Check Point Software: Weak Billings Growth Keeping Investors From Being Bullish

|
About: Check Point Software Technologies Ltd. (CHKP)
by: Individual Investing Ideas
Summary

Billings growth continues to decelerate which continues to result in minimal revenue growth.

Management reiterated their 2019 guidance, which now seems a little more challenging to beat.

However, valuation remains on the lower-end of legacy software security providers.

Check Point Software (CHKP) reported a somewhat uninspiring, with almost all metrics in line with consensus expectations, though billings growth continues to decelerate. The stock remains in line with comparable valuations, though has lower growth rates, declining margins, and minimal upside to guidance. While the stock is only down ~5% since reporting earnings, the minimal billings growth combined with management reiterating guidance (which now seems somewhat difficult to surpass) should make investors somewhat cautious about owning the name.

CHKP is one of the legacy IT security players still competing in the market and despite rebounding very strong from their December 2018 lows, which was up nearly 35% at one point, the stock has trended downwards and is ~15% from recent highs. With the company reporting another in line quarter with billings growth decelerating again, it is challenging to see this name have much upside from these levels.

Chart Data by YCharts

Valuation remains near the middle of their comp group and there could be some downside risk over the coming quarters. With revenue growth of 4% and billings growth of only 1%, it is challenging to believe the company will start to re-accelerate at a meaningful pace. Guidance for Q3 was pretty much what consensus expected and with full year guidance being reiterated, this implies growth accelerate to ~6% during the latter part of the year.

While I still remain somewhat positive on this name over the longer term, the recent Q2 performance was not inspiring or created many catalysts for the stock to rip higher over the coming months. With other security competitors growing at faster rates, accelerating billings growth, and expanding margins, I believe there are other areas in this market to properly invest your money.

Competitive Landscape

CHKP is an IT security solutions provider focusing on areas such as network security, endpoint security, mobile security, data security, and security management. They are considered one of the legacy players in the security market and has faced intense competition over the past few years. While CHKP provides efficient and effective IT security tools, it should not be valued on a revenue multiple, and investors should focus more on its earnings multiple.

The main areas CHKP competes in have seen increased competition from companies that solely focus on a specific area of IT security. Network security has become very saturated by four main players: Palo Alto Networks (PANW), Cisco (CSCO), Fortinet (FTNT) and CHKP. Competitors are growing at a much quicker rate, thus taking market share from the company. This area of the IT security market continues to grow mid-single digits each year and is one of CHKP's main focus areas.

Data security will always remain a competitive industry. We keep seeing data breaches occur on what seems like a daily basis. Enterprises are becoming more protective about their data, and recent regulation in Europe, known as the General Data Protection Regulation (GDPR), brings hefty fines for enterprises that are found in violation of user data protection.

Q2 Earnings and Guidance

During the quarter, revenue grew 4% to $488 million and was in line with consensus expectations and similar to the growth seen in Q1. With revenue growth remaining this low for the past few quarters, it is very likely CHKP is losing share to some of their faster growing competitors. Product revenue decline ~3% during the quarter, marking the 8th consecutive quarter of decline. Management noted growth in the US showed healthy product growth, though this was likely offset by bigger declines in other geographies.

Source: Company Presentation

The bright spot in the company's potential revenue growth story remains within the subscription revenue, which grew 13% during the quarter. Security subscriptions are a much more valuable revenue stream given the fact they are more recurring in nature and have higher visibility. While security subscription revenue represents ~55% of revenue during the quarter, the rather impressive growth over the next few quarters could help push overall revenue growth above 5%, which could improve sentiment around longer-term potential.

Operating margin, while among the highest compared to competitors, contracted ~330bps compared to the year ago period. The 49.5% margin is strong, but with the company needing to reinvest more in S&M in order to improve their growth trajectory, we could continue to see pressure on the margin.

Source: Company Presentation

The lower than expected margins combined with revenue that was in line with consensus expectations led to EPS of $1.38 for the quarter. While this was $0.01 better than consensus expectations, this was largely due to CTHS repurchasing 2.8 million shares for $325 million during the quarter. With the stock remaining under pressure, now would be a good time for the company to repurchase shares (assuming they are believes in their own long-term story). The lower share count will ultimately continue to help the company's EPS, despite margins remaining under pressure.

During the conference call, management provided guidance to Q3 and reiterated their 2019 guidance. For Q3, management expects revenue of $480-500 million and EPS of $1.36-1.44. Despite the relatively wide range for EPS given the low earnings base, both of these guidance metrics were similar to what consensus was expecting.

Management also reiterated their 2019 guidance which includes revenue of $1.94-2.04 billion and EPS of $5.85-6.25. With revenue during the first two quarters of ~$960 million and growing ~4%, this implies a rather steep acceleration during Q3/Q4 in order to achieve the full year guidance range. I believe management was confident in reiterating guidance because some of the steps they have taken to improve their sales force to accelerate revenue growth. However, considering the much faster growth rates at competitors, I believe we are more likely to see the company either miss their full year guidance or reduce next quarter, rather than coming in much above the midpoint.

Valuation

Even with the recent weakness in the stock, down ~15% from recent highs, I believe upside to the name is somewhat limited given the low revenue growth and contracting margins. As the company continues to lose market share to the faster growing competitors, it will become even more challenging to accelerate revenue growth. While the company has done a good job repurchasing shares to reduce share count (helping EPS), this is only a temporary fix to a longer-term problem.

With revenue growth needing to accelerate during the second half of the year in order to come in ahead of the midpoint of 2019 guidance, we could see some increased pressure on the stock price throughout the quarter, especially right before Q3 earnings. Valuation remains a bit out of place, with P/E near the middle of the comp group despite CHKP having lower revenue and billings growth. I believe part of this is due to CHKP's leading operating margins, though these have been under pressure as of recently.

Chart Data by YCharts
Chart Data by YCharts

CHKP's P/E remains below the faster growth names of the group, such as PANW and FTNT, and rightfully so. Although CHKP's security subscription revenue grew 13% during Q2, it remains well below the 20%+ growth rates of PANW and FTNT. CHKP's valuation is similar to that of the other legacy players, such as CSCO and JNPR and this make sense. All three of these companies grow revenue below 10% and have experienced increased competition over the past few years.

For now, I remain on the sidelines given the difficultly in presenting much upside to current guidance in addition to billings growth decelerating to only 1% during Q2. I think if CHKP reports a weak Q3, we could see the multiple contract below CSCO and JNPR which would put a lot of pressure on the stock. Over the long-term, I believe CHKP's security subscription revenue growth could remain healthy and is it continues to represent more of the overall revenue, we could see revenue growth accelerate over the years.

Some risks to this thesis include CHKP's ability to maintain customers because of its legacy operations. Competition in the security market continues to increase, and the transition to cloud-based security subscriptions could prove to be challenging to CHKP's revenue growth.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.