Analysts are Mistakenly Tepid on Checkpoint

| About: Check Point (CHKP)

Oscar Gruss technology analyst Ehud Eisenstein recently met Check Point (Nasdaq: CHKP) founder, chairman and CEO Gil Shwed. As a result of that meeting, Eisenstein retained his “Hold” rating for Check Point with a target price of $20, just 5.5% over its share price at the time of the publication of the rating.

I think that the meeting with Shwed is important mainly because of the fact that the stock has been in the doldrums, for reasons unclear to me. One thing is clear, however, and that is that Check Point is not growing like it used to in the past, and even more worrying, especially for the analysts, is the fact that the company has still not managed to acquire a potential growth engine, at a time when the security market is bustling with mergers and acquisitions. It looks like Check Point is not taking part in this mergers and acquisitions game that analysts are so fond of, and perhaps that is why they are wary of it.

Eisenstein reiterated his “Hold” recommendation for Check Point, even though the stock is trading, so he says, at a multiple that is 31% lower than that of the competitors. If he came away from the meeting with Shwed just as troubled as he was before, this is worrying. It is definitely not a good sign if, after talking to a company chairman, you still believe that after trading at a price of $18.95, at a multiple of 14.2 for 2006, and 13.5 for 2007, the stock won’t rise more than 5.5% in the next 12 months. I have no doubt that Eisenstein came to the meeting hoping to hear about exciting developments that have not been heard from Check Point’s direction for some time, yet he still came away disappointed.

My conclusion, from what I have read, is that Eisenstein did not find the spark he was looking for, but that does not necessarily mean that the revival will not eventually happen. It means that Shwed did not talk bombastically, or brag, or spin a dream. That certainly does not mean that he does not have a dream, but rather that he prefers to keep a low profile for the time being.

I’ll start with Shwed’s attitude to mergers and acquisitions, as reflected in Eisenstein’s comments. Shwed is definitely looking to buy something but he doesn’t have a clear goal at present. However, he is opposed to any possibility of Check Point being acquired by another entity since he believes that a company like Check Point should be totally “free”, and not part of a provider who delivers a package to the customer with security included. Leading on from this, he believes that the fact that all the competitors have been swallowed up will work in his favor, since this means that Check Point will remain on its own and will stand out as the expert in its field.

This approach leads me to conclude that either EMC Corporation (NYSE: EMC), which recently acquired RSA Security (Nasdaq: RSAS), or IBM (NYSE: IBM), which recently acquired Internet Security Systems (Nasdaq: ISSX), also approached Check Point, but Shwed turned both offers down. Shwed’s comments reveal that although the Sourcefire deal is now history, Check Point is still interested in IP or WiMAX security technologies. In other words, Check Point still believes that a company that supplies all the security services on its own will fare better than one that is acquired by a big infrastructures provider.

This approach will, obviously, come as a disappointment to any analyst looking to hear news that will give cause for excitement in the investment banking industry. However, the truth is that in the deluge of recent acquisitions, the most recent of which was IBM’s acquisition of Internet Security, it would be difficult to give a clear opinion as to which option would be better for the shareholders. Have the shareholders of RSA and Internet Security benefited at all by the acquisition of their companies by EMC and IBM? The facts do not indicate that this is the case, yet it is still difficult to say.

Where does Check Point’s weakness lie? According to Shwed, the problem lies in sales volume. The fact that the company has hired a global sales manager and is training 30 sales representatives, says, in effect, that Shwed believes that strengthening the company’s sales operations is the preferred course of action at present. Eisenstein feels that Check Point’s Achilles' heel is South East Asia - China, India, and especially Japan. Sales in this region were fairly stagnant in 2005, compared with those in 2004. Check Point is working to increase its sales in China, India, and Japan, and has dispatched a senior sales manager to the region to oversee the effort.

Eisenstein says that Internet security, VPN products and support services is a highly competitive field, and is apparently undergoing a process of consolidation. “A number of Check Point’s current and potential competitors can adapt themselves much quicker to the changes in the market and industry,” Eisenstein writes. “Check Point is likely to experience a fall in its profit margins, a fall that will be caused by a price war and fierce competition. Check Point faces several other risks, such as the reliance on a limited number of distributors (Nokia for example, S.G.), and the successful launch of new products.” So to sum up, Check Point’s problem, as expressed by Eisenstein, is primarily a lack of growth, although together with this lingers a fear that the company won’t even manage to mark time.

This opinion is worth comparing with that of “Forbes” writer Andrew T. Gillies who wrote a long article on Check Point on September 6, in which he interviewed the company’s deputy chairman Jerry Ungerman. In his article, Gillies quotes Friedman Billings Ramsey equity analyst Daniel Ives, who describes Check Point as a “cash generating machine. Their growth has been the issue.” In other words, Eisenstein has voiced the opinion of most analysts.

Ungerman attempted to explain to Gillies that growth was a temporary problem. The failed attempt to acquire US intrusion detection software company Sourcefire was a process that taught Check Point a great deal about the possibilities for acquiring companies in the US. Gillies said that Ungerman hinted that the experience with the Committee on Foreign Investment in the United States hadn't deterred Check Point from dealmaking in the US, and that his company and Sourcefire remains in contact about deal possibilities. “The timing was unfortunate,” he claimed, adding that the factor that slowed things down was the Congressional tantrum and the Bush administration's embarrassment over the proposed takeover of certain US port operations by Dubai's Dubai Ports World.

Ungerman is quite confident about Check Point’s success, and from his article it would appear Gillies also sees things positively. “In recent months, the company has faced its share of proverbial rockets from Wall Street and Washington alike,” he claims, and that, I feel, is exactly where the problem lies.

I believe that Check Point has simply found itself in a long period - longer than anyone ever imagined - of increasing competition in the market, with mergers and acquisitions the order of the day. From the standpoint of quality, no technological company in this field even comes near Check Point, so we can view its current situation as a temporary period that has lasted too long. The conclusions of Eisenstein and other like-minded analysts (the overwhelming majority in this case) are quite definitely reasonable and acceptable but having said this, the following scenario is also not improbable. Having finally broken down the barriers in the East something that has a chance of happening (at least in the same measure as the chance that it might not happen) Check Point acquires Sourcefire or a similar company, which could happen too, by which time someone may manage to persuade Shwed to be receptive to the idea of a merger. What would happen then?

What I find encouraging at present is the large number of analysts that have changed their ratings from “Buy” to “Sell” and “Hold.” Three months ago, 19 analysts rated the stock “Buy”, 11 rated it “Hold”, and two rated it “Sell.” Today only eight analysts recommend buying Check Point shares, 23 recommend holding it and three recommended selling the stock. The last time that the analysts despaired of Check Point, a year ago, the stock responded by rising more than 25%. I think that the figures speak for themselves, and the stock is therefore cheap. But please consult experts.

Published originally by Globes [online], Israel business news - © Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.