Check Point: Infinity Could Justify A Spike From $101-$119 To $245

Summary

  • Check Point Software Technologies Ltd. offers three different options to secure the network, the cloud, and the client’s users.
  • I am assuming that the company’s R81 product, which was released in 2020, should successfully find significant demand.
  • I expect that the system will be successful because it offers not only prevention and security management but also autonomous threat prevention and AI-driven security policy systems.
  • I expect sales growth of 7.5% from 2021 to 2025, an EBITDA margin of 55%, and a UFCF margin close to 45%. Notice that 2025 UFCF may stand close to $1.305 billion.
  • I believe that the new AI-driven security policy systems against zero-day attacks would imply a total valuation that could go from $139 to $245.

3d render, infinity symbol, neon light, loop, ultraviolet spectrum, quantum energy, pink blue violet glowing line, string, abstract background

wacomka/iStock via Getty Images

In my opinion, the 5th generation of cyber threats needs a new generation of AI-driven security policy systems against zero-day attacks. That’s exactly what Check Point Software Technologies Ltd. (NASDAQ:CHKP) engineered with its new Infinity-Vision product. Assuming that the company’s new products are successful, I used three DCF models to project a fair price of $139 to $245. With this in mind, I will be a buyer of shares at the current price mark of $101-$119.

Check Point Software Technologies Is Building Momentum

With more than a 90% increase in Generation 5th attacks, which include multi-vector and zero-day strategies, the demand for cyber security will soon spike. Therefore, in my opinion, in the next 4-6 years, investments in cyber security companies will pay off:

increase in gen V cyber attacks

Source: PowerPoint Presentation

Among different players in the cybersecurity industry, I would highlight Check Point Software Technologies Ltd., which offers three different options to secure the network, the cloud, and the client’s users. The most relevant products are called Quantum, CloudGuard, and Harmony:

future of cyber security

Source: PowerPoint Presentation

That’s not all. I believe that it is the right time to have a look at CHKP’s financial projections. Notice that in the last quarterly report, the company noted that its new product, Infinity, appears to be gaining momentum with triple-digit growth. In my view, we need to assess the future performance before the company commences to deliver sales growth and many people are aware of the new momentum. We want to act before the market makes the move:

CHKP Q2 update

Source: PowerPoint Presentation

Base Case 1

There are several events that I consider very likely. They are included in case 1. First, we will most likely see an expansion of Internet usage, and most organizations all over the world will expand their extranets. Companies will most likely understand the benefits of adopting cloud infrastructures, not only because more users can connect from anywhere, but also because it may be cheaper than proprietary intranets. Under these circumstances, organizations will most likely sign partnerships or hire entities like CHKP, which will make billions by offering data security measures, data encryption, and data loss prevention measures.

CHKP will also be able to connect to the systems of Apple, Google, and Microsoft by accessing APIs or related technologies. Notice that this is very important for CHKP. The company makes tons of money by protecting systems like those of Apple, Google, and Microsoft. If these companies don’t share a certain amount of data with third parties like CHKP, IT protection may get a bit complicated.

Under case 1, I would also expect that regulations from governments for data security and privacy protection won’t damage the company’s ability to protect systems. On the contrary, I hope governments will consult with big technology companies in order to establish a framework that makes CHKP’s role a bit easier. As a result, CHKP may obtain more sales, and its free cash flow margin may increase.

Finally, there is something else. The company has been operating since 1993, so I believe that the management knows well how to deal with competitors, execute acquisitions, and successfully negotiate prices. It means that I will not be expecting a significant decline in the price of CloudGuard, Harmony, or Infinity. Notice that the company disclosed some risks from the cloud and SaaS delivery models, but I don’t expect them in this case scenario:

The increasing prevalence of cloud and SaaS delivery models offered by us and our competitors may unfavorably impact pricing in both our on-premise enterprise software business and our cloud business, as well as overall demand for our on-premise software product and service offerings, which could reduce our revenues and profitability. Source: Annual Report

My numbers are based on my previous assumptions and are comparable with the figures of other analysts. I have not obtained extraordinary results or anything that would surprise the investment community very much.

My assumptions include 5%-6% sales growth, EBITDA margin close to 54.4%, UFCF/Sales close to 43%, and 2025 UFCF between 1193-1201. The table below offers more details:

Author

Source: Case 1 With My Assumptions

In my CAPM model, I used a beta close to 0.8, cost of equity between 5% and 7%, and cost of debt close to 5%. I also had a look at the WACC of other software companies, which stand at 4%-10%. With all this information, I used a WACC of 5.51%, which is not very far from that of other investment analysts:

comparison with other estimates on CHKP

Source: CHKP WACC % | Check Point Software Technologies

In the last 13 years, the company’s EV/FCF ranged from 10x to 19x. With this in mind, I expect that most analysts have used an exit multiple between 10x and 19x terminal free cash flow:CHKP EV to free cash flow

Source: YCharts, and Author

Putting everything together, with an exit multiple of 12x and terminal FCF close to $1.259 billion, I obtained an enterprise value of $16.5 billion. The implied price is equal to $139. The company is currently trading below the $139 mark, so I believe that traders may consider a position in the stock:

Author

Source: Case 1 With My Assumptions

CHKP stock chart

Source: Seeking Alpha

Very Optimistic Case 2

Let’s be optimistic now. In case scenario number 2, I assumed that the company’s innovation through R&D and strategic partnerships would lead to effective protection against the 5th generation of cyber threats. The management would be successful in offering the highest-quality products in the market, and the communication strategy would also be well established. As a result, most clients would want to prevent threats, and protect their systems with CHKP.

