Not too many tech stocks get a second act, and Check Point Software's (Nasdaq:CHKP) heyday was back in the mid-to-late 90s, alongside companies like Cisco (Nasdaq:CSCO) and Symantec (Nasdaq:SYMC) that have likewise been unable to recapture former glories. The question for shareholders, though, is whether oncoming next-gen competition will damage this business as much as feared and whether they have the patience for the Street to come back around to the value of this business.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Q2 Results More Relief Than Remarkable
Check Point's second quarter results didn't dismiss the concerns about its declining growth rate, but at least they seem to be broadly better than feared.

Revenue rose 9% from last year and 5% from the first quarter, as product revenue increased 12% sequentially (on a 20% increase in enterprise appliance unit volume). Service revenue growth was more subdued, though, growing 1% from the first quarter. Curiously, while Check Point's large exposure to Europe (roughly 40% of sales) is seen as a threat, sales in this region grew faster than in the Americas.

Check Point continues to operate a supremely profitable enterprise. Gross margin improved more than a half-point to over 88%, while operating income rose 4% from the first quarter on higher selling and marketing spending.

SEE: A Primer On Investing In The Tech Industry

Can Check Point Withstand Next Gen Competition?
Check Point's territory has gotten substantial more crowded in recent years, and it looks like competition is only going to intensify on the hardware side. Palo Alto Networks looks set to be the new darling in security hardware, and both Fortinet (Nasdaq:FTNT) and Palo Alto use a more advanced technology than Check Point.

If that weren't enough, Cisco (Nasdaq:CSCO) seems serious about trying to stay relevant in security, and F5 (Nasdaq:FFIV) believes this can be a growth market for it as well. And then there are also companies like Sourcefire (Nasdaq:FIRE), Intel (Nasdaq:INTC) and Dell (Nasdaq:DELL) all looking to make their mark.

That's a crowded space (and there are still more companies I could list), and it puts substantial pressure on Check Point to continue to innovate. Unfortunately, if the bears are right, Check Point may be boxed in and forced to compete on the basis of offering cheaper, less cutting-edge solutions. That wouldn't necessarily doom the business, but it won't help sentiment at all. Of course, the alternative - upping R&D spending and/or doing an expensive deal for an up-and-comer - carries its own risks as well.

SEE: 6 Candidates For The Next Great Tech CEO

Go Bigger or Go Home?
I still happen to believe that Check Point's long history and solid reputation in enterprise security gives it some leverage against those competitors that view security as more of an add-on market. Nevertheless, Palo Alto and Fortinet are clearly making their mark at a time when it seems Check Point is more interested in talking about large buybacks.

I do wonder if a company like EMC (NYSE:EMC) would think about acquiring a security business, but given EMC's preference to pay up for tomorrow's technology, I'm not sure that Check Point would fit the bill. EMC isn't the only fish in the sea, but I wouldn't bank on the thesis that Check Point draws a bid - rather, I think Check Point ought to be thinking about the investments it needs to make to stay near the top of the leaderboard in what is still a very attractive market for the long-term.

SEE: Why You Shouldn't Wait To Buy These Tech Products

The Bottom Line
I'm a fan of Check Point, but to check my own enthusiasm I try to take a more conservative stance on their forward growth prospects. To that end, I forecast less forward revenue growth (mid-single digits) and less free cash flow conversion than even those sell-side analysts who rate these shares as "Neutral." Even still, an estimate of 5-6% forward free cash flow growth still produces a fair value in the mid-$60s.

While I think there is definitely value in Check Point shares, investors need to be realistic about how an investment here might play out. The stock still carries a double-digit EBITDA/EV multiple and Wall Street is well-nigh obsessed with top-line growth at tech companies. Consequently, this could be a stock that just muddles through for long stretches of time and investors need to have a long-term horizon to see the value come out in these shares.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing

    In Search of the Rate-Proof Portfolio

    After October’s better-than-expected employment report, a December Federal Reserve (Fed) liftoff is looking more likely than it was earlier this fall.
  2. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  3. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  4. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  5. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  6. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  7. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  8. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  9. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  10. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center