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Y2K spooks security stocks

Demand for network-security products is taking a hit because big chunks of IT budgets are earmarked for Y2K spending. This week, Wall Street marked the trend by bidding down security stocks.

Internet security stocks took a big hit this week thanks to revenue shortfalls, analyst downgrades, and worries about the diversion of corporate budgets toward Y2K spending.

Both Network Associates and Axent warned Wall Street that their quarterly revenues would fall short of expectations.

Investors are concerned that corporate computing budgets may be diverted to address looming Y2K problems faced by many companies, resulting in lower sales of security software for the rest of the year. Analysts say these worries have already hit companies in the enterprise resource planning sector, where stock prices are languishing.

Shares of SAP, the largest ERP software maker, have fallen since the German software giant last month warned analysts of sluggish first quarter sales, with Y2K taking part of the blame. Last week, PeopleSoft echoed SAP's experience, saying demand caused by the Y2K had dried up.

This week, it was the security sector's turn to get hammered. "The paranoia surrounding Y2K is hurting all these stocks," said Todd Raker of ING Barings, who this week downgraded both Axent and firewall vendor Check Point Technologies.

Raker said Y2K worries about security stocks may be overblown but they're real, nonetheless. "I think it will have impact on revenue, but I don't think it'll be a disaster," he said.

"Y2K is putting a squeeze on a lot of these vendors," said David Breiner, who follows Axent and other security stocks for Volpe Brown Whelan. But he noted that different factors affect each company.

In the security sector, "There have been very few consistent success stories," said Breiner. Security Dynamics, parent of RSA Data Security, relies on a handful of products for its revenue, he said.

Although Check Point, with a relatively narrow product focus, hasn't been hit by a Y2K slowdown yet, Raker thinks one will come later this year.

Axent and Network Associates both attributed their woes in part to a Y2K slowdown, but they also had trouble closing orders by the end of the quarter. Secure Computing, another vendor with a broad line of security offerings, warned last week that first-quarter revenue would be 36 percent below the comparable 1998 period.

That slew of earnings warnings led Check Point late Wednesday to say its results are up to expectations. "We have not experienced the difficulties which some of our competitors state are affecting their business," CEO Gil Shwed said in an unusual statement.

Check Point's stock bounced back today, closing at 33.6875, up almost 7 on the day. Check Point, which opened the week near 40, and other security issues were pulled down by the bad news from Axent and Network Associates.

Axent rebounded today too, closing up 1.6875 to 11.0625. Axent shares dropped from 20 on Monday, the day of its warning, to close at 8.06, a 52-week low.

Network Associates, however, continued its downward spiral today, closing at 14.75, down 1.25. The stock opened the week above 30, and even the rollout of new security software on Monday didn't stem its fall.

"All the security vendors are going to face difficulties in the third and fourth quarters," Raker said. "Check Point is the most sheltered because a firewall is easy to install. Some of the Network Associates or Axent solutions are more complex and enterprise-wide."

Other companies are insulated by investor perception about their business. Raker believes investors see digital certificate company VeriSign as a consumer e-commerce play because it issues digital IDs to retailers like Amazon.com. But Entrust, another digital ID firm that is focused on the enterprise market, is more vulnerable.

Security software is usually a tougher sell, said Breiner, because it addresses potential problems, not something that's causing a corporate security manager pain today.

"Security is a more subtle value proposition" than other types of software, he said.

Industry analyst Jim Balderston of Zona Research professes to be mystified about why Internet security stocks aren't awarded the large price premiums so common in the Internet sector.

"You cannot do electronic commerce, you cannot do extranets or partner applications, without security. It's a building block of all these other opportunities," said Balderston, who thinks the nature of security technologies scares off investors.

"Security is still arcane and largely invisible. To most people, it's technically indecipherable," he said. "That may be one of the reasons why these companies don't get that Internet slack."