Check Point Takes A Hard Crosscheck

By Stephen D. Simpson, CFA | April 25, 2012 AAA

It looks likes Check Point Software (Nasdaq:CHKP) has come to an end, or at least a hard pause. While this leading enterprise security company had a decent first quarter and the guidance revision wasn't that bad, the fact remains that even a small disappointment is all it takes for a tech stock to see large disappointment from the market.

A Tough First Quarter
Check Point's first quarter results weren't terrible, but the stock has been on a pretty good run and expectations (and worries) have started to catch up with the price.

Revenue rose 11%, with product revenue up 5%. That hardware performance isn't so bad, given the realities of other first quarter tech results, but the billings number was not all that strong. Couple a soft billings result with weaker guidance (even if just slightly weaker) and that's all it takes to cast a pall on the results.

Profitability is still solid, though. Operating income rose 22% on a GAAP basis, and the operating margin continues to expand.

SEE: Zooming in on Net Operating Income.

How Much of a Threat Is Next-Gen Competition?
So far, Check Point has done a pretty solid job with its migration to hardware (security appliances). The company has stacked up pretty well with the likes of Cisco Systems (Nasdaq:CSCO) and Juniper Networks (NYSE:JNPR) and taken some share in the market.

Unfortunately, there are other competitors out there, and their momentum may be on the upswing (and at Check Point's cost). Privately held Palo Alto Networks (which recently filed for an IPO) is widely seen as one of the best up-and-comers in the security space, with its next-gen firewall technology. Along with companies like Fortinet (Nasdaq:FTNT) and Sourcefire (Nasdaq:FIRE), then, there is the risk that Check Point is going to be on the wrong side of some upcoming product launches.

Moreover, with Dell (Nasdaq:DELL) buying SonicWall, it's pretty clear that there are a large number of "interested parties" in this market and market share is not going to come easy. Remember, too, that F5 Networks (Nasdaq:FFIV) has jumped into this market as well, and recently announced some solid deal wins.

Does Check Point Need to Buy to Keep up?
To be fair, reading through Palo Alto's S-1 suggests that there is a fair bit of hype around this company and that its real world strength is not quite as formidable as myth and legend suggest. Nevertheless, there is a real risk that companies like Palo Alto, Fortinet, SonicWall and Sourcefire have a legitimate leg up on this market.

Can Check Point keep up? I think they have the ability and resources to do so, but it is a question of how quickly they can adapt. There is a real risk, in my mind, that the company may feel it needs to patch the gap between now and tomorrow with a deal, and the multiples in this space suggest any such deal won't be cheap. That said, EMC (NYSE:EMC) has made quite a few expensive deals to stay at the top in storage and they have pretty much all paid for themselves.

The Bottom Line
I'm only forecasting compounded free cash flow growth of 6% for the next decade, and Check Point bulls will argue that that's too low. At that level of growth, fair value sits in the mid-$60s - not quite enough to argue for buying in today. Bump up the growth to about two-thirds to three-quarters of the trailing ten-year growth rate, and fair value jumps close to the mid-$70s, which is much closer to a buy.

While I am playing conservative, I'm sorely tempted to bump up those estimates and take a flyer on this one on the post-earnings sell-off. Check Point has proven that it knows the enterprise IT space and I just have a hard time believing that it won't adapt and adjust with the times, especially with the ways in which consumers' attitudes affect tech products.

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

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