SoundView Capital

The hosting kaleidoscope

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I’ve come a long way from Yahoo hosted sites in 2004. At the time my colleagues were impressed with how fast I was able to come up with such a “professional website” for what was then called Research 2.0. It didn’t take long to realize that Yahoo was all proprietary and inflexible so something more general purpose and open was called for.

Fast forward to today and even a small company like mine relies on a web of specialized hosting providers. I’ve found LiquidWeb to be a pretty solid general purpose host. There are plenty of alternatives and flavors but we’ve used them for a decade now and the performance, value and support are solid. But the AWS from Amazon is a force too powerful to ignore and we started using it for serving all “heavy content” like PDF files. It might also be hosting our IPO Candy video collection but we’re also looking at companies like Wistia for that.

Synthesis has become our host for the WordPress component of our content. Why? Because I’m tired of managing individual upgrades themes and plugins. Although we are building a new backend that will be hosted on a regular server it will still make sense for this front-end system to stay on a specialized hosting platform like Synthesis. WordPress offers their own enterprise hosting but it’s very expensive.

I have to wonder why nobody has figured out how to combine all these hosted services into one modular yet integrated and effective package. When you add commerce features like subscriptions (in our case) or sales the idea of having a single solution is pretty attractive.

At one end of the spectrum you have hosting providers like LiquidWeb where you have to put it together yourself. There are hosted services like Wix and WordPress.com and the like but they all lack the flexibility and specific features to build a business site that is in any way unique. As soon as you want to do one thing they don’t support you’re stuck.

It’s why soon I’ll be dealing with another host. To build something *really* interesting you need to push the envelope. One of my favorite new platforms is Meteor which we are building on now. Over time maybe everything we do will be on that platform but I’m not sure that’ll make sense. After all content ranges from the social (tweets, pictures, comments) to long-form content, collections of links, PDF objects and videos. They all need to stored and served effectively from somewhere and wrapped in contextual services like user access control, commerce and personalization. It’s not so simple.

Software has always been an intensely creative thing. Now that has morphed into a combination of programming and a web of online services. Much has been written about the API but that’s very much on the programming side of things. Weaving together a combination of insightful code with other services is the challenge of the day.

Screenshot 2015-04-09 09.38.33

 

Viscount Systems – putting it all together

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For the past 18 months we have written about Viscount Systems (VSYS) and their strong technology for internet-based security. Smart phones and an IT-based approach to management is what is driving change for all types of access control, including physical security. For example the newly expanded Microsoft Azure Active Directory Premium service is designed for widespread enterprise use and just became generally available.

There’s a palpable desire to finally rid buildings of proprietary, inflexible and expensive panel-based control systems. The situation is similar to the old days of proprietary telephones versus what we enjoy today with IP-based telephony.

The stock price and enterprise value of the company has expanded since the early days of our coverage but investors are still waiting for rapid revenue growth and expanding profitability.

Today we have some concrete reasons to raise or expectations for 2014 and beyond. Specifically:

1. Raised $2.4 million and is using some of this cash to build out sales and R&D/technical support teams. In the past the company has just been undercapitalized relative to the opportunity. Now they have the resources to be effective.

2. Management is now in what we would call “extreme alignment” with shareholder interest – not just equity but also compensation is directly linked to increasing revenue growth and expanding operating margins. In addition the team has a clear understanding of the consequences of needing any further capital in terms of dilution and is on a path to reach break-even by YE 2014.

3. Additional sales and support staff will help the company convert a large pipeline of qualified leads into actual sales. This has been an acute issue in the past. The new CEO Dennis Raefield was (among other things) President of Honeywell International from 1998 to 2003 and has the experience, network and experience to build the business at Viscount.

