Check Point Software Technologies (NASDAQ:CHKP) is a leading cybersecurity company which was founded back in 1993. The company's founder and CEO Gil Schwed is credited with inventing the first ever firewall and thus credibility in the industry comes as standard. Check Point also has some of the highest margins in the cybersecurity industry and has recently obliterated its financial expectations for the second quarter beating both revenue and profit estimates. The Cyber Security industry is forecasted to grow at a rapid 13.4% compounded annual growth rate [CAGR] up until 2029 and be worth $376.32 billion by the end of the period. In this post I'm going to break down Check Points business model, financials and valuation, let's dive in.
Check Point offers a diverse portfolio of Cybersecurity products across three growing industries; Network Security, Cloud Security and User Access Security.
Check Point's main product line is called "Quantum". This comprises of a selection of products that provide network security through Firewalls, Secure Web Gateways and Wireless access points. These work by continuously monitoring and inspecting network traffic, in order to filter out or block threats.
Its Web Gateways can be seamlessly connected via a "Unified Management Platform", which allows security admins to manage and gain visibility into their entire network. Quantum also includes a VPN solution that enables network traffic to be encrypted for remote users.
Check Points second product line is its Cloud Security platform called "Code Guard". This helps to "Secure the Cloud" for users across various cloud-based environments such as AWS, Azure and Google Cloud. The fact this solution is cloud-native means it scales with workloads and applications easily, which is a major selling point for customers. The platform also includes "posture management" which assesses the "security posture" of an application and then uses AI to detect changes. Its Cloud Workload Protection solution is also a popular method for securing "containers". These are "contained" software packages that run without the need for complex configuration. This makes them popular with rapid application prototyping and migrations.
Check Point Harmony offers a single connectivity solution for remote users. The platform accomplishes this through the "Zero Trust" methodology. This means users in the network are "not trusted" by default. They are given "least privileged access", which means they are only given access to the applications they need for their role. For example, the HR team is given access to HR applications and the Finance department is only given access to finance applications. This helps to stop attackers from "moving laterally" which is a dangerous tactic hackers use. The platform also offers an alternative to VPN connections which can become slow with multiple users. Zero Trust Security is a major growth industry given the rise of hybrid work. Companies such Zscaler ($20 billion) market cap have built their entire business on this product category, thus this gives you an idea of the potential.
Check Point generated strong financial results for the second quarter of 2022. Total revenue was $571 million, which beat analyst estimates by $10.7 million and increased by 9% year-over-year. This growth was double the rate of the prior year and driven by a strong increase of 12% in product revenue and 14% in subscription revenue. Deferred Revenue also rose to $1.666 million, up from $1.47 million in the prior year.
GAAP Operating Income was $209 million which did decline slightly from the $222 million in the prior year. This was mainly driven by an $18.8 million increase in R&D expenses which isn't necessarily a bad thing, as companies that invest more into R&D tend to produce greater shareholder returns long term. However, the company also saw operating expenses increase by $44.1 million year-over-year.
The good news is Earnings Per Share was $1.64 which beat analyst expectations by $0.03 per share and was only down 1% year-over-year. It also should be noted Check Point has the highest margins in the Cybersecurity Industry, which was the title of my previous post on the stock. From the chart below you can see Check Point (purple line) has a Gross profit margin of over 87% which is incredible. In addition, the company is actually profitable with 39% operating margin, but many other cybersecurity companies have negative margins.
Cash Flow from operating was $212 million, which did decline 19% year-over-year. At first glance, this may seem terrible but when we dive under the hood we see was mainly driven by $47 million in FX expenses, due to a strong dollar and $24 million in extra tax expenses. Therefore I don't deem this to be a major issue long-term and many companies are facing similar FX headwinds. I believe every market moves in cycles and the currency market will eventually correct.
Check Point has a solid balance sheet with cash and marketable securities which equated to $3.7 billion. In addition, the company has just $25 million in total debt which is incredible for such a mature company.
Management showed confidence in the quarter and issued $325 million worth of stock buybacks which was a positive sign.
In order to value Check Point, I've plugged the latest financials into my advanced discounted cash flow model. I have forecasted revenue to grow at an 8% rate next year and 7% per year over the next 2 to 5 years. This is aligned with analyst estimates and also is conservative given the industry tailwinds.
I have also predicted the operating margin to increase to 44% over the next 5 years, as FX headwinds start to reduce and inflation is forecasted to reduce. In addition, this includes an adjustment for R&D expenses which is why the base operating margin looks higher than the previously mentioned figures.
Given these factors, I get a fair value of $122 per share, given the stock trades at a $117 per share at the time of writing it is ~4% undervalued.
As an extra datapoint Check Point is trading at a Price to Earnings Ratio = 16.32 which is 10% cheaper than its 5-year average.
Many analysts are forecasting a recession and thus this may cause a temporary slowdown in IT spending.
The cybersecurity industry is extremely competitive with many players offering similar "best in class" solutions. These include Palo Alto Networks (PANW), Zscaler (ZS), CrowdStrike (CRWD) and many more.
Check Point is a cybersecurity pioneer with some of the highest margins in the industry. The company is immensely profitable and recently started to see growth also. The stock is undervalued relative to historic multiples and thus looks to be a great investment for the long term.
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