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No porn for you!
Blue Coat Systems keeps tabs on naughty Web surfers. But after a 500% run, is the stock a buy?
May 27, 2004: 4:19 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) - My bosses usually prefer it when I write about large brand name tech companies. So a story pitch about Blue Coat Systems, which has a market value of just over $400 million, would normally be met with bemused shrugs.

But if you put out a press release with the following headline: "Blue Coat Closes Back Door for Porn Opened by Google and Yahoo! Image Search", that gets even the most jaded editor's attention, regardless of how small the company is.

Blue Coat, formerly known as CacheFlow, was one of the hot tech IPOs of the late 90's, surging 427 percent on its first day of trading in 1999 before falling hard when the bubble burst.

But Blue Coat (BCSI: Research, Estimates) has survived and thrived by selling hardware that helps companies prevent employees from viewing inappropriate Web sites at work or using the corporate network to illegally download music or other copyrighted content. The company's motto is "Keep 'good' employees from doing 'bad' things on the Internet.

In the case of Blue Coat's new porn blocker, which it unveiled Tuesday, the company claims that it will go beyond merely filtering the addresses of known porn sites. It will also stop employees from using popular search engines to pull up indexed images of pornography.

"It's not enough to just enable an employee to not go to a URL with porn. You have to filter deeper at the search level," said Maria Lewis Kussmaul, director of research with America's Growth Capital.

Big bucks from keeping Web use clean

And Blue Coat has proven to Wall Street that keeping people from viewing naked pictures of Jenna Jameson and the like may be just as lucrative a business as producing porn.

The company reported extremely strong fiscal fourth quarter results after the closing bell Thursday. Blue Coat posted a net profit of 11 cents a share and sales of $21.1 million, compared to a loss of 14 cents a share and sales of $12 million a year ago. Excluding charges, Blue Coat earned 20 cents a share.

Blocking inappropriate Web sites like porn has been big business for Blue Coat. (Cue cheesy 70's music...boom-chicka-chicka-wow-wow!)

What's more, earnings are expected to more than triple in Blue Coat's next fiscal year, which ends in April 2005, and increase at a 32.5 percent clip annually over the next five years.

The integrity of computer networks remains a hot topic for big businesses. But most of Wall Street's attention has been focused on companies like Symantec (SYMC: Research, Estimates) and Network Associates (NET: Research, Estimates), which help stop bad things like viruses and worms from getting in to the workplace.

Slowly but surely, corporations are realizing though that they must also keep tabs on their workers as well -- as Big Brotherish as that may sound. Kevin Trosian, an analyst with Wedbush Morgan Securities, said that in addition to obvious concerns about workers' productivity, companies also have to worry about system slowdowns if their employees are hogging up bandwidth.

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And there are also legal risks associated with employees viewing racy sites (i.e. sexual harassment) or swapping music files (i.e. the Recording Industry Association of America decides to sue your company because one employee illegally downloaded the new Usher album). This puts Blue Coat in a good position to benefit.

"The focus is shifting more from perimeter security, anti-virus and firewalls, to internal security, controlling employees on the inside," said Trosian. "That is where companies are placing more tech budget dollars."

Does the stock have more legs?

Still, the big question for investors is whether or not this is already factored into the stock price. Shares of Blue Coat have enjoyed a humongous run recently, soaring 490 percent over the past 12 months and nearly 80 percent this year alone.

This rise has caught the attention of bearish short sellers. The number of shares being held short in Blue Coat has mushroomed from just over 78,000 as of mid-November to more than 675,000, or 7.5 percent of the available shares outstanding, as of mid-May.

Plus, there's the likelihood of increased competition given how well Blue Coat is doing.

Trosian said that current Blue Coat partners Secure Computing (SCUR: Research, Estimates), Websense (WBSN: Research, Estimates) and SurfControl, which sell databases that list "good" and "bad" URLs, could decide to compete more against Blue Coat on the hardware side.

Tech Biz
Computer Security
Blue Coat Systems Incorporated
By Paul R. La Monica

He adds that he likes the company's prospects but he'd be wary of the stock now, saying that at about 36 times fiscal 2005 earnings estimates, Blue Coat trades at a big premium to other security software firms he covers. Given the big run-up, Trosian thinks the stock needs to continually beat expectations in order to satisfy momentum investors.

To that end, the stock fell sharply after-hours Thursday, even though the company reported solid results, because analysts were expecting Blue Coat to report earnings, excluding charges, of 24 cents per share.

But Kussmaul said she thinks the stock is attractive, considering its sales and revenue growth prospects. Next year, revenues are expected to increase 46 percent to about $96 million. "I would not be sitting comfortably as a short in Blue Coat," Kussmaul said.

Analysts quoted in this story do not own shares of companies mentioned and their firms have no investment banking relationships with the companies.

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