Growth at Check Point Software Technologies Ltd. (CHPK, Financial) has slowed. But this resident of the Undervalued Predictable and Buffett-Munger screeners at GuruFocus has potential for investors who want a tech company that can consistently deliver increasing earnings.
With current concerns about internet security and hacking, it’s probably a good time to look at companies that help us protect our computers, servers and infrastructure. Check Point has been doing that for more than twenty years.
In the recent past though, the market has grown restless with its slowing growth, and that has depressed its share price, as this 3-year chart shows:
History
1993: The company is founded in Israel, based on an idea one of the founders developed while working on the security of classified networks for the Israeli Defense Forces. The first product was called FireWall-1.
1994: An OEM agreement with Sun Microsystems; a distribution agreement with Hewlett Packard; and the opening of a U.S. head office in California.
1996: The company goes public on Nasdaq, raising $67-million in new capital.
1998: A partnership with Nokia puts Check Point’s software into Nokia products.
2006: The company creates a unified security architecture under a single management console.
2009: Unveiling of its Software Blade architecture; acquisition of Nokia’s network security business, and FaceTime Communications' application database.
History based on information at Wikipedia.org and the company’s website.
Comments: A tech company that grew out of Israeli security concerns, and has grown through internal development and acquisitions. Now a public company for 20 years.
Check Point’s business
As indicated by the history, Check Point Software Technologies Ltd. is an IT security company, and it has used “. . . technologies to secure communications and transactions over the Internet by enterprises and consumers.” (Unless otherwise noted, the information in this section comes from the company’s 20-F filing, the equivalent of a domestic company’s 10-K).
It says in the filing that it, “. . . develops, markets and supports a wide range of products and services for IT security.” At the core of its products and services is, “. . . a unified security architecture that enables end-to-end security with a single line of unified security gateways, and allow a single agent for all endpoint security that can be managed from a single unified management console. This unified management allows for ease of deployment and centralized control and is supported by, and reinforced with, real-time security updates.”
Check Point’s products, based on the Software Blade architecture, fall into several categories, including:
- Threat Prevention
- Mobility
- Firewalls
- Security Management, and
- Endpoint Security.
It sells these products to a wide spectrum of customers, ranging from individuals to Fortune 500 companies, and reaches these customers through more than 2,700 vendor/partners.
Comments: As the current hacking of American political activity highlights, cyber security is a huge risk. Check Point has a wide range of products that deal with such threats, and a diverse base of customers; diversity made possible by working through its many vendor partners.
Revenue
Income is split fairly evenly among three segments, as shown in this excerpt from the 20-F for 2015:
And as this excerpt shows, almost half its revenue originates in North America (primarily, the United States):
This chart shows how that revenue has grown over the past two decades:
Comments: Check Point has consistently grown its revenues over the years, and part of that consistency comes from a diverse group of products and a diverse group of customers.
Competition
The company says, “The market for information and network security solutions is intensely competitive. . . .” and expects increasing competition ahead.
Named competitors include: “Cisco Systems Inc. (CSCO, Financial), Juniper Networks Inc. (JNPR, Financial), Fortinet Inc. (FTNT, Financial), SonicWall Inc. (owned by Dell Inc.(DELL, Financial)), Palo Alto Networks Inc.(PANW, Financial), WatchGuard Technologies Inc., McAfee Inc. (owned by Intel Corporation), Sourcefire Inc. (owned by Cisco Systems Inc.) and other companies in the network security space. We also compete with several other companies, including Microsoft Corporation (MSFT, Financial), Symantec Corporation (SYMC, Financial), International Business Machines Corporation (IBM, Financial), Hewlett-Packard (HPQ), FireEye Inc. (FEYE) and Websense Inc. with respect to specific products that we offer. There are hundreds of small and large companies that offer security products and services that we may compete with from time to time.”
Comments: Competition comes from both broadly-based and single product vendors; with this many competitors, there’s little surprise the company finds the competition intense.
Moat
In a GuruFocus article, Thomas Macpherson noted, “Check Point has been known as the leader in unified threat management (UTM) for the past 20 years. It has spent the last several years retooling its offerings to meet the SaaS model as well as new competitors. Its moat is considerable as it is extraordinarily difficult to swap out UTM security for a new vendor.”
Baron Global Advantage Fund’s May 2016 letter to shareholders included this paragraph on Check Point, “Check Point Software Technologies Ltd. is a leading cyber security vendor. Fears of slowing cyber security spending abated when Check Point reported a solid close to its year and showed early signs of strength in its next generation software products with subscription revenue growth acceleration. As a leader in the cyber security market, with a large cash balance and strong cash generation, we see continued opportunity for profitable growth.”
And Naman Shukla observed, “Check Point Software Technologies claims a client list of more than 100,000, offering it sufficient opportunity to upsell clients to innovative, updated products to maintain its position in the market with respect to the industry’s changes. Check Point’s 10-year relationships have rewarded the company with a 52% operating cash flow margin, which it has mostly delivered to the stockholders via share repurchases.”
Also noted in the 20-F for 2015: the company has 45 American patents, and another 34 patent applications.
Comments: A theme quickly emerges when we read assessments in other articles, and it’s akin to saying the rich get richer. Check Point has a solid place in the top echelons of the industry, giving it momentum, cross-selling opportunities and more.
Growth
Given this company’s leadership and solid moat, why has its stock price gone off the road and into the weeds? Here’s a 3-year chart of the share price:
If you check the Profitability & Growth column of on Check Point’s summary page at GuruFocus, a trio of red icons stands out among the sea of green ones. Revenue Growth, EBITDA Growth and EPS Growth all look bad in light of previous results.