4. On the development side a major certification (Federal Identity, Credential and Access Management or FICAM) will help boost sales to the government and government agencies. It will also help the company fend off competition because certification is not simple. There are some new products in the pipeline and some refinements like exploiting PoE (Power over Ethernet) in some existing products but 2014 is about closing sales for existing products. (For more background on FICAM refer to: http://www.idmanagement.gov)

A story early this year regarding new Viscount Freedom deployments from findBIOMETRICS explains fairly clearly the market conditions that are driving the opportunity for VSYS:

“The demands of security over the past decade have been constantly driven up by an increased number of threats of all kinds, yet facilities that would be deemed as critically important still don’t have access control that could be considered in any way modern. The fact of the matter is that the cost associated with implementing an up-to-date security system is costly, especially when it involves placing a new infrastructure.

This obstacle, rather than being a hindrance, is largely the reason behind the recent spread of Viscount Systems Freedom.Today the company announced its first contract of the new year, awarded by the U.S. Federal Government, to secure facilities in California and Vermont with Freedom.

[Freedom] overcomes the obstacle described above through its Freedom Access Bridge technology, which allows authentication devices (including those that verify via biometrics) to be operated and administered through a standard IT infrastructure already in place in the buildings being secured. No installation of control panels and additional wiring means none of the associated costs that keep the unsecured feeling insecure about their choice in access control.”

Wireless ubiquity continues to spread and with it the confidence to roll out more and more critical services on networks and rely on smart devices (phones, watches, cars) to interface with the user and they systems. Developments in the industry are worth noting as well including even more ubiquitous wireless networking with both Google (with Ruckus $RKUS) and Amazon (with $GSAT) bringing their own independent wireless networks to consumers and businesses.

In all this general excitement there will be a big shift to digital authentication and access control. Our work continues to show that Viscount Systems (VSYS) is still well in the lead on the software side and almost unavoidably in the path of this growing opportunity.

An updated version of our initial coverage report can be downloaded here: Viscount Systems (VSYS) The IT Bridge to Physical Security, May 2014.

 

Constant Contact Continues to Confuse

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We know the insides and outs of email marketing and even online social networking for business but have always failed to grasp Constant Contact (CTCT – $16).

Even after meeting with the company management we only came away with “we do what we do very simply with lots of hand holding for one and two person companies without any technology skills.” This was enough to describe the company but hardly an exciting investment.

By way of context we first talked about the stock as a short back in October of 2007 at $24 and published a fuller note on the company with a $14 IV estimate in February of 2008. Most of what we put forward in that research report remains true but acquisitions, especially the recent purchase of SinglePlatform, have blurred the picture more. We’ve uploaded the report and here is the link (PDF): Constant Contact CTCT Update February 2008

Constant Contact has tried to move into more areas like event management and social networking to provide additional offerings to their existing base of users. They’ve made some acquisitions to accomplish this but have not made any traction at all outside of their existing base of users. These acquisitions may not have moved the needle much (like NutShellMail) but they were fairly harmless.

Spending $100M for an also-ran in the online restaurant menu and promotion space is not good. (It’s true they are working to generalize their product but it’s mostly shown in the marketing and not the market. The number of employees is rather small and only about $5M has been invested in the company. That’s one hell of a premium. If CTCT had acquired this company for $15-20M I think we’d all give management the benefit of the doubt and at least give them credit for being a disciplined buyer. But that’s not the case here.

We also note that there are larger and more successful private companies (like www.yext.com) in this space.

Not everyone out there follows our Twitter stream so may have missed a quote we took from an online forum on email marketing where experts expressed the fact that “you probably won’t go wrong in choosing any leading platform from Mailchimp to Aweber as long as you don’t end up with Constant Contact.”

Their message is still that they are not trying to impress anyone who is technically savvy but in this world of “consumer driven IT” that strategy is not working. Consumers and their generally available technologies just keep getting better.

And alongside it all CTCT keeps looking clunkier.

[No investment position.]

Target demonstrates Amazon still rules online commerce.

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Amazon ($AMZN) is a controversial stock these days to be sure. We see 3 to 6 notes a day from short sellers about how this company is wildly overvalued / about to crash. The funniest one though is the recent flurry on the back of Target saying they would no longer sell the Amazon Kindle.

