Netegrity, Inc.

Ticker: (Nasdaq: NETE)
Phone: 781-890-1700
Web site: www.netegrity.com
Price (1/19/2000): $48 1/4

By Paul Larson (TMF Parlay)

How Did It Double?

One of the best performing stocks over the past two years has been that of Netegrity. It's fairly amazing to look back and see that the stock traded for as little as $1.50 per share back in November of 1998, only to head in essentially the same direction over the past 15 months -- up.

There really has not been any single piece of news igniting the stock -- just Wall Street's awareness of the company's potential. Netegrity is a key provider of security software for the e-commerce industry and has seen its sales grow quite nicely over the past couple quarters. In the third quarter the company had $3.3 million in sales, which was more than double the $1.3 million booked in the same quarter of 1998. And, while Netegrity is still in the red, margins have been improving rather dramatically.

In early November, Netegrity capitalized a bit on the excitement of Wall Street and sold 3.25 million shares in a secondary stock offering. 2.5 million of those shares were sold by the company (the rest were sold by insiders) at $40 a pop, giving Netegrity another $100 million or so in cash to play with.

Soon after the secondary offering, the stock continued its skyward trek. Though Netegrity's stock is now a tad off its recent high of $65 per share and has had relatively quiet trading volume, just about anyone who has owned the stock more than a few weeks is sitting on some fairly significant gains.

Business Description

Netegrity is one of the leading providers of software used to manage and control user access to e-commerce applications. The company's flagship product is SiteMinder, which allows other companies to centrally manage network authorization and access. Netegrity's network security products are sold directly and bundled with network software created by other firms such as the Netscape/Sun Microsystems (Nasdaq: SUNW) alliance.

Netegrity is based in Waltham, Massachusetts.

Financial Facts

Income Statement
12-month sales: $9.7 million
12-month income: ($5.7 million)
12-month EPS: ($0.58)
Profit Margin: N/A
Market Cap: $816.2 million

Balance Sheet (as of 9/30/99)*
Cash: $11.2 million
Current Assets: $14.5 million
Current Liabilities: $3.6 million
Long-term Debt: None
(* Doesn't include effect of Nov. 1999 secondary offering)

Ratios
Price-to-earnings: N/A
Price-to-sales: 84.1

How Could You Have Found This Double?

One way to have perhaps seen the rise in Netegrity coming was to look at the company's margins. As one can see in the table below, margins have been improving for some time now. There's a very valid reason we here at the Fool offer a rising margins screen. If a company can continue to improve its margins, profitability is assuredly in the cards down the road.

        Q3 1999     Q2 1999    Q1 1999 
Gross Margin    74.8%       70.5%      65.3%
Net Margin     (50.8%)     (51.3%)    (69.7%)

Where to From Here?

Considering Netegrity's financials and positioning, it looks like profitability is expected soon. Sales are growing quite dramatically and margins are improving -- a surefire recipe to improve the bottom line. Plus, if we look at the reasons why Netegrity's margins are healthier, namely a great deal of operating leverage thanks to SiteMinder's scalability, it makes perfect sense to expect those profits. According to Zacks, the mean analyst estimate calls for the company to earn $0.08 per share in 2000.

The company also has more than enough cash to organically grow its business, thanks to the recent secondary offering that brought the company's cash balance to about $110 million, or roughly $6.50 per share. There's also essentially no debt to speak of, making Netegrity's balance sheet just about as clean as they come.

On the valuation front, Wall Street has given Netegrity some mighty large shoes to grow into. The company currently has a revenue run rate (last quarter's sales times four) of $13.3 million, and these sales come with plenty of red ink. Contrast this to the $800+ million market capitalization Netegrity has at this writing, and we see that the company is trading at well over 80x trailing sales. Netegrity is also trading at over 500x the most forward profit estimate.

Will the company continue to see its sales grow? That is a pretty safe bet. Is profitability in the cards in the future? That looks like a pretty safe bet, too. Will the company generate enough cash flow to justify its current valuation? Well, that is certainly a bit tougher question to answer.

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