To put those figures in perspective, let’s look at the recent trend in Earnings Per Share, as listed at GuruFocus:
- 3 years: 8.1%
- 5 years: 11.5%
- 10 years: 14%
If I were a growth investor who’d held Check Point for a number of years, I might be getting restless, too. I might even look at one of the company’s competitors. Stephen Simpson sums up that angst in an article at SeekingAlpha:
“A few things seem to be perpetually true about Check Point Software Technologies. Despite a prominent position in the market, including leading firewall market share, nobody is ever really happy with this Israeli IT security company. The company's growth is no longer in the double digits. The company doesn't spend as much on R&D as Palo Alto or Fortinet. The company doesn't 'play to win,' but instead focuses on more or less holding steady in the market. And so on.”
We should also note that while its growth may have slowed, Check Point has consistently reduced its share count over the past 10 years, as this chart shows:
Comments: All of this taken together suggests that Check Point is slowly transitioning itself from high-flying tech company to steadily-performing tech company. Perhaps we’ll even see a dividend one of these years.
Other
Check Point is incorporated in Israel and headquartered in Tel Aviv, Israel.
It is listed on the Nasdaq, and its American head office is in San Carlos, California.
The company has a non-executive chairman, Marius Nacht, who has held that position since 2015.
The chief executive officer is Gil Shwed, who is also a director and one of the company’s founders.
At the end of December last year it had 1,303 employees and contractors.
Fiscal year end is December 31.
Ownership
Among the investing gurus followed by GuruFocus, 12 have holdings in Check Point. Jeremy Grantham (Trades, Portfolio) tops the list with 1,441,000 shares, followed by Pioneer Investments (Trades, Portfolio) and David Herro (Trades, Portfolio).
It’s a popular holding with institutional investors, which collectively own some 80% of the company (source: GuruFocus):
As we also see, it has a modest short contingent, with just over 7% of shares outstanding.
No insider holdings show here, but in its 20-F, the company refers to employee stock options and an employee stock purchase plan. Presumably this involves non-common shares.
Comments: A strong showing by pension funds, mutual funds and other institutional investors suggest this stock has their long-term confidence.
Check Point by the numbers
Comments: The current share price is not far above the 52-week low, the company has a strong ROE and reasonable P/E, and it bought back nearly 5% of its shares last year.
Financial strength
Check Point earns excellent scores for financial strength and profitability and growth, as this shot of the GuruFocus dashboard shows:
In the Growth section above, we discussed Check Point’s strategy of delivering consistent growth, rather than all-out growth. Note that it spends significant sums each year on share buybacks, funds that might have gone into R&D or other growth-generating areas.
Note, too, the company receives a 4-Star (out of 5) predictability rating from GuruFocus, indicating steady growth on the metrics that matter (helped by the share buybacks). Here’s a 10-year chart of its EBITDA:
Free cash flow, which had slipped for a couple of years, now appears to be getting back on track:
Comments: A solid company which may not grow as fast as it once did, but one that has a high probability of consistently delivering reasonable growth every year.
Valuation
Check Point has places on both the Undervalued Predictable and Buffett-Munger screeners, telling us there’s value here that’s not recognized by the market.
But how does it compare with its peers in the Global Software – Application industry? Reasonably well, according to GuruFocus, which reports that while the industry median P/E is 24.13, Check Point clocks in (on Oct. 14) at 19.55.
It has a PEG ratio of 1.95, which normally would put it right at the high-end of the fair-valuation range. However, this is a tech company so we wouldn’t expect anything too low; in fact, its PEG once reached an astronomical 51.57.
And according to GuruFocus, the industry median PEG is 1.93, which is, to all intents and purposes, the same as the Check Point number. And within the Global Software – Application industry, Check Point is right in the middle for PEG.
When it comes to putting a value per share on the company, GuruFocus says, “Check Point Software Technologies Ltd is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value, 2) Peter Lynch Fair Value. The Median P/S Value of Check Point Software Technologies Ltd for today is 80.90. The Peter Lynch Fair Value of Check Point Software Technologies Ltd for today is 34.87.” These two valuations obviously bracket the closing price on Oct. 13 of $76.35.
The Discounted Cash Flow Calculator (Fair Value) values the company just slightly below the current price:
I see that the DCF came in at $74.72 even though the discount rate over the next 10 years is set at 14%, which reflects the growth rate over the past 10 years. Had that been set at 8.1%, the rate over the past three years, that DCF price would have come in much lower. However, at the same time, we might argue that a 4% terminal growth rate is too pessimistic.
Comments: A wide range of valuations come in for Check Point, but if we remove the furthest outlier, the Peter Lynch Fair Value of $34.87, we come reasonably close to the current price. That leaves us with the notion Check Point is currently fairly-valued, a position backed up by the P/E and PEG ratios.
Conclusion
Check Point Software Technologies is no doubt a good company with much to commend it.
But, it has become a stock for value investors or for those who seek steady growth. It will not fit the needs of investors looking for dramatic price gains. It’s no longer a shooting star tech stock producing big double digit gains every year.
If you want technology in your portfolio, without undue risk, this is worth putting on your shortlist. While it does not pay a dividend, it has consistently bought back its own shares, pushing up the intrinsic value of the stock.
Disclosure: I do not own shares in any companies listed in this article, nor do I expect to buy any in the foreseeable future.
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