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Clean Machines

Anti-virus software is McAfee Associates' stock in trade.

The Company: Based in Santa Clara, California, McAfee Associates Inc. is a leader in the network security (virus protection) software market. It is also becoming a leading provider of network management software. A pioneer in selling products directly over the Internet, McAfee was the first company to achieve success as a "shareware" firm, which has kept costs down and margins high. The company now sells through conventional channels as well.

The markets: With hundreds of clients, including IBM, General Electric and AT&T, McAfee sells its products in some 65 countries. Its explosive growth has mirrored the boom in computer networking and Internet use.

The sizzle: Demand for network-related software is soaring--and McAfee's revenues along with it. The company has, in part, hitched its wagon to another rising star: the Windows NT platform. According to a recent study by International Data Corp., a Framingham, Massachusetts-based market research firm, Windows NT's market share is expected to grow to more than 33 percent by the year 2000. In addition, computer viruses are spreading as the Internet grows. In 1996, according to McAfee, more than 11,500 viruses existed, with 200 new ones being created every month.

The risks: McAfee predicts an earnings growth of 45 percent in 1998, down from the 65 percent growth expected this year. Though actual revenues and earnings are not anticipated to slow drastically, the growth rate will probably slow percentage-wise. Although this is natural for any company, it can be unsettling to "momentum" investors, who look for blowout growth quarter after quarter.

McAfee also faces increasing competition. Norton is another company making strides in the Windows NT and virus protection market. Microsoft may one day be a serious competitor, too--it's been known to change from client to competitor in short order.

Historical financial performance: McAfee's stock has compounded 200 percent annually over the past three years, as sales grew to $181 million last year. The company has achieved 31 consecutive quarters of revenue growth, while gross margins on its software products have been above 90 percent--a figure few but Microsoft can boast. As a result, operating margins have climbed to a record 43 percent, and net margins averaged 26 percent over the past year.

Since its inception, McAfee has financed its operations primarily through internally generated funds. At press time, the company had $127 million in cash, no long-term debt, and no plans to change its financing methods.

Projected financial performance: Current analyst estimates call for McAfee to make $1.62 in earnings per share this fiscal year and $2.36 in fiscal 1998. At $61 per share, the stock is trading at 37 times this year's estimate. McAfee should trade at $94 by the end of 1998, or 50 percent above current prices. This isn't unreasonable if the company continues to meet or beat expectations and maintain or even expand margins.

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This article was originally published in the September 1997 print edition of Entrepreneur with the headline: Clean Machines.

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