Does anyone else think this is similar to publishers saying they won’t sell books on Amazon and music labels saying they won’t do business with Apple? You may not like it but stopping it is not an option.

As a family man I like Target ($TGT). Considering the way kids go through clothes you have to love the folks at Target for letting you get new wardrobes for your kids at remarkable prices. It’s also great for plastic containers, household supplies and stuff like that. My first reaction to the story that they were going to stop selling the Amazon Kindle was “what they sell electronics?”

Target has tried to be more relevant online but never succeeded. They sell the kind of stuff you go to the store for. Amazon and Target should actually be good partners. Target management should really think about that. You aren’t really competitors. Amazon doesn’t have stores remember?

Target may think that selling the Kindle is aiding and abetting the competition. The short-sellers on Amazon suggest that “Best Buy will be next!” Maybe they will. Both companies give you another reason not to visit their store. Which by the way we can tell you is 100% linked to success. If you have physical assets and fixed costs like Best Buy the whole point is getting more bodies into the store and increasing the propensity to buy just a little tiny bit. That’s all there is to it. Getting philosophical gets you into bankruptcy court. Just ask Circuit City.

The time to stop Amazon was at least 10 years ago. Too late now. On the retail side there is such a big fundamental difference which Target can never even hope to address: selection, availability and price. If I need a garbage can I’m going to Target. I know they have a few and one will be find. But if I want a DVI to VGA cable? What about a pair of 12″ scissors? Clay Shirky’s new book? Flax seed flour? In some cases yes or maybe but they might also be out of stock. So you just pay for prime and buy everything at Amazon. Prices are good and everything arrives at your doorstep in 48 hour or tomorrow if it’s worth $4 to you.

There are concerns of course. What about margins? What’s the right multiple for this? Etc. But arguing that somehow Amazon is going to be dealt a “blow” by Target or Best Buy reflects a basic misunderstanding of the market, consumer experience and the business.

This is the first of a three part look at Amazon that will shift into their cloud services and then into eBooks. The SoundView TechFund (which we advise) is long Amazon stock as a core position.

The biggest reason  to own Amazon in the end may be Jeff Bezos. Steve Jobs is gone. Steve Ballmer is clueless and based on what we see at Target, they don’t get it either.

 

 

Update on SMTP – Email Delivery Networks

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  • Since we published our original coverage report SMTP, Inc.: Here Come Email Delivery Networks on May 3rd the company has continued to execute on their growth strategy and the shares have settled into a more stable trading range. (See related post for more information.)
  • SMTP recently completed the acquisition of over 4,000 IP addresses that are the foundation of successful email delivery. This will allow them to support thousands of new customers.
  • The company also recently contracted to build up a new datacenter with a co-location provider that will allow for further growth and delivery of higher service levels. It’s expected to be handling customer volumes in Q3 of this year.
  • Social marketing and behavioral commerce trends led by companies like GroupOn and Livingsocial are adding to the already high demand for reliable email delivery services. Although message volumes are also expanding, email remains the single best common denominator for basic communication.
  • We continue to see this market evolve in a similar fashion as the content delivery space and expect that over time most internet infrastructure service providers (like Amazon and Rackspace) will want to add email delivery networks to their services.
  • SMTP will be reporting results for the June quarter in late July. Due to the nature of their business model we expect no surprises and a fairly smooth continuation of the growth that the company has been generating the last few quarters.
  • Investors looking for a rapidly growing, profitable (27% operating margins), small capitalization internet infrastructure service provider should take a close look at SMTP.
  • The company recently completed a “direct to market” IPO process and is just now accessible to pubic investors. Our intrinsic valuation (IV) remains $3 per share.

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NeoPhotonics Pre-IPO Company Snapshot

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THUMBNAIL

DRIVER: Cloud Computing
SOLUTION: High Bandwidth Optical Components
SIZE: Sales $180M(est), Profit $6M(Est), Employees 2,990
MODEL: 17% Growth, 30% GM, 4% OM, Margins Expanding
ADVANTAGE: Vertically integrating photonics with mainstream IC manufacturing methods which improves performance and lowers costs.
VALUATION: Our IV IS $13-14 versus the current $9-11 filing range.

