Daily Trouble |
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<DAILY TROUBLE>
Tuesday, May 4, 1999
Network Associates Inc.
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Website:
www.networkassociate.com
Phone:
408-988-3832
Price
(5/3/99): $13 1/16
HOW DID IT FIND TROUBLE?
Sometimes the best way to find a candidate for the Daily Trouble is to look where the most class action lawyers are hanging out. No fewer than 20 law firms have filed suit against Network Associates over the past several weeks. It remains to be seen where the lawsuits will ultimately end, but Network Associates' lawyers will surely be working plenty of overtime over the next few months, given the company's numerous troubles.
Among the things to trigger trouble in the stock (as well as the lawsuits) was an investigation by the SEC into the company's accounting practices for acquired research and development. Instead of immediately writing off these particular expenses, the company was forced to reverse these charges and amortize the expense. This revision altered 1998's expenses by $169 million and 1997's charges by $45 million. Even though the present and future cash flow produced by Network Associates is essentially unchanged, Wall Street absolutely abhors accounting difficulties leading to revisions of previous results.
Another factor leading to the stock losing three-quarters of its value over the past six months was a softening market for the company's core products. As those watching the enterprise software market can attest, Network Associates is not alone in its trouble. Another software company that found trouble in this market was Baan <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BAANF)") else Response.Write("(Nasdaq: BAANF)") end if %>, featured here a few weeks ago.
The softness has started to hit Network Associates' financial statements. On April 5 the company reported earnings per share for the fourth quarter of $0.40, well below the $0.46 the analysts were expecting. The company also warned about anemic results for the first and second quarters. Following through on its promise of weak numbers, on April 19 the company reported first quarter earnings before charges of $0.30 a share, still below the watered down analysts' estimates of $0.31.
With all the problems surrounding the company, it is of little wonder that much of the stock's value has been erased.
BUSINESS DESCRIPTION
Based in Santa Clara, California, Network Associates is the largest producer of anti-virus software in the world. Formerly operating under the name McAfee Associates, the company's products include the popular VirusScan software as well as numerous other software titles having to do with virus scanning, hardware monitoring and troubleshooting, protecting networks with firewalls, as well as encrypting data.
The company has expanded greatly over the past few years, but nearly all of this growth has been through acquisition. The company's name was changed to Network Associates after McAfee bought out Network General in 1997. Among the other firms that have been gobbled up by the company over the last three years include Pretty Good Privacy (PGP), Trusted Information Systems, Magic Solutions, Secure Networks, Dr. Solomon's, and Cyber Media.
Network Associates is a member of the S&P 400 MidCap Index.
FINANCIAL FACTS
Income Statement 12-month sales: $1,009.1 million 12-month income: $29.9 million 12-month EPS: $0.20 Profit Margin: 2.96% Market Cap: $1,862.7 million Balance Sheet Cash: $771.9 million Current Assets: $1,114.8 million Total Assets: $1581.9 million Current Liabilities: $246.3 million Long-term Debt: $378.7 million Total Liabilities: $827.0 million Ratios Price-to-earnings: 65.3 Price-to-sales: 1.8
HOW COULD YOU HAVE SEEN IT COMING?
Network Associates proves that even if you have "net" in your name and have a leading position in an emerging market, trouble can hit. One of the problems in valuing the company was the fact that so much of the company's growth has been through acquisition and not via internal "organic" growth. Mergers don't come cheap, and they often muddy the valuation picture for investors.
One of the troubling financial signs that Network Associates had was in its Statement of Cash Flows. In 1998 the company's cash flow from operations, the cash generated by Network's business, was $53 million. Meanwhile, cash flow from investing activities -- cash spent on investing in the business -- was $319 million. Investors should always be inquisitive when a company's cash going out greatly exceeds the cash coming in, and the statement of cash flows is a key tool every investor should use.
Yet another warning factor at Network Associates was the insider trading activity at the company. While insider selling alone is no reason to sell a stock, it should certainly raise some eyebrows when it happens in the breadth and magnitude at which it did at Network Associates last fall. No fewer than eight insiders sold stock in October and November at levels roughly triple today's price. Many of these sales were related to compensation-based options, yet seeing insiders aggressively selling out for millions of dollars should always alert suspicion.
WHERE TO FROM HERE ?
Unfortunately, it looks like there is little relief coming for investors in Network Associates any time soon. The company has indicated that demand has slowed rather dramatically at the hands of the Year 2000 bug. In general, those running corporate networks have shown a great reluctance to add new software to their systems before the Y2K problem has been definitively flushed out of their systems. Many organizations are in "lock down" mode and don't want to add another level of complexity with new software given the problems the millennium bug may potentially bring.
Given the weakness in the market, the company has continued to temper forward earnings estimates. Network has slowed sales to its distributors in what should result in an extremely bleak second quarter. One analyst is on record saying that second quarter sales could be as low as $20 million, or approximately one-tenth what it was in last year's second quarter.
Even though all appears to be gloom and doom around Network Associates at the moment, the company's anti-virus software continues to be tops in an important portion of the computing world. While the near-term finances may be extremely weak, many of the company's brands remain strong. In any case, a financial recovery, if it comes at all, will be one long road given the debilitating injuries Network Associates has sustained.
-- Paul Larson ([email protected])
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