Check Point Software Offers An Interesting Short-Term/Long-Term Tradeoff

I’ve been concerned for some time that Check Point Software (CHKP) just isn’t built to outperform, as I believe the company has pushed its “fast follower” strategy as far as it can go and risks ongoing erosion in the business. While the business still generates impressive levels of free cash flow, it’s tough to beat the market with low-growth software stocks, and Check Point has a decade-plus record of underperforming not only the security software sub-sector, but the S&P 500 overall.

I don’t like Check Point as a long-term holding, but I do feel better about the near-term outlook for the stock. The shares look priced for a double-digit return at today’s level, and strength in products like CloudGuard and Infinity may be able to shift sentiment a little more favorably. In this case, though I would view this as more of a trade, as I still have issues with the company’s competitive position over the longer term.

 

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Check Point Software Offers An Interesting Short-Term/Long-Term Tradeoff

Check Point Going Nowhere Fast

It is an oversimplification to say that software investors care only about growth, but growth is nevertheless a key driver of multiples. Check Point (CHKP) may be working hard behind the scenes, but the reality is that the company continues to lag rivals like Palo Alto (PANW), Fortinet (FTNT), and Cisco (CSCO) when it comes to revenue and billings, and it’s hard to see any meaningful reacceleration on the horizon.

The good news, if you want to call it that, is that I don’t think there are many investors interested in Check Point who expect a lot of growth out of the company. If the different billing cycle for Infinity is in fact obscuring underlying growth and this security as a service platform can catch on with more larger clients, Check Point could outperform. I’m not sold on the strategy though, and I continue to believe that Check Point has been surpassed by some of its rivals. The prospective return is getting more interesting, but isn’t high enough to coax me to take the risk.

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Check Point Going Nowhere Fast

Easier Comps And A Reasonable Valuation For Check Point

Check Point (CHKP) remains an intriguing, yet frustrating, investment option in the security space for me. On one hand, I like the company’s strong cash flow and large installed base. On the other hand, I continue to believe that the company has under-invested in the business and allowed Palo Alto (PANW), Fortinet (FTNT) and others to grow at their expense. With management stepping up its sales and marketing investments and an easier set of comps in the first half of 2019, the time may be ripe for Check Point to post a little momentum and perhaps outperform in a market that could still be pretty dicey in 2019, even though underlying security spending should remain healthy.

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Easier Comps And A Reasonable Valuation For Check Point

Wall Street Seems Skeptical Of Palo Alto's Transition

Past success may buy you a little benefit of the doubt on Wall Street, but only just a little. While it’s hard to quibble with Palo Alto Networks’ (PANW) track record as a disruptor and growth story in the security space, that hasn’t helped the shares so much in recent months. While security spending looks pretty healthy going into 2019 and the death of the firewall (due in part to transitions toward cloud/hybrid-cloud approaches) has been greatly exaggerated, Wall Street does seem uncertain about the company’s pivot toward more cloud-oriented solutions and a new executive leadership team whose career experience in the security space isn’t as deep.

I don’t dismiss those industry experience concerns out of hand, but I think Palo Alto has brought on some talented executives that can help Palo Alto stay nimble and evolve – doing what worked in the past as your end-markets change is a pretty good way to get left behind in technology. Palo Alto looks cheap enough now that I’m a little paranoid and wondering what I may be missing; I get that the market has soured on tech stocks and that 2019 could be a more challenging year than 2018 was, but the shares seem to be discounting a pretty weak scenario today.

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Wall Street Seems Skeptical Of Palo Alto's Transition

Check Point Looks Like An Option To Consider In A Shaky Tech Market

Back when I paid more attention to football, my favorite team had a running back about whom I would say “if you need 3 yards, he’ll get you 3.5 yards; if you need 4 yards, he’ll get you 3.5 yards.” I’m reminded of that whenever I look at Check Point (CHKP), as this leading security software vendor continues to hold a strong position in the enterprise security market despite the inroads made by competitors like Palo Alto (PANW) and Fortinet (FTNT) and steady competition from the likes of Cisco (CSCO), as well as new up-and-comers. Check Point is unlikely to ever be a truly impressive growth story again, but the company’s margins, cash flows, and strong installed base have value – particularly in situations where the market has become much more worried about near-term growth prospects and valuation for software.