HIGHLIGHTS

• Cloud-based applications, in both consumer and enterprise markets, along with richer content types like HD/3D images and video, are making applications much more data intensive.

• Carriers are upgrading access speeds by moving to 4G wireless technology and bringing fiber closer to or into the home. At the same time, the number of devices at every access point is multiplying.

• The combination of higher speed access with data-intensive applications puts a huge strain on core network capacity and is driving a major shift from 10Gbps networking to 40Gbs and 100Gbs.

• This translates into improving demand for high speed optical networking technology and equipment, which is the core market served by NeoPhotonics.

• NeoPhotonics has some important process advantages that allow them to deliver devices with better price/performance characteristics than competitors.

• A fairly conservative base case generates an Intrinsic Valuation (IV) of $13-14/share, which compares favorably to the current $9-11/share filing range. If revenue growth accelerates there is upside to our current IV estimate.

POSITIVES, NEUTRALS, NEGATIVES

+ Demand for high-speed integrated semiconductors to support high-bandwidth communications and intensive graphic processing is large and growing.

+ NeoPhotonics is delivering a solution to system-makers that brings together unique advantages differing from traditional silicon-based integrated circuits and optical devices.

+ NeoPhotonics is a supplier to a broad range of top-tier system-makers including Alcatel, Ciena, Cisco, ECI Telecom, Ericsson, Fujitsu, Huawei, Mitsubishi, NEC, Nokia, and ZTE.

+ Photonic Integrated Circuit (PIC) technology is a key element in the scaling up of silicon-based semiconductor technologies to meet future demands. NeoPhotonics has achieved leadership in this area and has a broad range of experience and IP to sustain their advantage.

+ Management team and board have been together for some time and experienced many facets of the market, including early slow adoption, acquisitions, scale manufacturing and international expansion.

+ Operating margins are positive and expanding, helping to reward equity holders as the company grows.

= Although bandwidth demand is in a secular uptrend, the spending can be “lumpy” as perceptions about growth and access to capital varies considerably.

= Competition is strong but well-known in terms of products, strategy and market presence: Infinera (INFN), NTT, Finisar (FNSR), JDS Uniphase (JDSU), Oclaro (OCLR), and MRV (MRVC).

= China provides manufacturing efficiency but for some investors also entails a degree of operational risk. (2,598 of the 2,748 total employees of NeoPhotonics are based in China.)

– The industry gross margins average 36%, and thus companies in the industry have had lower operating margins and poorer returns on invested capital than other areas.

STOCK AND VALUATION

NeoPhotonics has proposed a filing range of $9-11/share. Our IV model (Attachment A) is included at the end of this report and suggests that $13-14/share is a reasonable market clearing price.

An analysis of comparable companies that includes both valuation and recent stock performance (Attachment B) is also provided. In reviewing NeoPhotonics versus the averages, it’s notable that the company is generating slightly better than average operating margins on an average gross profit level 10% below the average. The average TEV/Revenue multiple is 2.4x versus the 1.4x for NeoPhontonics at the mid-point of the filing range.

CONCLUSION

NeoPhotonics is well positioned to benefit from the trends of denser content  and more usage because they provide a key element to expand network capacity. The company has several strong competitive advantages including an efficient, vertically integrated process to deliver a broad range of photonic networking solutions on a chip. We’ve discussed the power of bringing new capabilities to silicon and it represents a fundamental long-term growth area.

The full report with additional roadshow notes, valuation and comp tables will be sent out to our email list later today.

[Disclosures: None]
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Getting back in touch with Constant Contact

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A couple of years ago I was happily short Constant Contact in the mid-$20’s (Nasdaq: CTCT) and enjoyed some gains as investor enthusiasm immediately after the IPO wore off and the shares traded closer to my Intrinsic Value estimate (which was $14 at the time.)

