If you are a subscriber to the social network site LinkedIn (LNKD), you may have received an email recently telling you about a security breach. The online dating service eHarmony said Wednesday that some of their users' passwords were stolen and millions appear to have been leaked onto the Internet. If you are from a rogue nation-state secretly developing weapons, you may be familiar with the computer viruses known as Stuxnet and Flame. In case you have not noticed, protecting our enterprise systems and even our home computers from viruses, worms, malware, etc. is big business and an absolute necessity. Additionally, the viability of the nascent "cloud" depends entirely upon securing our data.
Organized crime rings and other groups continue to launch cyber-attacks, so enterprises large and small need to have up-to-date data and system protection. With new types of threats, spending on network security remains a priority even in the face of tight technology budgets.
Symantec (SYMC) is the 800 pound gorilla in the network security subsector with $6,730 million in revenue. The other big player is Check Point Software Technologies (CHKP) with $1,278.8 million in revenues. Other, smaller players include Fortinet (FTNT), Imperva (IMPV), Proofpoint (PFPT), Sourcefire (FIRE), Vasco Data Security (VDSI) and Wave Systems (WAVX).
These companies provide software, appliances and services to protect data networks and websites from malicious attacks and security breaches. As the industry shifts from desktop computing to the "cloud", Check Point is capitalizing on the trend with security platforms for data centers and networks.
The market research firm Gartner estimates that the worldwide market for security software is growing about 14% per year. The growth reflects the increase in cyber-attacks reported each week in the papers and probably many more never reported at all. Gartner sees continued growth for this subsector.
In a recent article published by Bloomberg entitled, "Israel Army's Cyber-Knowhow Aids Firms Hiring Hackers," the authors describe how Check Point is hiring the "best and the brightest" coming out the Israel defense Force's cyber-defense and intelligence units. The article recounts a McAfee study that states that Israel in one of three countries best prepared to withstand a cyber-attack.
Check Point develops markets and supports a range of software, as well as combined hardware and software products and services for information technology (IT) security. The Company offers its customers a portfolio of network and gateway security solutions, data and endpoint security solutions and management solutions. Its solutions operate under unified security architecture. During the year ended December 31, 2011, Check Point introduced software blades, such as Application Control, URL Filtering, and an antibot software blade. The Company derives its revenues mainly from products, licenses, combined hardware and software products, software updates and maintenance and subscriptions. On April 17, 2012, it introduced ThreatCloud and GAiA unified secure operating system. On November 24, 2011, the Company acquired Dynasec Ltd.
For the quarter ending 3/12, EPS grew to $0.68 or 19.3% from the year-ago EPS of $0.57. EPS growth for the trailing twelve months was 14.2% as EPS went from $2.23 in 2011 to $2.66 in 2012. In 1Q12, sales were 11.3% higher, $313.1 million versus $281.3 million in 1Q11. Sales growth for the trailing twelve months was 12.8% with sales growing to $1,278.8 million from $1,134.1 million. In FY11, sales were $1,247.0 million and EPS diluted was $2.65. About 40% of the company's sales originate in North America and the remainder primarily from Europe and Asia.
Check Point consistently reports very high gross margins. The most recently reported gross margin is 86.4% as compared to the industry median of 59.6%. The five year average gross margin is 86.8%. Operating margins for the past twelve months is 52.7% whereas the industry median is -0.37%. Check Point has a five year average operating margin of 45.2%.
The balance sheet is very strong. The company holds no long term debt and carries $1,398.2 million in cash and short term investments on its books. The company neither pays a dividend nor does it buy back many shares.
The case for Check Point is that it is a very successful company on the leading edge of a growing segment of the network security industry. The company is very profitable, has superior profitability metrics and is growing. It also has access to some of the best minds in network security which enables it to stay ahead of the criminals and hackers.
The negative argument for Check Point is valuation. Looking at the usual relative valuation metrics, Check Point is overvalued. On a PE basis, the company is selling at a premium to the markets trailing PE and its forward PE. Is the premium warranted? The PEG based on estimated FY12 EPS and the estimated growth rate for the next five years is 1.4X. This is not especially high but it is not low either.
The trailing PE of 19.6X is above the company's five year average PE of 17.5; the PS ratio, at 8.37X is above the five year average of 6.96X; and, PB is 3.35X as compared to the average of 2.79X. The enterprise value ratios shown above are significantly above the industry medians.
Check Point's 52 week trading range is $47.79 to $65.00 and the Wall Street journal reports analyst target prices in the $57 to $78 range with a median TP of $67.00. Reuters has FY12 sales estimates ranging from a low of $1,369.65 million to a high of $1,393.76 million with an average of $1,379.07 million. Revenues for FY13 are estimated to range from $1,458.35 million to $1,542.30 million and average $1,511.15 million. Earnings estimates for FY12 range from $3.14 to $3.28 and for FY13, $3.29 to 3.67.
We think that fair market value is $32.44 or 10.3X our estimate of FY12 free cash flow. We would not be a buyer of Check Point today but will watch this company closely. It is well run, profitable and has the capability to grow in the coming years.