Check Point looks a little undervalued to me, and the company could benefit from somewhat easier comps in the coming quarters and improving salesforce execution, as well as ongoing growth in its Infinity Total Protection offering. Check Point isn’t going to be immune to an intense or prolonged sell-off in tech stocks, but I think it can hold up better than most and there’s decent underlying long-term value.

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Check Point Looks Like An Option To Consider In A Shaky Tech Market

CyberArk's Strong Execution Should Outweigh An Imperfect Valuation

As far as I’m concerned, CyberArk (CYBR) is delivering the sort of results that a young company leading a growing (if not emerging) market ought to be delivering. Improved pricing and product positioning, better sales execution, and increasing customer awareness of the importance of privileged access management (or PAM) and secure DevOps (a software development methodology) all seem to be coming together as a strong tailwind for CyberArk going into 2019.

I liked the CyberArk story back in mid-2018, but was less excited about the valuation. The shares are up since then, but not so much that I’m really kicking myself and particularly relative to what I see as stronger underlying improvement in the business. I do worry about the risk of further market de-rating (in other words, lower multiples for stocks in general and tech stocks in particular), but CyberArk does seem undervalued and I’m reluctant to get too fussy about valuation with a strong operating story that still has room to deliver meaningful growth in the coming years.

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CyberArk's Strong Execution Should Outweigh An Imperfect Valuation

Without More Revenue Growth, Check Point's Valuation Is Almost Beside The Point

Normally, investors would be happy with a company that generated more than twice as much operating income growth as revenue growth and actually reduced operating expenses. But then, software isn't a normal sector and Check Point Software Technologies (CHKP) isn't a normal company. In a sector where revenue growth is a major driver, Check Point's focus on expense discipline and organic/internal development hasn't been generating much revenue growth and hasn't helped the share price much next to Fortinet (FTNT), Palo Alto (PANW), or the Nasdaq.

One of my biggest concerns about Check Point is that the company will keep itself lashed to the mast of a ship that's not going anywhere (traditional firewall-type security) instead of taking more aggressive steps toward growth in the evolving enterprise security world. I don't doubt that Check Point has the resources to change its trajectory, but I'm not sure it has the will. With that, although the share price/value proposition is interesting, I'm nervous about buying into a lower-growth software story, given how challenging and frustrating they can be.

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Without More Revenue Growth, Check Point's Valuation Is Almost Beside The Point

After A Strong Run, Check Point Doesn't Look Like A Bargain

I've had a lot of respect for Check Point (NASDAQ:CHKP) for a long time, and the company's less impressive growth rates (and emphasis on margins) compared to Palo Alto (NYSE:PANW) and Fortinet (NASDAQ:FTNT) have created a few buying opportunities over the years. Buying opportunities emerged three times since mid-2015, with the latest run taking the shares up about 50% on renewed evidence that Check Point can still, in fact, generate pretty good revenue growth.

I keep Check Point on my watch list to take advantage of those pullbacks but right now doesn't look like one of those opportunities. I think the company can generate high single-digit long-term FCF growth from here, and I think the opportunities in cloud and mobile are still meaningful, but I want more than the high single-digit return that seems to be figured into today's valuation.

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After A Strong Run, Check Point Doesn't Look Like A Bargain

Proofpoint Growing On The Back Of Human Error

In college, I had a friend whose father was an aeronautical engineer and who liked to say that whatever improvements they could make in terms of avionics and flight control systems, they couldn't do as much about "the squishy pink thing at the front". In other words, human error is always a factor in complex systems, and that applies to network security as well. While firms like Palo Alto (NYSE:PANW) and Check Point (NASDAQ:CHKP) do a lot to secure enterprises from an array of threats, companies are still vulnerable to an employee clicking on a malware attachment or inadvertently (or deliberately) sending out privileged information.

