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Would IBM Dare Make a Big Data Security or Cybersecurity Acquisition?

Investors and traders alike just never seem to stop with the endless chase of market rumors. Usually, investors and traders might really want to consider the source or driving force behind merger rumors. The latest market chatter is that FireEye Inc. (NASDAQ: FEYE) could be bought by none other than International Business Machines Corp. (NYSE: IBM).

While 24/7 Wall St. does not place much merit on this rumor, there are two things two consider here. First is that IBM CEO Ginni Rometty needs to find some sustainable growth to offset the doldrums for the core business. Second is that security is such a hot growth avenue now, with what seems just like endless growth in the segment, that maybe IBM should consider looking at other data security acquisition, even if the rumor is just around FireEye.

The first thing to note about IBM is that its stock has been held back massively. Trading at $158.50 or so, IBM has a $156 billion market cap. It also has used its cash to pay dividends and buy back stock, to artificially engineer higher and higher earnings per share. IBM had $24 billion in cash and equivalents at the end of June, if you count its long-term investments.

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Now if IBM was going to buy a data security company, the question is which one might fit the bill, one that would add to revenues and earnings. IBM’s revenue shrank to about $93 billion in 2014, and its operating profit fell yet again down to $18.5 billion. 24/7 Wall St. wanted to look at five of the top data security players that might make sense for IBM to own, and we have added in their 2014 revenues and operating income. We did not discriminate in the security plays being hardware and software or just on the enterprise software side. At this point, IBM investors want growth and they would likely tolerate if that growth was from hardware and/or software as long as the margins are high.

FireEye Inc. (NASDAQ: FEYE) has a market cap of $7 billion. The 2014 revenue was only $425 million and its operating income was a loss of $479 million. FireEye is expected to post operating losses in 2015 and 2016, while revenue is expected to grow to $640 million in 2015 and $880 million in 2016. Trading at $44.75, it has a 52-week range is $24.81 to $55.33 and a consensus price target of $53.66.

Palo Alto Networks Inc. (NYSE: PANW) is the other data security leader that is thrown around constantly as being the best in class. It has a market cap of almost $16 billion now. The 2014 revenue was only $598 million, and its operating income was a loss of $215 million, while it reported operating earnings per share of $0.40. FireEye is expected to post operating earnings of $0.83 per share in 2015 and $1.61 in 2016. Revenue is expected to grow to $900 million in 2015 and $1.2 billion in 2016. At $188.50 at last check, Palo Alto Networks has a consensus target of $193.20 and a 52-week range of $78.62 to $200.55.

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Check Point Software Technologies Ltd. (NASDAQ: CHKP) has been deemed the leader of data security for years now, but the premium valuation is no longer there due to a more steady base of business. It has almost a $15 billion market cap, against revenue of $1.5 billion and operating income of $801 million in 2014. The company is expected to earn better than $4.00 per share in 2015 and 2016, with revenue growing to $1.63 billion in 2015 and $1.76 billion in 2016.

CyberArk Software Ltd. (NASDAQ: CYBR) has a $1.9 billion market cap and a $60.25 share price, with earnings expected to grow to $0.43 per share in 2015 and $0.60 per share in 2016. CyberArk revenues were $103 million in 2014, and are expected to grow to $140 million in 2015 and $182 million in 2016.

Fortinet Inc. (NASDAQ: FTNT) has a market cap of $8.3 billion and a $48.90 share price, with earnings expected to be $0.52 per share in 2015 and $0.71 per share in 2016. The $770 million in 2014 sales are expected to reach $1 billion in 2015 and $1.2 billion in 2016.

Unfortunately, looking backward is not always useful. Another unfortunate issue is that none of these companies would seem to really move the needle much higher on IBM’s top or bottom lines. The market caps on some are high enough that IBM would be widely criticized in paying up so much, and the lower market caps just will not even come close to moving the needle. Still, IBM needs more profits and revenues that it can plan on ahead. That means that the companies trading at super-high multiples might not fit that bill.

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Would IBM buy a data security leader? It is a hot area with massive growth. That growth just comes with a very high price tag, and IBM has been criticized for making expensive acquisitions that have not added much to its growth in the past.

Now consider that IBM trades at about 10 to 11 times its earnings expectations, but that earnings have been financially engineered. IBM also is expected to now have only $83.2 billion in annual sales in 2015 and $82.5 billion in 2016. It seems as though IBM could acquire all the top enterprise security players, and the vast amount of cash and/or stock would be massive without helping to move the needle much on the bottom or top lines.

By Jon C. Ogg