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Steven Chen
Steven Chen
Articles (24)  | Author's Website |

Urbem's 'Wonderful Business' Series: Check Point Software Technologies

Company has able management, decent capital allocation, high switching costs, industry tailwind and intense competition

December 01, 2019 | About:

Israel-based Check Point Software Technologies Ltd. (NASDAQ:CHKP) is one of the global leaders in making the internet secure, reliable and available for corporations and consumers. The company provides technology solutions for protecting corporate enterprises and governments from cyberattacks. Building on its heritage of pioneering the first firewall and with a long track record of industry-leading cybersecurity solutions, the company’s products provide corporate enterprises and governments worldwide with protection against a wide range of cybersecurity threats. As of fiscal 2018, 47% of its revenue was generated in the Americas (mainly the U.S.), 37% from Europe and the remaining 16% from the Asia Pacific, Middle East and Africa.

Check Point was founded by Israeli software engineer Gil Shwed, who is considered the inventor of the modern firewall. He is also the current CEO of the company, owning around 17% of the total shares. Co-founder and current Chairman Marius Nacht owns roughly 4%. Such sizable insider ownership indicates an aligned management interest. According to the company’s annual report, Shwed requested to forego his salary and bonus for the past several years.

Check Point has made a committed effort to build the business methodically by focusing on a subscription-based model, recurring cash streams and managing overhead. As of the first nine months of 2019, security subscriptions accounted for over 30% of the revenue and grew at almost 13% year over year. Recurring revenue, including subscriptions and maintenance, represent more than 75% of total sales, up from roughly 67% in 2016. As shown below, the margins have been stable and robust.

As the business has grown, Check Point has been consistently delivering more free cash flow and net profit every year since its initial public offering (see below), implying conservative accounting and cash-richness of the subscription model.

No single company has been able to dominate the global cybersecurity market so far. According to International Data Corp., just under half of the worldwide market for cybersecurity was occupied by a collection of small companies. The market is expected to grow at a low-to-mid-teens compounded annual rate in the near term, which inevitably attracts more competition. Some players in the space, such as Palo Alto Networks (NYSE:PANW), chose to pursue an aggressive “loss-leading” strategy by spending heavily on sales and marketing to increase market share. According to IDC, Palo Alto more than doubled its market share from 7% in the second quarter of 2014 to 14.4% in second-quarter 2018.

Other competitors include Cisco Systems (NASDAQ:CSCO), Juniper Networks (NYSE:JNPR), Fortinet (NASDAQ:FTNT) and CyberArk Software (NASDAQ:CYBR), all of which conduct a more balanced growth strategy. In recent years, Cisco, the current market leader, has hovered around 15% of the global market share, although it has declined from 16.5% in the second quarter of 2013 to 15.5% in the second quarter of 2018.

Meanwhile, Check Point has been consistently occupying a tenth of the market, though down from 12.6% in second-quarter 2013 to 10.7% in the comparabel quarter of 2018. In addition to Palo Alto, Fortinet is another market share achiever, up from 6.3% in second-quarter 2013 to 10.7% in second-quarter 2018.

From a return perspective, Check Point is the clear outperformer with consistent returns on invested capital compared to Fortinet, Juniper, and CyberArk (see below).

To fend off competitors, Check Point has developed considerable switching costs that inhibit customers from changing cybersecurity solution providers. Its superior technology and comprehensive services would make businesses and governments hesitate to spend time and capital on migration and integration as well as risk its mission-critical IT system and data by switching over to a new vendor (even at a lower subscription fee).

The company is often accused of not being aggressive enough on sales and marketing to drive growth. For example, Check Point typically spends 25% to 30% of its sales on selling, general and administrative costs, compared with approximately 50% at Fortinet and almost 60% at Palo Alto. Nonetheless, at Urbem, we favor the return over the growth (in case that both cannot be achieved at the same time). The management at Check Point demonstrates decent capital allocation skills, which is what we require.

Moreover, remember that Check Point has been transforming its legacy “one-off” product license sales toward a subscription-focused business. While its top line is increasing at a low-to-mid-single-digit CAGR, its deferred revenue, which is an excellent leading indicator for future growth, has been growing at a high single-digit or even double-digit rates for several quarters now.

Disclosure: The mention of any stock in this article does not constitute an investment recommendation; investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Check Point Software Technologies.

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About the author:

Steven Chen
Steven CHEN is a quality-focused investor (with bottom-up opportunistic approaches), an ex-hedge fund analyst on Wall Street, a serial entrepreneur, computer scientist, and free-market capitalist. He contributes to well-known financial media sites, such as GuruFocus, SeekingAlpha. Steven is the Managing Partner of Urbem Partnership, a value/quality-focused investment partnership fund (www.urbem.capital), and Urbem Capital, the research boutique that focuses on the highest-quality 0.1% of all public companies worldwide.

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