Goldman Sachs Conference: ISS Holds Its Own Against the Big Guys

Chalk one up for the little guy.

ISS Group (ISSX), parent of Internet Security Systems, thrives in a land of giants. It became an overnight star when its shares bolted 77% on the day it went public at $22 per share in March 1998. Since then the stock has been a steady if not glamorous performer, ending today's trading at 51 1/2. The company even turned a little operating profit last quarter.

What's special about the Atlanta-based company is that it proves entrepreneurs needn't fear Cisco (CSCO) if they pick the right field.

Last year ISS sold $36 million of security products. With gross margins of 85%, it is growing revenue 167% annually. ISS has deals with partners such as the carriers MCI WorldCom (WCOM) and GTE (GTE). The supplier Nortel (NT) also employs ISS technology. Possible new partners might include Ericsson (ERICY) or Alcatel (ALA), both suppliers in Europe.

"There are places or niches that can be served well and better by small companies," says portfolio manager Paul Cook with Munder Capital, a recent buyer of the stock. "There's a lot to be said for a company that is focused."

Cook invested in Network Appliance (NTAP), a supplier of network storage servers, because it holds a similar position. Both ISS and Network Appliance present at the Goldman Sachs Technology Investment Symposium Thursday.

Companies are spending ever-increasing amounts of money to protect their networks and their Web sites from intruders such as disgruntled employees or hackers. The old "firewall" for corporate networks cannot thwart hackers who start from the inside.

In 1992, Christopher Klaus, an 18-year-old computer whiz at Georgia Tech, devised a way to spot potential attackers throughout a system. He incorporated ISS two years later and in 1995 brought in Tom Noonan, a software veteran from Dun & Bradstreet (DNB), to help with management. Noonan took over as CEO in late 1996, while Klaus remains chief technology officer.

A year ago, Cisco entered the market by acquiring ISS's direct competitor, WheelGroup, a private San Antonio, Texas, software company. On the face of it, having Cisco as a rival is a company's worst nightmare.

Noonan remembers that a year ago, many industry observers and corporations assumed that only a company offering a broad array of products would win the day. "And who better to do that than Cisco?" says marketing manager David King, who was a marketing vice president at WheelGroup before it folded into Cisco.

It didn't happen. In fact, ISS has prospered.

"It's ironic that Cisco has not made a larger impact" on the security business, given its dominance of network switches and routers, says analyst Matthew Kovar with Yankee Group. Upstarts like ISS Group have found plenty of room to operate.

But Cisco's dominance of the corporate networks may have played against it. Corporations proved unwilling to trust all their security and related network products bundled together.

You can trust ISS to scan a Cisco router with the same vigilance as a 3Com (COMS) switch. And Noonan says ISS' success commands the attention of top executives much like Cisco, a boast that few Cisco rivals can make. Ted Julian, an analyst with Forrester Research, says corporations would rather buy the specialized, flexible software that ISS offers rather than expansive suites of products.

Network Associates (NETA), another rival of ISS, offers such a suite and says customers prefer it. But ISS still shares customers with Network Associates thanks to its strong intrusion-detection software. IT director Wendy Nather of Warburg Dillon Read, for instance, is a customer of ISS for intrusion detection and uses Network Associates for various other functions.

Next month the company intends to issue 2.8 million more shares of stock, raising roughly $150 million for working capital. Having for the moment fended off the Cisco challenge, don't be surprised if ISS is on the prowl for possible acquisitions.

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