The core of the short argument in the past was that CTCT had to rely on a fairly long contract period with a customer to recoup their high customer acquisition cost. The industry is also characterized by many players and low switching costs. When combined with a high valuation it was easy to identify as a good short. (Link to the old research note in PDF.)

The company has come a long way since then and has certainly grown into their early valuation excess. I’ve been neither long nor short these past two years but have spent some time taking a fresh look at the company including a visit to the company back in August. It’s interesting to note their revenue growth (and expectations for future growth) have declined considerably in the past two years.

Quite a few shares are sold short on CTCT, and the stock has moved up fairly sharply in the past few months and is now finally breaking out to a modest new high above $26. This sets the stage for a dénouement of sorts as a new strategy to additional services to existing customers is tested in the market.

More Customers or More Revenue per Customer?

I’d imagine the shorts are noting that the company has seen a few quarters where subscriber additions were lower than expected. At the same time, though, they have managed to get more revenue per customer by selling additional features (like event marketing, online surveys and social media tools) to existing subscribers.

This dynamic may make the stock price a tug of war between longs and shorts for the next few quarters. Generally speaking, our IV estimate would not be impacted by a small reduction in revenue with a corresponding increase in operating margins. However, there does come a point where if growth is slow enough the multiple might be revised down.

In the near-term, earnings growth is poised to be quite strong which isn’t going to help the shorts with a compression of the multiple if it comes through. CTCT is a well-followed stock with 14 analysts covering it and 12 of these having positive ratings on the shares. Ona GAAP basis, earnings per share are expected to go from 10c in 2010 to 34c in 2011 and 60c in 2012. Analysts and the company focus more on EBITDA and adjusted earnings per share because they are higher and this makes the shares look less expensive.

Is there a brand story here?

As a firm we don’t use Constant Contact and have never really liked it. We’ve tried several alternatives and have ended up liking MailChimp more. But it’s important to remember that there are a broad range of customer types out there.

Constant Contact makes no apologies about being targeted toward the small and technically limited business person out there. Their emphasis is on ease of use and support. It’s no secret that you can use a combination of MailChimp and Google Docs to do what Constant Contact charges $30/month for. Many people do just that. But for many, they prefer to pay a little for something that simply works and is well supported. They have a business to run, and costs for solutions like Constant Contact are generally a much better bargain than services like the Yellow Pages which can easily run from hundreds to even $1000/month.

I haven’t seen any rigorous reviews or studies yet, but Constant Contact seems to be positioned as basic email/online marketing with training wheels. There’s nothing wrong with that if it sticks and the company continues to deliver on it. There are about a dozen serious alternatives and they all have their boosters and detractors. Since email/online marketing is a general purpose tool that everyone needs, the end result may just be a growing but still fragmented market for many players.

Stock Conclusion

Unfortunately there isn’t much to do at this price in my view. The IV suggests a price of $25 which is about where the shares are trading. However, if I wanted to make a bet I’d think the stock may be in a position to squeeze shorts and see some near-term upside for two reasons:

  1. The economy seems to be picking up and online activity keeps accelerating. This provides a backdrop against which CTCT numbers could come in better than expected due to a pickup in overall demand and willingness to spend.
  2. If the “online social marketing platform” meme gets established and CTCT becomes one of those “anointed” situations where the market decides a theme and a stock go together, the IV won’t matter (at least for a while.) Look at what has happened to stocks like OpenTable (OPEN) and Motricity (MOTR.)

For the traders out there, a long position in CTCT would make sense to play the breakout and the potential short squeeze. We’re too focused on our IV methodology to play it but don’t want our conservatism to spoil the fun for anyone else.

[Disclosures: None]

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Missed MIPS

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Being pretty focused on mobile Internet, I’ve spent a good deal of time with Qualcomm and ARM Holdings but didn’t see the MIPS Technologies train leaving the station.  And based on our IV analysis, it looks like we are too late.  Still, the situation at MIPS is now one that we will have to watch and add to our coverage of the mobile Internet ecosystem.  The positioning of the company may encourage momentum investors to pile into this one and push it further past our own IV estimates. The company reported a good quarter last night and is indicated up another 10% this morning even after the strong run that it has had.

