MCAFEE INC MFE
June 28, 2010 - 12:41pm EST by
pman908
2010 2011
Price: 31.75 EPS $2.57 $2.88
Shares Out. (in M): 160 P/E 12.3x 11.0x
Market Cap (in $M): 5,040 P/FCF 10.0x 9.0x
Net Debt (in $M): -850 EBIT 0 0
TEV ($): 4,190 TEV/EBIT 0.0x 0.0x

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Description

MFE is one of the leading players in the strongly growing security technology industry, but trades a price that unreasonably reflects secular decline. At $31.75, the stock (excluding $6.00 of cash) trades at 8x-9x 2010 FCF, and that FCF should grow in the low double digits. The stock has declined from $40.00 to the low $30's over the last month or two for three reasons:

1. A small earnings miss in 1Q and slightly weaker than expected guidance in 2Q.
2. Fear that the declining Euro would have a severe impact on earnings.
3. General stock market fears and specific sell off in technology stocks as hopes for a strong economic recovery diminish.

Over the next 6-12 months, as investors realize that these fears represent an overreaction to some fairly mild headwinds, I expect to see the stock recover significantly and approach the $40-$45 level (reflecting 11x-13x FCF plus $6.00 of cash) previously seen before 1Q earnings.

Strong levels of cash on the balance sheet ($6 per share by YE), significant repurchases (repurchased 3% of market cap in 1Q), and the potential to be acquired (recent rumor from HP) all provide a reasonable floor for the stock here.

Earnings Miss: MFE slightly missed its revenue and earnings due to the ability the inability to close some large corporate deals, and some weakness in its small to medium business segment. Even with the earnings and guidance miss, the company still grew 5-7% organically (12% including acquisitions) and expects to grow revenues and earnings in the low double digits over the course of the year. MFE generated $140M of FCF for 1Q alone. However, as what often happens with technology stocks, slight earnings misses lead to a large overreactions and a resulting buying opportunity. The company recently reiterated 2Q earnings guidance at a late May analyst meeting.

Euro: Europe represents 25 % of revenue and earnings and the Euro has slid from $1.32 at the time of their 1Q earnings announcement to $1.23 today. The company has suggested that for every $0.10 decline in the Euro, EPS will decline by about $0.05. According to that math, the decline in the Euro will impact annual earnings by about $0.04-$0.05 (or $0.40-$0.50 per share of value assuming a 10x multiple).

Fear of "Double-Dip" in the Global Economy: MFE has sold off along with many other technology stocks due to fears about the sustainability of the global recovery. Although fears of a global recovery seem legitimate, security spending grew 12% in 2008, and 5% in 2009, while other technology companies experienced 5-10% revenue declines. This is driven by a proliferating thread landscape from hackers, terrorists, and spies (malware has been increasing by several hundred % per year), emerging technologies such as virtualization and cloud computing, and an evolving regulatory and compliance environment. CTO's have no choice but to spend more on security, and MFE (and arguably SYMC) are the only companies that can provide a large corporation with a full range of products.

The key risks to the investment are 1.) The proliferation of free products could have an impact on the consumer division (which is about 35-40% of revenues), and 2.) Dilution of 3-4% per year resulting from stock options and stock performance units negatively affects GAAP earnings as compared to FCF, and dilutes shareholders.

Catalyst

  •  Resilience of business in strong or weak economic environment
  •  Minimal impact of Euro
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    Description

    MFE is one of the leading players in the strongly growing security technology industry, but trades a price that unreasonably reflects secular decline. At $31.75, the stock (excluding $6.00 of cash) trades at 8x-9x 2010 FCF, and that FCF should grow in the low double digits. The stock has declined from $40.00 to the low $30's over the last month or two for three reasons:

    1. A small earnings miss in 1Q and slightly weaker than expected guidance in 2Q.
    2. Fear that the declining Euro would have a severe impact on earnings.
    3. General stock market fears and specific sell off in technology stocks as hopes for a strong economic recovery diminish.

    Over the next 6-12 months, as investors realize that these fears represent an overreaction to some fairly mild headwinds, I expect to see the stock recover significantly and approach the $40-$45 level (reflecting 11x-13x FCF plus $6.00 of cash) previously seen before 1Q earnings.

    Strong levels of cash on the balance sheet ($6 per share by YE), significant repurchases (repurchased 3% of market cap in 1Q), and the potential to be acquired (recent rumor from HP) all provide a reasonable floor for the stock here.

    Earnings Miss: MFE slightly missed its revenue and earnings due to the ability the inability to close some large corporate deals, and some weakness in its small to medium business segment. Even with the earnings and guidance miss, the company still grew 5-7% organically (12% including acquisitions) and expects to grow revenues and earnings in the low double digits over the course of the year. MFE generated $140M of FCF for 1Q alone. However, as what often happens with technology stocks, slight earnings misses lead to a large overreactions and a resulting buying opportunity. The company recently reiterated 2Q earnings guidance at a late May analyst meeting.

    Euro: Europe represents 25 % of revenue and earnings and the Euro has slid from $1.32 at the time of their 1Q earnings announcement to $1.23 today. The company has suggested that for every $0.10 decline in the Euro, EPS will decline by about $0.05. According to that math, the decline in the Euro will impact annual earnings by about $0.04-$0.05 (or $0.40-$0.50 per share of value assuming a 10x multiple).

    Fear of "Double-Dip" in the Global Economy: MFE has sold off along with many other technology stocks due to fears about the sustainability of the global recovery. Although fears of a global recovery seem legitimate, security spending grew 12% in 2008, and 5% in 2009, while other technology companies experienced 5-10% revenue declines. This is driven by a proliferating thread landscape from hackers, terrorists, and spies (malware has been increasing by several hundred % per year), emerging technologies such as virtualization and cloud computing, and an evolving regulatory and compliance environment. CTO's have no choice but to spend more on security, and MFE (and arguably SYMC) are the only companies that can provide a large corporation with a full range of products.

    The key risks to the investment are 1.) The proliferation of free products could have an impact on the consumer division (which is about 35-40% of revenues), and 2.) Dilution of 3-4% per year resulting from stock options and stock performance units negatively affects GAAP earnings as compared to FCF, and dilutes shareholders.

    Catalyst

    •  Resilience of business in strong or weak economic environment
    •  Minimal impact of Euro
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