Back in the day, Check Point Software (Nasdaq:CHKP) was in that rarefied sphere of must-have tech stocks. Unlike many of its peers from that era, though, this computer hardware/software developer has not only stayed in the game but continued to prosper as a leader in the network and gateway security field. However, Check Point's valuation has long since come back to more reasonable levels, and it may be time for investors to give this name a serious look.

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A Solid Start to the Year
Check Point did not blow the doors off the quarter with a financial report that will send its analysts into hyperventilation, but it was a solid quarter all the same. Revenue grew 15% for the period and surpassed the high end of the range, as product revenue rose almost 16% to $105 million. Deferred revenue performance was not quite as impressive; it rose 10% for the quarter to more than $460 million and slipped about 1% on a sequential basis.

Where Check Point really continues to impress is in its profitability. Gross margin (on a GAAP basis) climbed almost a full point to an eye-popping 85.9%. Operating income is likewise impressive; GAAP operating income rose 22% to over $141 million, while the operating margin was 50.2%. (For more, see The Bottom Line On Margins.)

Unfocused Competition Is Helping the Business
Check Point certainly has competition on the software side of its business from companies like CA Technologies (Nasdaq:CA), Symantec (Nasdaq:SYMC) and Intel's (Nasdaq: INTC) McAfee. But that competition is nothing new and nobody seems to have developed the killer app that buries the competition. Instead, the players focus on the respective markets where they have typically done the best (Check Point, for instance, does not focus as much on the consumer as some others).

On the hardware side, though, Check Point seems to be building some momentum. The companies compete in the security appliance space with the likes of Cisco (Nasdaq:CSCO) and Juniper (NYSE:JNPR). While these companies have increasingly put security features into hardware, that has not been a killer for Check Point. Cisco is not very focused on security (or on anything else apparently) and Juniper is more interested in networking. That has given Check Point an edge and opportunity in security, as that is not an area where companies are especially inclined to go with only "good enough" or "discount" offerings. (For related reading, see Cisco's Painful Transition.)

More Blocking and Tackling
Companies like Fortinet (Nasdaq:FTNT) offer the sort of competition that forces Check Point to continue to invest and innovate. That said, with so much of the company's revenue making it down to free cash flow (over 50%) that really is not a problem.

It looks like most of Check Point's moves are going to be subtle at this point. The company is going to be refreshing its hardware sometime this year, moving away from legacy products developed with Nokia (NYSE:NOK) as a partner. On the plus side, that should give the company better pricing and margins. (For more, see Free Cash Flow Machines.)

Longer term, the company also needs to figure out what it wants to do with its cash. There's a lot of it on the balance sheet and that could clearly be used to do M&A. Companies like
Websense (Nasdaq:WBSN) are out there and would expand the company's revenue possibilities, but those deals come with a catch: Check Point is so profitable right now that almost any deal the company does (of any scale, at any rate) is going to ding its margins in the short-term.

The Bottom Line
Even presuming that Check Point can't do much to improve its margins or cash flow margin from here on out and that revenue growth is going to drop into the high single digits, the company still looks cheap on a discounted cash flow basis. Check Point also seems to be an appealing acquisition candidate that could offer some floor to the stock price, although incredible margins and a solid market position suggest that floor probably isn't necessary. (For more, see The Value Investor's Handbook.)

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Tickers in this Article: CHKP, CA, SYMC, CSCO, FTNT, NOK, WBSN

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