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Sourcefire, Inc. (FIRE), Cisco Systems, Inc. (CSCO): This Strategic Network Security Deal Is Worth Watching

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Recently, Sourcefire, Inc. (NASDAQ:FIRE) shot up almost 28% in a single day after the announcement that the company will be acquired. Cisco Systems, Inc. (NASDAQ:CSCO) has offered around $76 per share to acquire Sourcefire, with the total transaction value coming to $2.7 billion. Is a $76 per share a fair price for Sourcefire? Is Cisco right in acquiring Sourcefire? Let’s find out.

One of the leaders in intelligent cyber-security technology

Cisco Systems, Inc. (NASDAQ:CSCO)Sourcefire, Inc. (NASDAQ:FIRE) is the intelligent cyber-security technology company, offering solutions to a diverse customer base, including global enterprises, the U.S., and international government agencies. In 2012, Sourcefire derived around $135 million, or 61% of the total revenue, from product sales, while technical support and professional services contributed around $87.6 million, accounting for 39% of total 2012 sales. Its largest customer was EC America, the subsidiary of immixGroup, representing as much as 19% of total sales. The company has more than 2,500 customers in more than 180 countries.

Sourcefire, Inc. (NASDAQ:FIRE) has consistently grown its revenue, from $76 million in 2008 to $223 million in 2012. However, net income has fluctuated in the range of $(6) million to $20 million during the same period. What I like about Sourcefire is its cash generating ability. In 2012, its operating cash flow was $43 million while free cash flow came in at $34 million. Moreover, the company has quite a strong balance sheet. As of March 2013, it had $267 million in equity, $206 million in cash and short-term investments, and no debt. Sourcefire is different from other IT companies I’ve come across as it has grown itself organically. The goodwill and intangible assets were only $20 million.

The strategic deal in network security business

By acquiring Sourcefire, Inc. (NASDAQ:FIRE), Cisco Systems, Inc. (NASDAQ:CSCO) could expand its footprint in the network security field. Cisco is famous for its switching products, generating around $14.53 billion in 2012 sales. The security business is quite small, with only $1.35 billion, accounting for only 3.7% of the total revenue. The combination of Sourcefire and Cisco will strengthen Cisco Systems, Inc. (NASDAQ:CSCO)’s coverage and the expertise in security, helping to accelerate business growth and market penetration.

The combined business will offer world-class threat research and security intelligence, with security services platform, cloud delivery, and network integration. Cisco Systems, Inc. (NASDAQ:CSCO) mentioned that Sourcefire, Inc. (NASDAQ:FIRE) CTO Martin Roesch and other Sourcefire’s executives would work for Cisco’s security group. Hilton Romanski, the VP of Cisco Systems, Inc. (NASDAQ:CSCO) Corporate Development, was bullish about this acquisition, he said: “Sourcefire aligns well with Cisco’s future vision for security and supports the key pillars of our security strategy. Through our shared view of the critical role the network must play in cybersecurity and threat defense, we have a unique opportunity to deliver the most comprehensive approach to security in the market.”

At $76 per share, Sourcefire is worth nearly $2.37 billion on the market. The market values Sourcefire quite expensively, at more than 7.9 times its sales. Cisco, a much bigger company, has a much lower valuation. Cisco is trading at $25.70 per share with a total market cap of $137 billion. The market values Cisco at only 2.87 times its sales and 8.08 times its trailing EBITDA (earnings before interest, taxes, depreciation, and amortization). Income investors might like Cisco better with its decent dividend yield of 2.6%. The payout ratio is also conservative at only 29%.

Checkpoint is more innovative and more flexible

Indeed, many investors might think Cisco has paid a high price for this acquisition. However, it seems to be rational for Cisco as the company has been losing market share in the network security field to several small companies such as Checkpoint Systems, Inc. (NYSE:CKP) and Juniper Networks, Inc. (NYSE:JNPR). According to Infonetics Research, Cisco was still the leader in the network security industry, while Checkpoint and Juniper Networks, Inc. (NYSE:JNPR) have been fighting for the second position in this market.

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