Looking to Secure Repeat Sales, ISS Group Will Acquire Netrex

SAN FRANCISCO -- Internet Security Systems (ISSX Quote), which made its name building alarm systems for computer networks, is ready to play security guard as well.

ISS Group, parent of Internet Security Systems, is acquiring Netrex Secure Solutions for stock worth $57 million in a pooling-of-interest transaction expected to be announced early Tuesday. ISS will also assume the outstanding stock options of Netrex employees. Atlanta-based ISS provides software that helps corporations detect intruders and weak spots on their computer networks. Netrex of Southfield, Mich., runs a round-the-clock network-security monitoring service.

"Our customers are just begging for this," says ISS CEO Tom Noonan. Many of ISS' corporate customers lack the staff to monitor their network-security systems. By pairing with privately held Netrex, ISS can secure repeat sales with a broad customer base, he says.

Netrex counted sales of $21.8 million in 1998, while ISS brought $55 million in revenue during the last four quarters ended June 30.

"This [deal] makes our business model more like that of a VeriSign (VRSN Quote) and less like that of an SAP (SAP Quote)," Noonan says. ISS makes about 65% of its revenue on licenses, which is somewhat similar to business software maker SAP, and 35% on recurring sales and services. Netrex largely has recurring service revenue, similar to network-services company VeriSign. Noonan expects Netrex to boost ISS' operating margins.

ISS expects the deal to be nondilutive in 1999 and accretive in 2000.

Unlike Network Associates (NETA Quote), which acquired numerous security companies in recent years, ISS has long focused on a single niche of the security business: detecting intruders. ISS made a rare acquisition in October 1998, snapping up privately held March Information Systems of London for cash and stock worth $6.2 million.

ISS went public through Goldman Sachs in March 1998, in a high-profile stock offering that made its founder Christopher Klaus, then a 24-year-old programmer, a symbol of young Internet success stories. Shares climbed to 43 from 11 in one year as word spread that ISS' products held their own against Cisco (CSCO Quote), the leading provider of Internet equipment.

The stock has since traded lower, slipping to 27 from 38 after the company reported earnings on July 19. ISS met analyst estimates in the second quarter, increasing its revenue 131% to $16.9 million from a year earlier and notching profits of $1.6 million. Still, Goldman Sachs analyst Rakesh Sood removed ISS from his firm's recommended list and lowered the stock to market outperform. Some bulls worried that the shares' momentum had subsided.

Noonan says the concerns are based more on valuation than on fundamentals. "We blew through [Goldman's] price target in six weeks," he says.