2023-11-01 16:57:35 ET
Summary
- Check Point's growth rate stabilized in the third quarter, and management commentary suggests conditions are improving.
- Check Point continues to introduce new products and engage in M&A to help modernize its product portfolio and support growth.
- Check Point's modest valuation must be weighed against fairly soft revenue growth and margin compression as the company's business evolves.
Check Point Software's ( CHKP ) third quarter results were fairly unimpressive, but it was notable that Check Point's growth rate appears to have stabilized, and the company was far more upbeat about its prospects going forward. Only time will tell if Check Point's optimism is reflective of improving conditions across the cybersecurity market or is specific to the company.
Check Point's PE ratio has been in a tight range over the past decade and is currently near the lower end of that range. As a result, this could be considered an attractive entry point, but investors should consider the interest rate environment and Check Point's low growth rate and declining profitability.
Market
Check Point sounded far more constructive about the demand environment on the third quarter earnings call , providing reason for optimism going forward. Demand deteriorated significantly in late 2022, and this carried over into the first half of 2023, but Check Point seems to believe that the market may have bottomed. This belief is based on a number of positive indicators, like annualized bookings growth, solid RPO growth and strong renewals.
In particular the firewall market may have bottomed, with the third quarter showing improvement. This could be a positive indicator for companies like Fortinet ( FTNT ) and Palo Alto Networks ( PANW ), although this needs to be weighed against Juniper's ( JNPR ) results, which were not as positive. Check Point's exposure also skews towards enterprises and Europe, which could help explain relative strength.
This does not mean that the macro environment is no longer an issue though, or that demand is suddenly strong. The high interest rate environment is discouraging customers from paying upfront for multi-year deals, resulting in shorter billing duration, and is contributing to customers delaying refresh deals.
Check Point
Check Point continues to introduce products and engage in M&A to modernize and expand its product portfolio. A number of new products were recently launched, including Horizon Playblocks. Horizon is a prevention-first security operations security suite, which includes a MDR SOC service and an XDR SOC platform. Playblocks is a collaborative security platform that automates security, helping to save time and resources. It aims to prevent attacks from spreading by eliminating siloes. The detection of any potential threat triggers preventative actions throughout a unified security infrastructure.
Check Point also launched Infinity Global Services at the start of the year, which provides customers with a range of services that help to alleviate problems caused by a shortage of cybersecurity talent. Infinity Global Services currently employs around 350 security consultants and provides over 30 different services to 2,400 global enterprises .
Check Point recently added to its Infinity Global Services capabilities across networks, cloud and security operations:
- Network security - Network Operations Center and Security Operations Center as a service
- Managed cloud security - Cloud security experts to facilitate cloud migration, enhance cloud security posture and provide managed CSPM and CNAPP services
- MDR - Extends Horizon MDR with Microsoft Sentinel platform capabilities for security analytics, incident detection and response
Check Point also continues to be an active acquirer, purchasing three companies in recent months, which brings the company’s total to 20. The biggest of these was the $ 490 million acquisition of Perimeter 81, which forms the basis of its SASE solution. Perimeter 81 launched in 2018 and now serves over 3,000 customers with its 200-person team.
Their solution offers:
- Secure internet access for remote users and branch offices
- Cloud delivery with on-device protection
- Zero-trust with full mesh connectivity among users, branches and applications
- Fast deployment
Perimeter 81 has been recognized as a leader in the Forrester Zero Trust Wave.
Check Point believes that SASE is complimentary to its current product portfolio, making success in this market strategically important. It is therefore not surprising that the company made a relatively large acquisition to build a footprint in this market.
SASE is an attractive market, but there are a number of large companies in the space with compelling solutions. Fortinet is potentially better positioned as ZTNA is built into its hardware, and the use of ASICSs with hardware accelerators enables SSL decryption at scale. Zscaler ( ZS ) believes that a hardware focused approach to network security cannot protect enterprises in modern environments. Palo Alto Networks is also a formidable competitor due to its distribution footprint and comprehensive product portfolio. From a technical perspective, Cloudflare ( NET ) and Netskope also both have strong solutions. Even if Check Point has limited success in SASE and primarily sells into its existing firewall customer base, SASE could still help to drive growth. Palo Alto has stated that SASE deals are generally worth 2.5-3 times more than an equivalent firewall deal.
Check Point also recently acquired Atmosec to expand its technology portfolio. Atmosec is a SaaS security vendor that provides technology to secure applications that are being run from the cloud. Customers are able to discover and disconnect malicious applications, prevent communication with risky third-party applications and fix SaaS misconfigurations. Atmosec was founded in January 2021 and employs 17 people .
Financial Analysis
Check Point’s revenue increased by 3.2% YoY in the third quarter to $ 596 million . Fourth quarter revenue is expected to be in the $636-686 million range, which would be a 3.5% YoY increase at the midpoint. Based on Check Point commentary, recent acquisitions are probably providing something like a 1.5% revenue growth tailwind. Given this, and management’s commentary regarding an improvement in the macro environment, it seems likely that fourth quarter guidance is conservative and that results should be expected to come in towards the higher end of the guided range.
Figure 1: Check Point Revenue Growth (source: Created by author using data from Check Point)
The performance of Check Point’s business continues to vary significantly across segments, with subscription revenue growth offset by product and license weakness. Subscription revenue was up 15% YoY in the third quarter, driven by Harmony products and Harmony E-mail Security in particular. Infinity was another area of strength, recording strong double-digit growth YoY. Infinity revenue now exceeds 10% of total revenue. Delays in refresh projects contributed to a 14% YoY decline in product revenue. Check Point has stated that its fourth quarter pipeline is stronger though.
Figure 2: Check Point Revenue Growth by Segment (source: Created by author using data from Check Point)
Check Point’s gross profit margins are still in the process of recovering from pandemic related supply chain issues. Given the ongoing shift towards subscription revenue, gross profit margins may face headwinds longer-term, particularly if Check Point finds success in SASE.
Figure 3: Check Point Gross Profit Margin - TTM (source: Created by author using data from Check Point)
The burden of operating expenses also continues to rise as Check Point’s business evolves towards subscription revenue. Operating expenses were up 9% YoY in the third quarter due to headcount, cloud infrastructure, marketing and travel costs. The increase is largely related to sales and marketing, which is reflective of the difficult demand environment and the growing importance of the subscription business. Check Point is also now selling much more aggressively, with customer engagement rates almost doubling in the past year.
Figure 4: Check Point Operating Expenses (source: Created by author using data from Check Point)
Conclusion
Check Point still has a $3 billion cash balance and continues to generate solid free cash flows. This cash flow is largely being directed toward acquisitions and share repurchases. Check Point purchased 2.5 million shares for $325 million in the third quarter, helping to provide support to the stock.
Check Point appears to be broadly priced in line with the market given its modest growth. A potential reacceleration of growth in coming quarters could provide some upside though, particularly given that the company's PE ratio has drifted towards the lower end of its recent historical range. Longer term, investors should bear in mind that revenue growth is likely to be largely offset by margin compression as Check Point's revenue mix evolves.
Figure 5: Check Point Relative Valuation (source: Created by author using data from Seeking Alpha)
For further details see:
Check Point Software: Growth Up, Margins Down