So what is the positioning?

MIPS has been around since the mid-1980’s when there was major debate around Complex Instruction Set Computing (CISC), with the Intel x86 architecture being the primary example, and Reduced Instruction Set Computing, which had a number of players, including ARM, which some might say eclipsed MIPS in terms of overall success.

Overall, one would have to say that the x86 approach has won out in desktop and server computing.  Apple was one of the last mainstream users of RISC architecture based on the PowerPC instruction set from IBM.   However, the market for processors outside of desktops, laptops and servers is massive and growing rapidly.  Processors are embedded in communication gear, TVs and set-top boxes, automobiles, medical devices, appliances, etc.  And there are now myriad companies making embedded processors for all of these markets.

The key is that all these chip makers need to decide on a standard instruction set so that their chips can be easily programmed and integrated into designs.  The market has boiled down to four: x86, PowerPC, ARM and MIPS.  Both ARM and MIPS can be viewed as “pure play” companies in the embedded market.  Both follow a licensing model whereby chip makers license the designs so that they can make devices that support the architecture and instruction sets that end-market customers require.

The rise of the smartphone has raised the stakes and the interest level in this market.  Up until recently, MIPS has been a fairly quiet and ignored player compared to ARM.  However, the company hired a new CEO from Cavium, a networking chip supplier that has become a very hot stock (sporting a $1.3B market cap and a 12x price/sales multiple as I write this.)  Cavium is a MIPS licensee so the CEO has gone in with both eyes open and a vision for the company.

Thanks to an improvement in the underlying business and some stated goals to become a major player in the smartphone market MIPS is being looked at differently.

Maybe we missed it, maybe we didn’t…

The first stop for me in looking at MIPS was to crank out a quick Intrinsic Value which came to $11.70.  Thanks to the strong report last night the stock should run past that figure today.  But I’ve upped it on our watch list within the mobile Internet segment of our ecosystem.

Looked at another way, though, it might be tempting as either a takeover target or a pairs trade (short ARM, long MIPS) here.   For example, ARM has a market cap of just over $8B and is trading at about 16x sales.  On a relative basis at least it makes MIPS look cheap with a $440M EV and a 5.6x TEV/sales ratio.  So a pairs trade here makes sense.  And for any player wanting to get into this market an acquisition of MIPS is pretty manageable and well under $1B at this point versus the possible $10B needed for ARM.  MIPS looks less risky with more upside for an a buyer on that basis.

[Disclosure: none at the time of this writing]

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Observations on Kenexa purchase of Salary.com

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Today Kenexa (KNXA) announced the planned purchase via tender of Salary.com (SLRY).

On the plus side, the cloud technology space is begging for consolidation as companies find themselves using scores of vendors across their many business areas and processes. Companies are trying to broaden their offerings and companies are trying to consolidate their many vendors.

At the functional level the acquisition makes plenty of sense given that Kenexa has been focused on “talent management” and Salary.com has been in “compensation management” and on-demand HR solutions.

Both companies have the same business model, which is the classic on-demand/SaaS model we have all grown so accustomed to.

There are a few things that investors may or may not like about this transaction:

1. The price at just under 2x sales is reasonable. However, Salary.com hasn’t grown much in the past two years, no doubt thanks in part to the weak employment market. Worse still, the company has done little to control spending and has been losing money at an $18M annual rate.

2. Due diligence has been limited and Kenexa participated in an auction process, which means that they are likely to discover far more information once the deal closes and that there are bound to be some negative surprises.

3. Current customers of both companies may demand price concessions before any benefits of “cross-selling” can materialize. Most of the management commentary has been focused on opportunity but we know corporate customers are also interested in leveraging consolidation to get better “bundled” pricing.

