Failure to adapt is one of the surest ways for today's winners to become tomorrow's losers. IT security company Check Point Software (Nasdaq:CHKP) looks to be addressing that risk as best it can, with ongoing product development and migration. While this is by no means the cheapest stock out there, investors may still want to consider this name as a somewhat balanced trade-off of growth and value.
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Another Solid Quarter to End the Year
Check Point reported that revenue rose 12% in the fourth quarter. That more or less matched the averaged analyst estimate. Deferred revenue, though, was up 19% this quarter and seemed to beat expectations by a more meaningful extent. As Check Point moves on with a somewhat new model, investors should expect deferred revenue to be a more meaningful metric.
Although Check Point already boasts exceptional profitability, management still drove improvements. Gross margin improved about 60 basis points, while GAAP operating income rose 19% (driving operating margin up three points). (For related reading, see A Look At Corporate Profit Margins.)
A New Annuity Model?
Check Point has been seeing good uptake of its new software blade products, and its appliances are finding their way into the replacement cycle for an enterprise firewall infrastructure that's getting a bit long in the tooth. To that end, 2012 will see a major update to Check Point's appliance portfolio and the first really new hardware in a couple of years.
With new products, a new model is likely emerging. Check Point is focusing on driving customer adoption of so-called "annuity blades" that can produce a stream of revenue over a period of years. If successful, this will alter the revenue composition of Check Point and create a longer-tail stream of deferred revenue.
Big in Its Core, Looking to the Periphery
Check Point has a very solid market share position in its core markets like enterprise firewalls. Appliances represent an incremental growth opportunity; Check Point has trailed companies like Fortinet (Nasdaq:FTNT) and SonicWALL in unified threat management (UTM) and has about 15% of the overall appliance market - on par with Juniper (Nasdaq:JNPR), but well behind Cisco (Nasdaq:CSCO).
It's not just about penetrating the appliance business. Check Point also has the opportunity for greenfield growth in market categories like IPS, DLP and encryption. Though none of these markets are as large as Check Point's traditional markets, together they are quite considerable. Keep in mind too that as hardware and software evolve, so too do the security needs of enterprise clients. In other words, "the next big thing" for Check Point may not even exist today.
What's the European Story?
Check Point gets more than one-third of its revenue from Europe and a slowdown on the continent is near the top of every analyst's list of worries for 2012. Fourth quarter results seem encouraging enough, but if conditions get worse companies will cut IT spending. There's an argument to be made that companies will skimp less on security IT than other areas, but the risk is still there.
The Bottom Line
Security is an ever-evolving market and that makes Check Point's market leadership set in something much less solid than stone. Nevertheless, the company has shown a rare ability to roll with the punches and reinvest prudently in its own business - not to mention supplementing when and where it needs to with acquisitions.
Check Point is not especially cheap from the perspective of EV/EBITDA or EV/revenue, but the company has a long history of good returns on capital and solid cash flow generation. If Check Point can grow its free cash flow at a 10-year CAGR of just 6%, these shares look about 30% undervalued. That does not seem demanding, but investors need only look at names like Microsoft (Nasdaq:MSFT) or CA (NYSE:CA) to see the valuation compression risks that go with slower-growth software names. (For related reading, see 4 Steps To Picking A Stock.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.