Your Boss may be watching

On the Web? Your boss may be watching

Companies are rushing to sign up for high-tech tools that let them monitor and control what their employees do online. Here's why -- and how you can profit from the trend.

By Michael Brush

Chances are -- according to our own Web site traffic statistics -- youˇre reading these words in your office or cubicle while your boss thinks you're working.

Donˇt worry. We won't say a word.

But the odds are getting better each day that your boss already knows.

Cyber security at work isn't new, of course. But as security risks from Web surfing multiply and more employees use the Internet, an increasing number of companies are signing up for high-tech spy tools that let them see -- and control -- what their workers do online.

Workplace-privacy experts donˇt have hard numbers yet on how many businesses watch and control Web usage. But judging by the explosive growth at companies providing these tools, Web filtering is coming soon to a cubicle near you -- if it's not already there.

Look at the impressive growth at Websense (WBSN), for example, the market leader in this space. Last year, Websense reported a 21% jump in the number of workers around the globe whose Web surfing gets monitored and controlled by the company's Web-filtering tools. The number rose to 19.8 million from 16.4 million in 2003.

Not surprisingly, there's money to be made here for investors who pick the right stock. Two other companies targeting this niche, Secure Computing (SCUR) and Blue Coat Systems (BCSI) have recently reported growth similar to that of Websense.

Big brother has legitimate concerns
While you may find it disturbing that your boss knows your Web surfing habits and can tell you what you can do on the Internet, it makes sense to cut managers some slack. Companies have several good reasons for clamping down on Internet usage.

If you download porn or visit hate sites at work, your actions may wind up as evidence in a costly sexual harassment or discrimination lawsuit. One in five employers already has e-mail subpoenaed in legal proceedings. Surfing habits and downloaded images can be equally problematic, says Nancy Flynn, of ePolicy Institute, which consults companies on Internet and privacy policies in the workplace.

¨Often what happens is employees will not only visit a porn site, but they will print out material or forward videos and photos and they will save the material to a hard drive,〃 Flynn says. Once a lawsuit is launched, computer forensic experts may come in and dig up secrets from hard drives -- including records of Web sites visited by employees.

Piercing corporate defenses via the Web
Corporate networks are well-fortified against viruses coming in through e-mail. But theyˇre not so good at blocking spyware programs that download automatically from Web sites. Web filtering gets the job done by simply blocking dubious sites. In the most-recent quarter, about half the sales leads at Blue Coat Systems came in because of concerns about spyware, says Erik Suppiger, an analyst who covers the stock for Pacific Growth Equities.

Web-filtering tools also suppress bandwidth hogs like peer-to-peer file-sharing services for downloading music or movies. After all, grabbing tunes for your iPod may seem innocent, but it could be sopping up bandwidth needed for a Web-based conference down the hall.

¨Anything that chews up a lot of bandwidth, we limit that,〃 says Douglas Wride, the finance chief at Websense. Web-filtering tools can also suspend low-priority activities when broadband capacity taps out. As more companies turn to Internet-based phone systems, this could be crucial for keeping phone systems up and running, Wride says.

Companies typically pay about $15 to $20 a year per employee for Web-filtering tools. So if Web filtering prevents a worker from wasting just an hour of time, it pays for itself.

How Web filtering works
Web-filtering tools like Websense Enterprise set up checkpoints that block or limit access to millions of Web sites and billions of Web pages. Web filtering typically blocks the ¨sinful six:〃 pornography, hate sites, gambling, tasteless material, violent content and illegal activities. The filters let companies give workers limited access to sites for personal use, like shopping or checking on sports scores.

The databases containing forbidden Web pages are constantly updated. Any new sites that workers visit are uploaded to the Web-filtering companies. Then theyˇre reviewed -- and blocked if necessary.

Web-filtering companies are quick to reject the notion that their tools are used to ¨spy〃 on workers. True, their systems can generate reports on Internet use, but most managers donˇt have the time to do anything but put the Web-filtering tools on autopilot. ¨Monitoring is an incredibly time-consuming task, whether you do it manually or through software,〃 says Wride. ¨You can generate reports, but if you are managing behavior correctly you donˇt have to see the reports.〃

Privacy losses, portfolio gains
About two-thirds of Websense's revenue comes from current customers who renew subscriptions, so investors can feel confident the money will keep rolling in. The company also has about $10 per share in cash and is buying back stock -- often a sign of more stock-price gains ahead. Shares recently traded for $59.

Secure Computing, which gets about 40% of its revenue from Web-filtering tools -- and most of the rest from sales of firewalls that protect corporate networks from intrusion -- saw some healthy insider buying last summer. Chief Executive John McNulty purchased $384,000 worth of his companyˇs stock last summer for $6 to $6.50, according to Thomson Financial. The company has about $1.50 per share in cash. The stock recently traded for $9.

Blue Coat Systems, which recently sold for $18.50 per share, has $3.50 per share in cash. Blue Coat Systems fell $3.80, or 17%, on Feb. 25 when it beat earnings estimates but guided for lighter-than-expected growth this quarter. Given the long-term growth trends in the sector, that sell-off looks like a good opportunity to pick up shares.

Stocks cheaper than they look
Given the valuations on these stocks, some analysts are cautious -- especially since major competitors like Microsoft (MSFT) could come into the space. But several factors suggest itˇs well worth buying these stocks, particularly at times when the stock prices do come down.

Websense, for example, has a price-earnings ratio of 35 times the coming year's earnings, which seems rich. But thatˇs the wrong way to value the company. The reason: The cash Websense collects from customers is recorded as revenue over time -- a process that delays that cash being converted to earnings. Fourth-quarter 2004 sales at the company grew by 40%, compared with the prior-year period, to $31.7 million.

Other high-growth software companies book most of their revenue immediately, which gives them relatively lower price-earnings ratios, says Ken Allen, a software sector analyst at T. Rowe Price. Instead, it makes more sense to value Websense based on how its cash flows compare to its stock price, which makes the current price seem more reasonable relative to other software companies.

Spying opportunities abound overseas
There's plenty of room for continued growth. Even with security concerns widespread, the "vast majority of companies are still not protected in this area,〃 says Brian NeSmith, chief executive of Blue Coat Systems.

Wride, the finance chief at Websense, thinks market penetration in the United States comes in at 30% to 40%. ¨Every quarter we sign up a large customer and it amazes us that they did not use our kind of product before,〃 he says.

Things look even better abroad. Wride estimates only about 20% to 25% of European companies use Web filtering, and the numbers are even lower in Latin America and Asia. ¨We are very early in the growth stages, because of the international markets,〃 he says. Meanwhile, the number of workers with high-speed Internet connections should double over the next three years globally, to 600 million from 300 million, he says. That creates even more demand, of course.