IGH's  Instablog

Check Point Software was established in Tel Aviv 1993. Their founder and CEO Gil Schwed pioneered the internet firewall industry with a proprietary technology that arrived just as corporations worldwide were moving their networks from closed systems to open internet based architecture. The need for Firewall security software in-turn exploded. Between 1996 when the company went public and 2001, Check Point’s annual sales increased from just $32mln to over $500mln. Thereafter though a post-bubble overhang set in with sales stagnating over the following six years. What has impressed us about the company is the patience that management and the board showed over this relatively fallow period.

While most companies can hardly stand the pain of a year of below-trend growth let alone five or six, management resisted all number of calls from bankers and investors to make a transformational acquisition to restart growth. With plenty of cash in the bank and all manner of activity going on around them, the temptation must have been great. These types of deals though are fraught with risk, and in most cases end up undermining the raison d’être of the acquiring company.

Towards the end of 2008 however an opportunity did come along which was imminently sensible. Many years prior Check Point had struck a relationship with Nokia to sell their software architecture preloaded on what was known as a security appliance. Nokia had great success with this proposition at a time when they had ambitions beyond mobile phones. Under a new CEO and with ever increasing competition in the phone market Nokia ultimately decided to exit the security business. With 25,000 customers all using a Check Point Software solution, there was only one logical buyer. Check Point was able to acquire the business at a bargain basement price, giving them direct access to a customer base which might have taken a decade to build on their own. The fruits of this deal are already playing out as the company begin to upgrade and offer some of their newly launched products and engage directly with these new customers. In 2009, a tough year by any measure, Check Point grew sales and pre-tax income by 15% and generated about 10% of its market cap in free cashflow. This resumption of growth after a period of stagnation will drive significant shareholder value over the coming years. Netting off the cash on their books, we acquired Check Point shares at just 9.5x 2011 earnings, and believe the business to be worth a good 60% more than our purchase price. Management seem to agree having bought back 17% of the free float since 2005, very sensibly acquiring shares in a business they know and understand and avoiding all those annoying investment banking fees... how very shrewd!

Rocky Mountain Enterprises is the largest dealership of Case New Holland construction and farm equipment in Alberta and Saskatchewan, Canadian provinces rich in energy and agricultural resources. Rocky also provide the lucrative aftermarket service and spares for this equipment. Its business is split equally between agriculture and construction where they compete with brands such as Caterpillar and Deere. 

 

The twin effects of plummeting energy prices and the credit crises of 2008 hit Rocky’s industry hard. The construction business today is running at about 50% of its peak levels. Rather than sit back though and wait for end markets to recover, management see this as a great opportunity to invest in the industry through consolidation. The local industry is fragmented with lots of family owned businesses operating below scale. Furthermore, the downturn has left many as willing sellers or looking for the opportunity to be part of a larger organisation. Consolidation amongst Rocky’s customers is also placing greater emphasis on the benefits of scale to meet their needs. 

 

Rocky’s CEO Matt Campbell has a successful track record of consolidation. Rocky Mountain in fact grew out of a business which he formed in 1993 when he purchased a series of stores from Case Construction. In 2007 this business was merged with another dealership called Hi-Way Service, with 4 subsequent acquisitions since forming the current business. Paying less than 3x trailing EBITDA, these acquisitions have generated a payback after only 18 months as back office and management functions are integrated and greater emphasis placed on the lucrative spares and servicing elements of the business. We liken this strategy to building a bridge to the next upturn and will place the company in a terrific position to prosper as a much larger organisation. 

 

Being aligned with a CEO who is also the largest shareholder is important. He has a strong vested interest in getting it right, but doing so in a way that doesn’t risk the business…. a refreshing departure from someone loaded with options and various other “heads-I-win, tails-you-lose”, incentives. On our estimates we have been able to purchase the shares at less than 5x 2011 earnings and only 30% of 2011 sales, set against projected EPS growth in excess of 50% for each of the next 2 years. On various measures of value we believe the shares to be worth a multiple of our purchase price.