Research

When I first started Securosis I was a little surprised at the number of due diligence and other investor-related projects that started flowing through the door. At Gartner we couldn’t engage in these kinds of projects (for some very good reasons), but being independent allowed me more flexibility. Since then we’ve continued to work closely with a variety of investment partners and clients. One of our partners is Marker Advisors, a boutique financial analysis and consulting firm here in Phoenix/Scottsdale. We like them for their dead-on analysis, and habit of buying us Mojitos on Friday afternoons. I wish I could tell you some of the stuff these guys are up to, but suffice it to say they have an extremely good pulse on the market. (We also suggest you follow Peter Kuper, who is blogging over at IANS and is another one of our favorite partners). We asked the guys at Marker for their take on the security software market, and they were kind enough to let us post their response. Some of this information is counter-intuitive, and shows why the economy isn’t the only issue the security market faces. We’ve broken it into two parts: # 2008 was a tough year economically, but most software companies discovered ways to grow revenue. The 20 companies we are closest to and favor (what we call our “coverage” list) grew revenue 18% (organically) YoY in 2008; an outstanding performance given both the environment and an overall market that grew at less than half that pace. Our larger “universe” of the 75 software companies we follow grew ~16% (including acquisitions). However, growth in both groups slowed in the 2H08 to ~9% YoY. The big question that needs answering is at what rate will revenue grow in 2009, and then 2010? To best determine this answer, let’s first take a look at why revenue grew last year: New product cycles. The first major new product cycles since 1999/2001 spurred investment in 2006 > 2008. 2008 capped a multi-year reinvestment cycle, as many companies managed to finally complete the move to Web-based technologies (from client server) in most applications/infrastructure, as well as upgrade to the latest generation of IP networking products. Existing vendor spend. Software companies with large customer bases were able to sell these new products (often at a discount) into a market that wanted to spend with existing vendors. Add-ons increase ASPs. New add-on products (product line extensions) helped increase ASPs, as customers looked to improve the productivity and broaden the use of new installations. Support costs increased. Many vendors pushed through 2007/2008 increases in maintenance and support charges, as pricing power shifted back to the vendors (for oh so short a time). International growth. International growth helped overcome a relatively difficult U.S. market. Budget Shifts. Budgets allocations shifted towards our favored sectors – Security, Web Content Management and Virtualization. Weak dollar. The dollar’s weakness pushed growth up in the 2H07 and the first half of 2008. M&A boosts results. Acquisitions in late 2007 and early 2008 boosted 2008 revenue results by a couple of percent. However, most of the factors that made 2008 a solid growth year are no longer present in 2009: We are at the end of this decade’s major product introductions. The next round of innovation appears to be focused on “cloud” computing, not data center computing. As customers evaluate where to install their next server and whether to rent or own software, they will spend less now. The economy will only make it easier to consider this a “transition” year. The large customer bases that were heavily mined throughout 2008 are nearing exhaustion. Although they did not overspend like they did in 2000/2001, they are appropriately stocked. Add-ons are slowing. Add-on products continue to get shipped, but it’s going to be a slow year for innovation. There will be no major new product cycles until 2010-2011. Moreover, the future product cycles will be more cloud-based and subscription priced, so look for evolution in business models. International growth will not be as much assistance in 2009, as EMEA, APAC and China all slow spending. We have picked up a growing number of channel checks that suggest all three regions are now slowing materially. Budgets will shift towards a much smaller set of projects in 2009. If you are a strategic vendor and make the short list, the year will look decent (low double digit growth). If not, it will be a struggle (flat to declining revenue YoY). Security and WCM will continue to outperform, but ratcheted down a full notch. Applications will continue to underperform. Basic infrastructure will be mixed – virtualization will be solid, but communications and networking will be slowed by both “cloud computing” marketing and major vendor “next big thing” sales campaigns. It is no longer clear where organizations should invest… In their own data centers? Or should they outsource basic infrastructure like email, collaboration, and data services to the emerging cloud vendors? Or outsource it to their software vendors’ SaaS offerings? 2009 will be a good time to evaluative these options, while not making a major investment decision. It’s hard to predict the dollar – however, it’s unlikely to provide much tailwind given 1H08’s prolonged weakness. We believe acquisitions will pick up as the year progresses, as potential sellers understand we are in for a rough couple of years and valuations are not coming back strongly. In fact, we think many of the best investment opportunities will come in the form of M&A. In December 2008, Street analysts had 2009 revenue growth at around 9% YoY for our coverage names, and close to that for our universe names. SaaS and virtualization companies have higher expected growth rates, and application companies lower growth rates. Today those same analysts have cut growth projections to around 5% YoY. In examining the quarterly forecasts, it appears investors and analysts are looking for a 2H09 recovery in capital spending. The crux of our question is how could they possibly know

eWeek is reporting that Avinti is being acquired by Marshal8e6 this week. There has not been a lot of news in this sector of late, but this one is a little different, so what exactly do we have here? A web security appliance vendor merged with an email security software vendor, buying another vendor who leverages virtual environments to isolate code behavior. Marshal8e6 is the recent merger of the Mail Marshal email security guys with 8e6, the web security firm. Avinti provides a sort of application Habitrail to monitor code in its natural habitat, watch how it works and (since I am already running with this analogy) spot the evil hamster at play. From Avinti CEO William Kilmer: “Essentially we have a network-based device that would run a series of virtual images that can actually mimic the user’s desktop environment,” Kilmer said in an interview with eWEEK. “We’ll open it up, actually run it, and look for process or look for different signals that would indicate that it’s a virus.” While this is an odd mixture of technologies, the trifecta makes sense for them. Most vendors offer a combined email security and web security offering, and customers expect as much. But with signature based detection of spam and malicious code nearing the end of its useful lifespan, alternative methods of detection are needed and being used. I think in the short term Avinti’s behavior based inspection provides Marshal8e6 a very minor competitive advantage amongst some of their mid-tier competitors, but in the long run the Avinti approach is what is more interesting- providing a flexible ‘playground’ to test or deploy multiple inspection techniques, and I imagine allow the customer to cascade multiple methods at once. It also allows them to scale services on the back end on an as-needed basis with cloud or virtual computing, so if the customer wants to run appliances (software or virtual) they will have the option. Marshal8e6 of course faces the challenge of implementing a unified system and policy management interface for the combined product; all three products needed a refresh regardless, but this will be critical for both keeping existing customers happy and also making the product easy to use. Smaller email/web security firms are in a very tough position given competition from the top vendors, but if they can provide enough breadth of functionality to meet expectations while continuing to innovate, they have a good chance to survive this market. Share: