file transfer
technology and putting it all together. More recently, with the down turn of the tech
market, what Ive been impressed with is that theyve remarketed or repackaged
this technology to target vertical applications. They have a cash management application,
and an insurance claims application, an e-government application and they are not selling
the core technology to the customer. They are selling a way to bring your business on line
and save money, a good ROI sale. Therefore, what I would highlight about management is
their ability to adapt to the economic conditions and environment that they are facing,
and theyve managed to do it without missing a beat or missing numbers at any point.
CEOCFOinterviews Can you give us a picture of their
Mr. Smith: The core original business of validating certificates is a small market today.
It may be less than 10 to 15 million dollars on an annual basis, but as this whole
infrastructure builds out over the next 5 to 10 years it could grow into a multi-billion
dollar market, and they are positioned to be the leader there, which is one of the things
that has us excited about the stock. But theres a question of how quickly that
happens and how quickly the market expands. If you look at the market more broadly, as the
market for providing solutions to move processes online, that is a much bigger market
CEOCFOinterviews What would you like
to see them accomplish over the next year to reach that next level?
Mr. Smith: The key for ValiCert Inc. is to
reach cash flow positive. This was one of the last companies that came out under the
Internet model of IPOs and public offerings, where the company could still be burning a
lot of cash and not have that much revenue. They are currently burning about 8 million
dollars a quarter of cash, and the management believes and we do as well, as long as they
hit their plans, that they have enough cash in the bank to take them to profitability
without accessing the capital markets. However, clearly, that is the issue on investors
minds, and that is what they have to execute and prove the next year. We would expect them
to be profitable at the very end of 2002. What I think also highlights some of the quality
of their management, is their recognizing the economic environment that were in
today. They took the proactive step of reducing their expenses through a head count
reduction of about 10%, to help enable them to meet that profitability objective.
CEOCFOinterviews Are there any other
companies that you would like to highlight?
Mr. Smith: There are two other companies
that I would highlight as being long-term leaders in the space. One is VeriSign, Inc.
(NASD: VRSN), a large cap company which is very well managed, and the other would be RSA
Security Inc. (NASD: RSAS), which is in the strong authentication space, and it has some
pretty core technology in encryption as well as their main business, which is the
authentication. They are also a player in the emerging area of digital certificates.
Therefore, it has been one of the longer term, steady performers, and we thing that is an
interesting long-term play as well.
Thank you for your very insight on this Industry.