Of course, I am very optimistic here, but just think for a second that Quantum, CloudGuard, Harmony, and Infinity-Vision are leaders in their respective market segments. In that case scenario, it would be wonderful for the management and shareholders because the company’s FCF and sales would spike up:

Check Point products

Source: Products

In this case scenario, I would also be assuming that the company’s R81 product, which was released in 2020, would successfully find significant demand. I would also expect that the system will be successful because it offers not only prevention and security management but also autonomous threat prevention and AI-driven security policy systems against zero-day attacks. With these factors in mind, employees protecting their systems will not be unprotected when Windows, Apple, Google, or any other company discloses a zero-day vulnerability. CHKP fixes the system automatically:

R81’s new Infinity threat prevention policy enables security teams to implement, in a single click, security best practices that are automatically and continuously updated.

Source: Annual Report

Note that CHKP has a significant amount of cash on hand and no financial debt. In my opinion, the management will be able to showcase the new capabilities of R81 by paying millions in marketing expenditures: CHKP 10-Q report

Source: 10-Q

Under these special circumstances, I expect sales growth of 7.5% from 2021 to 2025, an EBITDA margin of 55%, and a UFCF margin close to 45%. Take a look at the table below and notice that 2025 UFCF stands close to $1.305 billion:

Author

Source: Case 2 With My Assumptions

My assumptions are pretty ambitious. If they come true, everybody on Wall Street may be willing to acquire shares of CHKP. As a result, I used a WACC of 5%, which is lower than that in the previous case scenario. Note that I am expecting a decrease in volatility, which may explain the reduction in the cost of equity. Bankers may also offer better conditions, which may lead to a reduction in the cost of debt.

In sum, my exit multiple stands at 23x, which is the multiple observed in 2015, one of the best moments to hold CHKP shares. I also used net debt of -1.8 billion and 132 million shares outstanding, which implied a total valuation of $245:

CHKP price & EV to free cash flow

Source: YCharts

Author

Source: Case 2 With My Assumptions

Extremely Conservative Case 3

Let’s think about everything that can go wrong. First, the management may not be as smart as other competitors. Take into account that the IT industry evolves very rapidly. What is working today, may not be working tomorrow. If the company cannot innovate at the same pace that other market participants do, customers may leave the company. As a result, revenue growth may not be as large as expected. Note that in case 3, I used sales growth of only 4.9%, which may be a bit disappointing for investment analysts.

The company may also face some difficulties because the management mostly depends on ten large distributors. If they suddenly decide that the company’s FCF margin is too fat, they may claim a larger part of the company’s revenue. As a result, the company’s FCF/Sales would decline, which may lead to a significant decline in the company’s valuation:

During 2020, 2019, and 2018, we derived approximately 57%, 55%, and 53%, respectively, of our sales from our ten largest distributors. In 2020, 2019, and 2018, our two largest distributors accounted for approximately 39%, 37%, and 36% of our sales, respectively. We expect that a small number of distributors will continue to generate a significant portion of our sales.

Source: Annual Report

As shown in the DCF model shown below, I used an EBITDA margin of 52%, 2025 UFCF of $1.083 billion, and UFCF/Sales close to 40%:

Author

Source: Case 3 With My Assumptions

With a WACC of 6.7% and exit multiple of 9.99x, the sum of the enterprise value stands at $12 billion, and the implied price is equal to $108. In light of this result, I believe that the upside potential is larger than the downside risk.

Author

Source: Case 3 With My Assumptions

My Takeaway

I am optimistic about CHKP’s innovation to protect against the 5th generation of cyber threats. Besides, I believe that the new AI-driven security policy systems against zero-day attacks would imply a total valuation that could go from $139 to $245. If many things go wrong, I outlined a pessimistic case scenario with a target price of $108. With the current price mark at $101-$119, I will definitely be a stock buyer.

This article was written by

I am an financial advisor living in Europe. I conduct due diligence for clients across multiple sectors. I hold more than 15 years of expertise.I only write about my opinion. Investing in securities involves risk of loss that readers should be prepared to bear. No investment process is free of risk; no strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
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Disclosure: I/we have a beneficial long position in the shares of CHKP either through stock ownership, options, or other derivatives. 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.

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