A Profit Powerhouse in Security Software
By Jonathan Rudy
The S&P Focus Stock of the Week is Check Point Software (CHKP ), which carries S&P's highest ranking of 5 STARS (buy). Check Point, with dual headquarters in California and Israel, is the worldwide leading provider of network security products, including virtual private networks (VPNs) and firewalls. With the shares down approximately 30% in 2001, we believe investors have an opportunity to purchase Check Point at a compelling price.
With the rapid build-out of the Internet and following explosion of e-commerce, there is a tremendous need for absolute security in order to conduct transactions over the Internet. As a result, business at Check Point remains strong as corporations have Internet security as the top information technology spending priority.
The company offers solutions that enable secure, reliable and manageable business-to-business communications over virtually any Internet Protocol (IP) network. Check Point's products also include traffic control/quality of service and IP address management.
The company's Enterprise Security Management product line includes its Firewall-1 family, its VPN-1 family of virtual private networking solutions and some associated products. Firewall-1 integrates access control, authentication, network address translation, content security, auditing and enterprise policy management. VPN-1 helps protect the privacy and integrity of network communications by establishing a confidential communications channel for virtual private networking.
Check Point's primary competitive advantages have been its best of breed technology and its ability to stay one step ahead of the competition by reinventing itself. For example, Check Point moved successfully into the VPN market while business was still booming for its Firewall products. The company believes that its next major opportunities are with its Secure Virtual Network architecture (SVN), that provides a single security framework for enterprises. This enables a company to connect and secure all elements of its enterprise network: networks, systems, and users.
Check Point also sees a major opportunity for its consumer retail technology, called Sofaware. As broadband connections continue to grow, these 'always on' internet access connections create a need for 24/7 security products.
Worldwide e-commerce is expected to soar to $2.6 trillion by 2004, from approximately $272 billion in 2000, according to estimates by International Data Corp. In order for this growth to occur, however, Internet security software must play a leading role. IDC estimates that the worldwide market for Internet security software totaled $4 billion in 1999. This market should reach $11 billion in 2004 according to IDC.
We believe that the VPN market has the potential to be the fastest growing segment of the Internet security market, with an expected five-year annual growth rate ranging from 40-50%. The firewall software market is also expected to grow in the mid-20% range over the next five years. In 2000, Check Point held 41% of the world firewall software market, up 10% over 1999. CHKP holds 52% of the VPN market.
Since going public in 1996, Check Point has been able to produce consistently strong financial results. The company has easily achieved 50% top line and bottom line growth since 1996. In its most recent quarter, ended March 31, 2001, Check Point posted revenue growth of 86%, and net income growth of approximately 140%. International revenues comprise approximately 47% of its business.
The most impressive aspect of this profit machine are its margins. The company's operating margin was an extremely impressive 61% for its most recent quarter. With a much lower Israeli tax rate, Check Point's net margin is equally impressive, widening to 58% in the quarter.
Check Point had over $760 million in cash and investments at March 31, 2001. This equates to approximately $3.00 per share. The company also has no debt, and consistently posts returns on equity in excess of 40%.
Standard & Poor's anticipates that Check Point will be able to sustain these strong margins and post revenue and earnings growth of 50% over the next two years. S&P's EPS estimate for 2001 is $1.33 and for 2002 is $1.98. At 46 times S&P's 2001 EPS estimate, Check Point is attractively valued considering its outstanding profitability and 50% near-term growth rate. With its results during the recent economic slowdown, Check Point has proven itself very worthy of a premium growth multiple to the market. S&P's 12-month price target is $99, which represents a price-to-earnings (p-e) multiple of 50 on the 2002 EPS estimate, and a p-e to growth rate of 1. This represents a 12-month return of approximately 60% from its recent price of $63.
Rudy follows computer software and services stocks for Standard & Poor's