We completed a quick Intrinsic Value analysis for Salary.com and it suggests that Kenexa is not wildly overpaying for the company. A scenario of restoring revenue growth to 10% and bringing SG&A down consistently from current levels to a more normal 50% of revenue generates an IV of $3.50/share.

As with most acquisitions, the value is going to be in how Kenexa can aggregate an excellent combined customer set with a rich set of data for better decision making and more efficient businesses processes.

It’s feeling like M&A activity levels around cloud computing are going to remain high this year. We’ve seen the recent activity in “big data” with Greenplum/EMC and 3PAR/Dell or HP and also the SaaS applications space.

[Disclosure: None]

Why does Intel need the cow?

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I was mildly surprised with the Intel purchase of McAfee, which is somewhat better than being bored by the Dell/3PAR deal. At least HP has come along and made the plain girl in the corner appear more interesting. Anyway, moving on to Intel/McAfee…

Nobody refutes the fact that security is an extremely important aspect of cloud infrastructure. All the enterprise systems players take it seriously and have been building on their solutions for years. Companies like Cisco, EMC, IBM and Microsoft have spent a small fortune on both development work and acquisitions in security.

Intel is always looking for ways to add more functionality and value around their core chipsets, so security algorithms and embedded processing make sense. But these are technologies and techniques that can be either licensed (probably for no money up front and a very small royalty) or acquired through what would really be technology acquisitions that are counted in the millions of dollars rather than billions.

In fact, we’ve found little companies like Zix Corp (ZIXI) that have embedded solutions that make email and messaging in applications within healthcare and financial services secure and encrypted, all in the background and at very low cost. This type of technology is available, deployed broadly, and not expensive.

So why buy what is really a large scale consumer and enterprise business to go after a slice of the embedded infrastructure that is needed for cloud and mobile computing?

Sadly, the answer I keep bumping into is “because they can,” and a company their size “needs to do something big” so that people believe they are “serious” about the space. These are lousy reasons from an investment standpoint. Furthermore, it’s also lousy from a business standpoint. One way to show how serious you are is to deliver outstanding solutions. Intel sold their anti-virus business to Symantec over a decade ago and certainly knew about putting security primitives into the core back then, but hasn’t pursued the security market with any gusto during this time.

To be fair, Intel, after many struggles, has managed to finally integrate and embed at least some level of core networking and graphics processing into their chipsets. I’d be willing to bet that this came at horrific costs looking back 10 years but it’s there today and memories are short.

It isn’t that security integration doesn’t make sense, it’s that Intel could have done it fairly easily already and licensed or acquired key technologies along the way easily and at much lower costs. That is what adding value is all about from a management standpoint, building and buying assets that you then make into something far more valuable. In this case Intel paid the premium for McAfee shareholders and took $3B+ out of their own shareholder pockets.

The example we see pointed to most often is EMC. EMC did diversify away from a pure storage company with a steady stream of purchases including RSA, Documentum and VMWare to name three (there were many more.) But then that asks for the question “Is that Intel really going to embark on a software infrastructure strategy?” That would suggest they might be interested in companies like Akamai (AKAM), Solar Winds (SWI), Progress (PRGS), Adobe (ADBE), BMC (BMC) etc.

The good news there is that these are some of the few technology businesses that have higher gross margins than the existing Intel business. The bad news is that Intel doesn’t know anything about running a software company. They might be able to learn (so far not so good…) but if they do it’s going to cost plenty.

McAfee will be disrupted by the acquisition, as is the case 99% of the time in acquisitions like this. What happens in the wake will be telling insofar as to whether Intel management is here to build shareholder value or serve their ego and succumb to laziness by acquiring big chunks of market position without wishing to do the work to build them or even keep them. Unfortunately for them, they started out with a 15 yard penalty right at the kickoff so they have that much more work to do.

On the margin this is also good news for a recovering Symantec, which has been making progress but can certainly use a bit of wind at their back which is what this deal is likely to do – at least for the next 12-18 months.

[Disclosure: No positions although an asset management partner of R2, Aberdeen Investment Management, owns shares in Zix Corp.]