Ronna Abramson

Return to Article

Downgrade Debate at Internet Security

Ronna Abramson

Shares of Internet Security Systems(ISSX Quote) sank Tuesday after an analyst downgraded the stock to a sell rating, citing more intense competition in the intrusion-detection market and customer dissatisfaction.

The downgrade brought a heated rebuttal from the company's CEO, who claimed the note was laden with inaccuracies.

ISSX shares fell as much as 8.2% Tuesday before closing down 70 cents, or 5.5%, at $12.09. Shares were at $12.06 in after-hours trading.

Tuesday morning Fulcrum Global Partners analyst Alan Weinfeld lowered his rating on ISSX to sell from neutral for the second time this year. Weinfeld noted that the intrusion-detection market once dominated by ISSX has attracted at least a dozen public and private vendors in the last two years.

Until 2002, Weinfeld wrote, most other intrusion-detection systems were not fast enough or generated too many false positives to compete with ISSX. But emerging competition from private companies such as Lancope and Intruvert Networks, bought by Network Associates (NET Quote), surpassed the functionality of ISSX's latest product, released in July, while larger rivals such as Cisco Systems(CSCO Quote) and Symantec(SYMC Quote) can use their resources to eat away at ISSX's market share.

Weinfeld wrote that the company's "recognized licensed-software intrusion-detection business has not grown in the last seven quarters." Seven quarters ago, the fourth quarter of 2001, ISSX posted $30.7 million in license revenue, while in its latest quarter, the second quarter of 2003, the company's license revenue rang in at $24.3 million.

"We think the best way to participate in the growth in intrusion detection is as part of a larger enterprise security offering in companies such as Symantec and Network Associates," advised Weinfeld in his note. He has buy ratings on both Symantec and Network Associates. His firm does not do investment banking and he does not own any shares of Symantec, Network Associates or ISSX.

However, in an interview Tuesday, ISSX CEO Tom Noonan said the company has been competing against Cisco since the company entered the market through an acquisition in 1997. Despite those six years of competition, Noonan said, research firm IDC still shows ISSX's market share at double that of Cisco.

"The more relevant point, which he doesn't make in his report but is very, very clear, is the traditional legacy security companies ... have realized the inadequacies of that technology and they're desperately trying to acquire start-up companies ... because the intrusion prevention is the future of security, and we invented it," Noonan said.

But Weinfeld said his firm's proprietary survey of 50 ISSX users found that more than 34% of customers are currently highly dissatisfied or will remove ISSX software. Among the complaints: an inability to use ISSX software with other products and unhelpful tech support. "Especially damning to ISSX's industry standing was the fact that its product failed to detect Code Red," Weinfeld added, referring to the disruptive worm that hit in 2001. In a phone interview, he said at least one customer in the survey reported such an experience with Code Red.

Noonan also rebutted those charges, saying his company's technology detected and prevented Code Red before the attack occurred. ISSX was part of a consortium of companies and government groups that issued a public warning on Code Red in July 2001.

Noonan said ISSX is trying to get a copy of Weinfeld's survey and noted that the analyst has never talked to any officials at ISSX. He also cast doubt on the survey by noting that his company spends an entire quarter trying to reach 30 to 40 customers for its own internal surveys.

"I have no idea what the motive is for this report, but it is littered with inaccuracies," Noonan said. "There are no facts to support them."

But in a telephone interview Weinfeld stuck by his report and insisted he has tried contacting the company's chief financial officer, only to be told by a secretary that he won't speak with Weinfeld. In addition, he said he has never been able to ask a question on the company's earnings calls.

"We're standing by what we said in January, throughout the year and today," he said.

Weinfeld issued his first sell rating on ISSX on Jan. 23, a day after the stock closed at $20.47. He raised the rating to neutral based on valuation on Feb. 24, when shares fell into the $12 range. Weinfeld said the stock's current valuation, trading at 25.8 times his 2003 estimate and 22 times his 2004 estimate, is expensive. He set a price target of $10.

Weinfeld believes ISSX can meet third-quarter consensus estimates, which peg earnings at 11 cents a share on $59.2 million in revenue, according to Thomson First Call. But he said he is concerned about the company's fourth-quarter pipeline and its ability to win new customers with a recently launched, unproven intrusion-detection appliance. Analysts are forecasting that the company's revenue will grow 10.8% in the seasonally strong fourth quarter.

"As consolidation is rapidly taking place in this industry, to be a long-term winner, ISSX must, we believe move away from just the best-of-breed approach and show a greater vision in the next year or two beyond a multiclass appliance that may not work," Weinfeld wrote.