Keeping the Bad Guys at Bay in the Internet Jungle

It’s a jungle out there on the Internet where so many bad guys lurk -- trying to invade corporate networks, drop spyware onto your hard drive, or trick people into revealing personal secrets.

So anyone who runs a corporate computer system knows it’s a top priority to protect networks from the bandits and pirates. Many small companies turn to SonicWALL (SNWL) for the products and software to get the job done.

In what may be a sign of how aggressive the bad guys are becoming, SonicWALL had a great 2005. Its stock rose above $8 from below $5.

But in a sudden reversal, SonicWALL shares gapped down and crashed hard to $6.50 earlier this year. The weakness came on news that SonicWALL purchased a smaller company in its space and issued earnings guidance that didn’t exactly jib with Wall Street expectations.

That’s when insiders stepped up to the plate and bought shares – once again. Chief executive Matthew Medeiros purchased $100,000 worth at $6.75 in late February. That brought total insider buying since early December up to $515,000. Much of it was above current levels – meaning you can now get the stock cheaper than where insiders recently saw value. The buying was all in the $6.75 to $7.90 range.

What do insiders see in the stock?

Cash hoard

SonicWALL came public in 1999, and it was smart enough to do a secondary near the peak for tech stocks, in March of 2000. The company still has about $240 million in cash left over, or around $3.70 per share. It’s using the money to buy back stock – always a good thing for shareholders – and acquire smaller companies to build out its product line.

Acquisitions don’t always work out. That may be one reason investors sold SonicWALL after it announced yet another purchase in early February – this time buying MailFrontier, a company specializing in messaging security.

But acquisitions are how SonicWALL plans to grow faster than the small-business information technology market, already projected to grow 7% to 10% a year.

Before MailFrontier, SonicWALL recently bought a company specializing in data backup and protection called Lasso Logic, and enKoo, which offers a kind of virtual private network technology.

As an outsider, it’s impossible to know whether these acquisitions will work out. But the solid insider buying while investors worry about these takeovers suggests they will be profitable.

The razor blade model

Next, SonicWALL is the kind of company Warren Buffet would like if he purchased tech stocks. That’s because besides all the cash, SonicWALL follows the “razor blade model.” Instead of selling razors, SonicWALL sells the hardware behind intrusion protection systems. Then customers can buy more add-ons with new features, and they have to come back each year for the software upgrades. SonicWALL believes it can do a better job of selling more razor blades – the software and add-ons.

International growth

Right now SonicWALL only gets about 32% of its revenue from foreign sales, while peers get 50% or more. The company hopes to change that. “We believe Europe and Japan present the most immediate growth opportunities for the company,” believes Sterne, Agee & Leach analyst Andrey Glukhov, who has a buy rating and a $9 price target on the stock. SonicWALL recently formed a sales partnership with Cannon, which should help in Japan.

The bottom line: Small Internet security companies face a tough challenge going up against giants like Cisco (CSCO). But SonicWALL’s products are cheaper, and easy to use. And if the company does a good job of digesting all the recent acquisitions and making them work, this stock could get back on track. “A breakthrough quarter may occur towards the back half of 2006,” says WR Hambrecht analyst Ryan Hutchinson. If he’s right – and insiders seem to agree -- now’s the time to buy, along with the insiders.

Disclaimer

At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.

For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.