Stock Watch: Three Ways to Profit from Software M&A

The news on Monday that Hewlett-Packard (HPQ) will acquire Cupertino, Calif.-based ArcSight (ARST), a software security firm, for $1.5 billion, has led to increased speculation about the prospects for other software security stocks.

Not surprising: When HP announced the news, shares of ArcSight soared more than 25% to close at $43.91. The deal, which will give HP a greater arsenal to ward off threats by hackers and viruses, pits the company against big players such as IBM (IBM) and EMC (EMC). But it also gives HP a major presence in a software niche that accounts for about $1 billion in annual corporate spending.

Now, rumors are swirling that HP could be considering another software security acquisition to help round out its offerings. In addition to HP, it is also likely that companies such as IBM, EMC and Oracle (ORCL) could be targeting smaller players to help beef up their own security arsenals even more.

Already on Tuesday, there were reports that networking company Radware (RDWR) could be in discussions with IBM and HP in a deal reported to be $945 million -- or $45 a share -- which would be a 60% premium to the stock's price. On the news, shares of Radware were up more than 38%.

Speculating on Take Overs

So far, there has been no announcement on Radware. But there are others that could be ripe for takeover as well. One such company is Tel Aviv-based Check Point Software Technologies (CHKP). While ArcSight sells security information and event management software which companies can use to analyze behavior on their sites and prevent cyber-threats, Check Point focuses on security and storage software. The stock which now trades around $35 has a market cap of $7.2 billion, an attractive forward price/earnings ratio of 13.6 and almost $1 billion in cash and no debt.

Another company that investors have also been nibbling at is security firm Ft. Lauderdale, FL.-based Citrix Systems (CTXS) which is a play on virtualization software. Shares of the company, which has a market cap of more than $12 billion, trade around $65. The stock has moved up significantly in recent days and doesn't look exactly cheap with a forward PE of 29. But the stock's rise is fueled partly by speculation and it could go higher. The company has about $800 million in cash and no debt.

M&A Activity Picking Up

Finally, investors may also want to consider the opportunities for Sunnyvale, Calif.-based Fortinet (FTNT), which is a significant player in Unified Threat Management devices which combine firewalls, antivirus software, and intrusion prevention software. These products would make a nice addition to HP's growing security software business. The stock, which trades at just over $22 per share, giving the company a market cap of $1.6 billion, has also moved up recently and with a forward PE of 46 it looks expensive at current levels. But like others in this sector, its total cash of $252 million and no debt makes it an attractive take-over target, on a fundamental basis.

Mergers and acquisition activity in the technology sector is likely to continue, with many companies sitting on huge piles of cash and little debt. Especially attractive are small cap stocks, which in recent days have been outperforming large caps. The Russell 200 index of small cap stocks is up 8.3% so far this month -- a great deal of that rise based on the expectation that M&A activity will continue to pick up. If that happens, investors in some of these stocks could stand to do very well.