By David Randall
NEW YORK (Reuters) - The last time email could be called a sexy business, Facebook founder Mark Zuckerberg was celebrating his tenth birthday. Yet Proofpoint Inc, a $1.6 billion market cap email security company, is catching the eye of fund managers by gaining share in a market that many investors have left for dead.
Twenty-six small-cap funds added Proofpoint to their portfolios over the last quarter, a nearly 15 percent increase from the quarter before, Morningstar data show. A total of 249 funds own the stock, a level analysts say is unusually high for a company with a market value of its size that has yet to show a profit.
The interest comes amid a renewed corporate focus on protection against hackers and state-sponsored cyber attacks following well-publicized data breaches at several retailers and financial firms. Six of the 10 largest breaches in history have occurred over the last year.
About 95 percent of targeted attacks begin with so-called phishing attempts - bogus emails designed to trick users into entering their log-in information or other sensitive data, according to a 2013 report by Verizon Communications Inc on data breaches.
At the same time, the dominant providers of security software have made missteps that allowed Proofpoint to gain market share, analysts say.
Intel Corp's security division (which until recently was known as McAfee) "gave themselves a very black eye" by waiting three years between software upgrades, said Rick Holland, an analyst at Forrester Research. The division, however, disputed that assessment on Monday, saying its email security software -- updated almost on a quarterly basis -- is in fact gaining market share.
Google Inc shut down its Postini business and expected to migrate those customers into its Google Apps product, but the company was "a little overzealous in its estimates of how quickly people were going to adopt" the change, Holland said.
Rivals dedicated to email security got bought by bigger firms, leaving Proofpoint the only pure-play email security provider, said Peter Firstbrook, a vice president with research firm Gartner who advises companies on email technology.
"It's like the Red Sea parted from a competitive standpoint," said John Bichelmeyer, lead portfolio manager of the $563 million Buffalo Emerging Opportunities fund.
Proofpoint, based in Sunnyvale, California, is one of only two rapidly growing email security firms, along with Microsoft Corp, in a market worth about $1.7 billion in 2012, according to Gartner. Proofpoint had 6 percent market share in 2012, versus 22 percent for Cisco Systems Inc, 20 percent for Symantec Corp and 8 percent for Microsoft. Gartner has yet to release data for 2013.
Proofpoint's gains could make it an acquisition target by a larger company hoping to expand its reach, even though its stock price has jumped 25.5 percent so far this year, analysts said.
"I thought they would have been acquired a long time ago," said Holland.
HIGH TARGETS BUT NO PROFITS
Analysts tracked by Reuters are largely bullish on the company, though they expect it to continue posting losses a couple more years. Thirteen out of the 14 analysts who cover the company rate it as a 'strong buy' or 'buy,' while Robert Breza at Stern, Agee & Leach rates it a 'hold.' At Thursday's closing price of $41.63, Proofpoint's stock was 12.4 percent below analysts' median target of $46.81.
The company, which went public in 2012 at $13 a share, posted revenues of $176 million in its latest fiscal year. Analysts tracked by Thomson Reuters estimate a loss of 18 cents per share, on revenues on $40.7 million, when it releases its quarterly results on April 21. It trades at a forward price to book value of 32.2.
Tim Klassel, an analyst at Northland Capital Markets, expects a loss per share of 50 cents this fiscal year and 28 cents next year.
Fund managers like Bichelmeyer, who has been adding to his position, say the company is seen as the only pure-play investment in the cloud-based security market, a relatively new industry that FBR Capital Markets expects to grow into a $7 billion market.
Proofpoint is rated as one of the top two providers of corporate email security products by Gartner, whose recommendations are closely watched by technology buyers.
"Proofpoint lives or dies by email, so they are more focused on their customers," Firstbrook said. "If you are an email administrator you want to work with somebody who is really focused on this problem over somebody focused on generic security and networking problems."
Holland, who also advises companies on email security technology, said Proofpoint has developed strong loyalty among returning customers.
"I have found that some customers may adopt Microsoft or Google and drop something like Proofpoint, but six months later they go back and have Proofpoint sitting in front because it is more robust," he said.
Yet email administrators do not always get to make the final decision on which products their companies purchase.
Cisco maintains it has an advantage over Proofpoint because it offers a broad line of security products that protect businesses across their network, from firewall to desktop computers.
"Malware gets through every day. When it does, you need to be able to watch it," said Cisco Vice President Scott Harrell.
Proofpoint is benefiting from word of mouth among chief information officers, said FBR Capital Markets analyst Daniel Ives. "Email security has vaulted to the top of priority list for CIOs, and Proofpoint has established themselves as the clear leader," said Ives, who raised his target price for the company to $49 to $47 on March 10.
For Proofpoint to continue its gains, management has to avoid the trap of email security firms made by expanding into other business lines, said Ives, the FBR analyst.
"This is a high growth environment. The downfall of companies in the past is when they don't stay focused and try to expand into other areas," he said. "If they stay focused, it's a green field opportunity."
(With additional reporting by Jim Finkle; Editing by Linda Stern, Richard Chang and Edwina Gibbs)