WBSN: Trying to Make Some Websense

Websense (WBSN - commentary - Cramer's Take) seems like a study in contrasts. The stock has shed more than a third of its value over the last couple of years in the face of declining earnings and cash flow. However, analysts covering the company have raised their 2008 earnings-per-share estimate by nearly 8% over the last couple of months, and the stock has recovered by a similar amount.

The big question is whether the latest moves are a head-fake, or represent an opportunity to get in near the bottom before the fundamental changes are widely recognized.

The Promise of SurfControl

Websense provides companies with Internet security tools to mitigate risks associated with malicious attacks, spyware, phishing and spam. It also provides tools for companies to analyze and monitor employee Internet usage. After doubling in size with its October 2007 acquisition of SurfControl, Websense is the category leader with a 21% market share. Websense generates nearly three quarters of its revenue in the Americas.

Facing declining growth rates from its large enterprise customers, Websense expects its growth to come from the small- and medium-business (SMB) market. In July 2007, it launched Websense Express, its first product designed specifically for the SMB category. It appears as though the initiative is bearing fruit, as deferred revenue (license sales that will be recognized in future periods) have increased more than 30% year over year, well ahead of the 17% growth rate in revenue as recognized. Since the deferred revenue will be recognized in the future, the increase in deferreds bodes well for future revenue growth.

Due to the way Websense must account for its acquisition of SurfControl, it will not recognize significant revenue until SurfControl customers renew their licenses, and it will also encounter higher expenses due to capitalized acquisition costs being written off over a four-year period. Cost of sales increased to 14% of sales in 2007 from 9% in 2006, though absent the acquisition-related issues, the increase was to a more modest 10.6%.

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At the time of publication, Trent had no positions in the stocks mentioned, although positions may change at any time.

William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.