That's where Proofpoint (NASDAQ:PFPT) comes in. This company has developed a suite of cloud-based products to help protect enterprises from email-based threats, targeted attacks, and data loss, as well as assist in archiving and governance. These shares are not cheap, not even on the basis of growth stock norms, but the company is gaining share, expanding its addressable market, and starting to see margin leverage.

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Proofpoint Growing On The Back Of Human Error

Seeking Alpha: Strong Share Growth And Margins Fueling Palo Alto Networks

By most reasonable metrics, Palo Alto Networks (NYSE:PANW) has a gravity-defying valuation. Then again, there's nothing particularly "reasonable" about the market share that Palo Alto is gaining within the growing security space, nor the company's strong positioning across a variety of technologies. If Cisco (NASDAQ:CSCO) and Check Point (NASDAQ:CHKP) can't do a better job of repositioning themselves to the leading edge of threat prevention, they are likely to continue to be involuntary share donors in the security market.

I am not going to argue that Palo Alto is cheap per se. I will say this, though - if Palo Alto can grab 15% share of the enterprise network and endpoint security market in 2019 (and the market continues to grow at a mid to mid-high single-digit rate) and generate 30%+ FCF margins, a $180 fair value is not unreasonable. If the company can reach 20%, the target can move above $200.

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Strong Share Growth And Margins Fueling Palo Alto Networks

Seeking Alpha: Can Fortinet Deliver A One-Two Punch Of Growth With Higher Margins?

It's probably true of all industries to some extent, but the enterprise/network security business seems to be one where there's always some nagging detail for the companies. Check Point (CHKP) has fantastic margins, but hasn't always been quick to innovate and seems willing to cede margin to maintain share. Palo Alto (PANW) has a great sales effort, but sometimes seems to overstate its own capabilities. For Fortinet (FTNT), the challenge is pairing good revenue growth and share gains with strong margins, and judging by management's guidance that challenge will continue on at least another quarter.

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Can Fortinet Deliver A One-Two Punch Of Growth With Higher Margins?

Seeking Alpha: Frustrating F5 Networks Zigs And Zags Again

Value investors and tech stocks are typically an oil and water mix, but I've had enough success with a value approach (or at least a GARP approach) that I always keep an eye on interesting tech names. One of the most interesting, albeit frustrating, names has been F5 (FFIV).

While F5 has a legitimately impressive share of the ADC market and bold plans to expand into nearby markets like security and diameter signaling, sluggish product growth and an uncertain future for the ADC market make this a tricky stock. Though Thursday's post-earnings rally doesn't necessarily take it off the list as a potential buy, investor expectations for product revenue re-acceleration may be upping the risk.

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Frustrating F5 Networks Zigs And Zags Again

Investopedia: Check Point Has To Restore Product Growth To Maintain Service Value

It's probably true that Wall Street predictably and consistently undervalues the service/maintenance revenue streams for tech companies - I thought it was true of Quest, which was recently acquired by Dell (Nasdaq:DELL), and I think it's true of both CA (Nasdaq:CA) and Check Point (Nasdaq:CHKP) today.

The problem for Check Point, though, is that the enterprise security market is changing and it's not clear that Check Point has invested enough R&D dollars to stay competitive. While it will be some time before rivals such as Palo Alto (NYSE:PANW), Fortinet (Nasdaq:FTNT), Sourcefire (Nasdaq:FIRE) or Dell's SonicWall can take their lunch money, better product growth is going to be an essential part of maintaining the value of this business.

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Investopedia: Growth Investors Turn Insecure About Fortinet's Growth

Fortinet (Nasdaq:FTNT) is one of the many growth tech stocks that I've damned with the praise of liking the company and the growth story, but finding the valuation to be too demanding and too vulnerable to disappointment. In the case of Fortinet, it looks like that particular bird came home to roost with third quarter results that weren't really that bad, but not nearly strong enough to keep a hope trade going.

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http://www.investopedia.com/stock-analysis/2012/Growth-Investors-Turn-Insecure-About-Fortinets-Growth-FTNT-CHKP-PANW-CSCO1017.aspx